The three most important valuation techniques - DCF

9 important questions on The three most important valuation techniques - DCF

What is the most thorough valution method?

DCF

What does Rf stand for in cost of equity?

Risk-free rate of return (e.g. Long-term average German 10-year Bund), typically assumed to be 3-4%.

What does Rm stand for in cost of equity?

Equity market risk premium (average long-term equity market outperformance vs. Risk-free investments), typically assumed to be 4.5-6.5%.
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What is the formula of debt ratio (DA) in WACC?

Net debt / total assets

How is FCF calculated from EBIT (operating income)?

EBIT (operating income)
+ D&A
= EBITDA
- increase in working capital
- capex
- cash taxes
= FCF

What is the formula of working capital?

trade receivables minus trade payables (and possibly inventory)

What are three advantages of DCF valuation?

  1. Very thorough and capable to accurately value cycles.
  2. True cash-flow based valuation; no approximation.
  3. Capable to value businesses that are temporarily unprofitable.

What are two disadvantages of DCF valuation?

  1. Complicated and complex, therefore time-consuming to develop.
  2. Due to the vast number of parameters, a plausible DCF outcome varies substantially between the lowest and the highest plausible value (every parameter is subject to views and opinions).

What happens to WACC if the interest rate increases?

When the fed raises interest rates, the risk-free rate immediately increases. A high cost of capital for the company might also increase the risk that it will default. That would raise the default premium and further increase the interest rate used for the WACC.

Higher corporate taxes increase WACC, while lower taxes reduce WACC.

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