dcf tutorial_part ii

8/7/2019 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

dcf tutorial_part ii

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