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Transcript of dcf tutorial_part II
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Discounted Cash Flow (DCF)
Tutorial Part II
Wednesday, February 7th, 2007
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Recap from Last Week
Basic Underlying Principles Time Value of Money (A dollar today is worth more than a dollar
tomorrow) Present/Future Value
PV=FV/(1-i)^n
FV=PV(1+i)^n Opportunity Cost
What is a business worth? A business is worth the present value of the expected future cash flows
of the business.
Ex. Target Corp (TGT):$60 Share Price
x 858.89 Shares Outstanding (mm)
= $51,533 Market Capitalization or Market Value ofEquity
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Recap cont.
What is Free Cash Flow?Net Income
Add: Depreciation
Less: Capital Expenditures (CAPEX)= Free Cash Flow to Equity
Basics of DCF Analysis
Compostion Computation Forecasting
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Tonight's Objectives
Screening for companies
Where do you find the financial data
Introduction to the DCF Model Example of how to use the model
Dell Inc.
Currently trading at $23.90/share, with a
52.42b Market Cap
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Screening for Companies
Web-site to use: Yahoo Finance Web Address: finance.yahoo.com
On the left margin click on StockResearch ->
Screener
Initial Screen Criteria
Price to Earnings (P/E) ratio no greater than 20
The Companys Return on Equity (ROE) shouldbe greater than or equal to 10%
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Where to find the data? On-line
Edgar
(http://www.sec.gov/edgar/searchedgar/companysearch.html)
Yahoo Finance, orReuters
File Looking for? 10-K: Annual Filing
10-Q: Quarterly Filing
Important Sections
Part I: (Business/Risk Factors) Part II:
Management Discussion and Analysis of Financial Condition
Consolidated Statements of Financial Position
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Introduction to the DCF Model
Four main sections of the DCF Model1. Historical Values
2. Future Projections
3. Discount Rate & Perpetuity Growth4. Comparison of the Fair Value to the Current Market
Price
Variables to change within the Model
Blue cells change Black cells DO NOT change
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Example: How to use the Model
Six Step Process1. Screen for the company
2. Find the financial data
3. Input the historical data into the model
4. Make future projections based upon research andinformation within the 10-K/10-Q
5. Apply the Discount Rate & Perpetuity Growth
6. Compare the Fair Value to the Current MarketPrice
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Step 1: Screen for the Company
Go to Yahoo Finance Website: finance.yahoo.com On the left margin click on StockResearch ->
Screener Screen initially for: Price to Earnings (P/E) ratio no greater than 20
The Companys Return on Equity (ROE) should begreater than or equal to 10%
Secondary Screen Price to Book less than 1.5 2.0 Debt to Equity Ratio less than 1.5 2.0 Current Ratio greater or equal to 1.0
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Step 2: Find the Financial Data
Use: Edgar
(http://www.sec.gov/edgar/searchedgar/companysearch.
html) Yahoo Finance, orReuters
Search for the 10-K/Annual Data
10-K
Financial data found in Part II of ConsolidatedStatements of Financial Position
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Step 3: Input Historical Data into theModel
Want to input historical data for the past fiveyears
Historical Data that we are looking for: RevenuesNet Income
Depreciation
Capital Expenditures (CAPEX)
Note: Revenues and Net Income will be found on the Income Statementand Depreciation and CAPEX will be found on the Cash FlowStatement
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Step 4: Make Projections
Need to forecast in the areas of(blue text): Revenue Growth Rate
Net Income Margin
Depreciation as a % of Sales CAPEX as a % of Sales
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Step 4: Projections (cont.) Dell Example
Revenue Projection facts to consider Historical Revenue Growth: 5 year average of 15.8%
Too high to use for a five year forecast?
