DCF Valuation Overview
Discounted Cash Flow (DCF) is the most reliable and widely used technique of valuation.
This is fundamental technique of valuation which is based on the principle that the value of an asset will depend on the expected cash flows which the asset will generate in future.
Similarly the value of company will depend on all those cash flows which the company will generate in the foreseeable future. DCF valuation gives the intrinsic value (Fundamental Value) of the company which is equal to present value of those cash flows.
Assuming other factors constant, higher cash flows will give higher intrinsic value and lower cash flows will lower intrinsic value.
Following are the various DCF Valuation models.
- Free Cash Flows Models (FCFF and FCFE)
- Economics Value added Model
- Residual Income Models
- Dividend Discount Models
Most of the time, companies are valued with Free Cash Flow models.
There are two Free Cash Flow models: FCFF and FCFE.
Out of two Free Cash flow models, FCFF is more widely used. You can next article to know more about FCFF and FCFE models.
Steps in Discounted Cash Flow Analysis (DCF Valuation):
The entire DCF valuation process can be divided into main 5 steps:
- Forecast Cash Flows (FCFF or FCFE)
- Calculate Discount rate (Cost of Capital or Cost of Equity)
- Forecast Terminal Value (With Multiple method or Perpetual Method)
- Calculate PV of FCF and Terminal Value
- Derive the share price (Fundamental, Intrinsic Value)
Let’s understand each step of DCF valuation one by one from next article:
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