Assignment #1 - Ohio State University



Assignment #4: Discounted Cash Flow

Submit this assignment electronically to the instructor by the due date

DCF

Using the Excel Income Statement you created in the previous assignment. Add a new spreadsheet labeled DCF. Copy the DCF template from the examples sent to you.

▪ Project 10 years of free cash flow and calculate a DCF target price.

Important inputs to think about…

▪ Are your margin projections increasing/decreasing/constant? Why?

▪ What has your sales growth rate been? What is your sales growth rate going forward? Is the growth rate increasing or decreasing? Why?

▪ Is investment in capital expenditures increasing or decreasing?

▪ Is depreciation & amortization increasing or decreasing?

▪ Does the change to Working Capital make sense? This is likely a negative number.

▪ What terminal growth rate are you using? Why?

▪ What discount rate are you using? Why?

▪ What is your tax rate?

▪ What is your target price?

▪ What assumptions are the key drivers of the stock’s target price (sales, margins, capex, etc)?

Hint: You may want to try several discount rate and growth rates since the DCF is very sensitive to small changes in terminal growth and discount rates. Try a sensitivity analysis matrix.

Note: For companies in the Financial Sector, assume Net Income is equal to Free Cash Flow.

Common Mistakes when working on this assignment:

• Select appropriate discount rate.

o We assume 10% is the discount rate of the market. If your company is more cyclical (i.e. less certain cash flows), use a higher rate. If your company is more stable than the market, use a lower discount rate.

• Select the appropriate terminal growth rate (this pertains to cash flow, not revenues).

o We assume that 4% is the terminal growth rate of the market. If you believe your company will grow at a faster rate than the market, use a slightly higher rate. If you believe your company will grow slower than the market, use lower terminal growth rate.

• The sales growth rate should slow over time. By the terminal year, sales growth should fade to your terminal growth rate.

• Look for sudden changes in Free Cash Flow Growth…this may mean you have a calculation problem.

• Make sure Depreciation/Amortization and Capex converge (i.e. offset) by the terminal year.

• Be sure to input correct shares outstanding, current price, Ticker, total debt and total cash.

• For cyclical companies, make sure that your margin assumptions in the terminal year are MID-CYCLE margins (i.e. average).

• You may need to add/delete lines from the template.

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