41% of sales in 2006 came from outside the U.S. In 2007 are looking to expand their sales outside U.S. Desktop PC sales growth continues to decline, as a result of
cheaper laptop prices, while mobility products sales are increasingas a percentage of sales
Servers business continues to grow as a percentage of sales As they expand outside the U.S. enhanced services business may
increase sales Michael Dell will take the position of CEO once again
Will he realign the company back to their core business?
Is the industry saturated from a domestic and internationalperspective?
Growth rates based off of sectors of Dells business Generally assumed that Revenues would grow for the next two years, then slowly
decrease
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Step 4: Projections (cont.)
Net Income Margin Assumed that over time Dell will keep their
margin in line with their historical average Used the historical five year average of5.8%
Depreciation as a % of Sales Used the historical five year average of0.7%
CAPEX as a % of Sales
Used the historical five year average of1.3%
Question: Why forecast Depreciation andCAPEX as a % of Sales?
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Step 5: Apply a Discount Rate andPerpetuity Growth
Discount Rate: Will assume a 10% Discount Rate as the
opportunity cost of my money
Perpetuity Growth Assumed the company is a Going Concern
Use a rate at or below the rate of inflation
Used: 2.5%
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Step 6: Compare the Fair Value to theCurrent Market Price
*Note: This tells you that according the DCF Model, we can buy1 share of Dell for $23.52 today, while the NPV of their futurecash flows are valued at $26.14 per share.
Discount Rate 1 .
PV of Pro ected Cash Flows $15,6 4.3
PV of Terminal Value CF $42,6 .4
Fair Value $5 ,2 4.
Shs. utstanding millions 2,23
Per Share Fair Value $26.14
Current Share Price $23.52
Margin % 11.1%
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Results from Dell Inc. DCFSIA isco te as lo ( ) Works eet - ell I c.
1 2 3 4 5
2002 2003 2004 2005 2006 2007E 2008E 2009E 2010E 2011E
er
et
ity
Reve
es $31,168.0 $35,404.0 $41,444.0 $49,205.0 $55,908.0 $63,735.1 $72,658.0 $82,103.6 $91,135.0 $97,514.4 $99,952.3
% Gro
th 13.6% 17.1% 18.7% 13.6% 14.0% 14.0% 13.0% 11.0% 7.0% 2.5
Net I
come 1,246.0 2,122.0 2,645.0 3,043.0 3,572.0 3,689.9 4,206.4 4,753.3 5,276.1 5,645.5 5,786.6
% Margin 4.0% 6.0% 6.4% 6.2% 6.4% 5.8% 5.8% 5.8% 5.8% 5.8% 5.8%
A :
e
reciatio 239.0 211.0 263.0 334.0 393.0 430.7 491.0 554.9 615.9 659.0 675.5
% of Sales 0.8% 0.6% 0.6% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7%
Less:
a
ital Ex
e
it
res 303.0 305.0 965.0 525.0 728.0 832.5 949.1 1,072.5 1,190.4 1,273.8 1,305.6% of Sales 1.0% 0.9% 2.3% 1.1% 1.3% 1.3% 1.3% 1.3% 1.3% 1.3% 1.3%
Free
as
Flo to Eq ity $1,182.0 $2,028.0 $1,943.0 $2,852.0 $3,237.0 $3,288.1 $3,748.4 $4,235.7 $4,701.6 $5,030.7 $5,156.5
Discount
ate 10.0
! "
o#
!
ro$
ected%
ash&
lo' s $15,604.3 Discounted%
ash&
lo' s: $2,989.2 $3,097.9 $3,182.3 $3,211.3 $3,123.7 $3,201.8! "
o # Terminal"
alue %&
$42,690.4
&
air"
alue $58,294.7
( hs. ) utstanding (millions) 2,230
PerShareFair0
al1
e $26.14
% urrent ( hare!
rice $23.522
argi3
% 11.1%
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What Weve Covered Tonight
Screening for companies
Where do you find the financial data
Introduction to the DCF Model
Example of how to use the model Dell Inc.
6 Step Process