In finance, discounted cash flow (DCF) analysis is a method of valuing a project, company, or asset using the concepts of the time value of money. All future cash flows are estimated and discounted by using cost of capital to give their present values (PVs). The sum of all future cash flows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cash flows in question.

Please complete the DCF for one of the companies listed below, and draw a conclusion as to how and why you would value the company based on the results of your DCF.

The formula for the DCF is as follows: The discounted cash flow formula is derived from the future value formula for calculating the time value of money and compounding returns. Review the attached PowerPoint Presentation for help.

Company:
1) Starbucks
2) Netflix
3) The Walt Disney Company
4) Tesla

Solution

Walt Disney Company Value: Using Discounted Cash Flow Methods

Company Valuation aimed at giving owners, potential buyers, and other interested stakeholders an approximate value of business worth. This assessment is especially necessary for Merger and Acquisition deals.  The most commonly used approach in company valuation is the Discounted Cash Flow (DCF) method. This method is based on  forward-looking data. It requires a relatively large amount of predictions for the future business situation of the company and the general economy. Fundamentally, changes in the underlying assumptions will result in great differences in the value of a company. The assumptions used and their influence on the outcome of valuation analysis should be known.

To determine the value The Walt Disney Company using this method, we will use the Net present value of its future free cash (FCF) flows discounted by an appropriate discount rate. The NPV of numerous future cash flows of the company is given by:

NPV = ∑ FCFt /(1 + r)t                                              

Where FCFt  ( FCF at period t)  which is the amount of cash not required for operation.  (Brealey, 2006).

Since DCF technique is based on future predictions, a scenario analysis is conducted to determine the effects of changes in the underlying assumptions.  There are mainly three scenario analysis namely the “base case or management situation” which uses the management’s estimations for the relevant metrics, the “bear-case” that calculates the company’s value if it performs poorly and the “bull-case” that uses very optimistic assumptions. In this valuation, I will assume the base-case to be the most important scenario in which the most likely scenario to happen will be built using the predictions and opinion of The Walt Disney Company management regarding the future development of the company and its relevant markets and competitors.

                                        To use the DCF to predict the value of Walt Disney Company, I will first consider developing scenarios to predict FCF for the next defined period (t). Based on the available data, I will use t=5years. The next step will be determining the weighted average cost of capital (WACC) to discount all future FCFs to calculate their NPVs. WACC is a rate calculated by weighting the sources of capital according to the financial structure of the company then multiplying the result by their costs. It is calculated as

WACC = Equity*Cost of Equity/ (Debt + Equity) + Debt*Cost of Debt/(Debt + Equity)

From  https://www.stock-analysis-on.net/NYSE/Company/Walt-Disney-Co/DCF/Present-Value-of-FCFF, the values of WACC for Walt Disney Company limited for a period of 10 years covering September 2006 to September 2015 are tabulated.

The terminal value (TV), the net present value of all future cash flows that accrue after the 5 years can then be calculated. TV is based on average expected growth as it is difficult to estimate the accurate figures of the expected company develop over a period of time. According to (Beranek & Howe, 1990), we assume a constant perpetual growth rate (g) for the time following the analysis was done.

TV = ∑ {FCFTV (1 + g)/(r – g)}

  where the summation limit is n = 1 to n = ∞

Finally, the company value is then approximated by:

Company value=∑ {FCFt/(1+r)t}+TV, summed up from t=0 to t = n where. Alternatively,

Company value=∑ {FCFFt/(1+WACC)t}, summed up from t =1 to t = n

The above equation uses free cash flow to the firm (FCFFt).  In company valuation, using DCF approach, we use the free cash flow to the firm’s FCFF which is the cash flow available to debt- and equity holders in which case all inputs are made based on accounting figures calculated before interests are paid out to the debt holders. FCFF is calculated by

FCFF = NOPAT + D&A – Capex – Increase in NWC

Where NOPAT is the net operating profit of the company after tax, D&A represents circulatory costs,  Capex represents the company’s capital expenditure and NWC is its  net working Capital The following data from  https://www.stock-analysis-on.net/NYSE/Company/Walt-Disney-Co/DCF/Present-Value-of-FCFF  is available for The Walt Disney Company The Walt Disney Company.

FCFF for Walt Disney Company

Of important consideration in this valuation is the Cost of Equity (COE) which equals Required return on equity (ROE). This is calculated using the capital asset pricing model (CAPM) which, in this case, defines the return  Walt Disney Company  investors expect for bearing the risk of holding a firm’s share ROE. COE is given by

COE = rf +β(rm-rf)

β is the  input factor representing the risk which holding the stock is expected to add to the investor’s portfolio. This input factor is derived using linear regression analysis, in which the dependent and the independent variables are respectively the excess return of the stock and excess market return (Rhaiem, Ben, & Mabrouk, 2007).

The interest rate that the company has to pay on its outstanding debt is the cost of capital  (COD). COD after tax is calculated as

COD = i*(1-t)

Where i is the interest rate on outstanding debt while t is the effective tax rate payable  by the company.

By substituting the formulae for COE and COD, WACC (including all factors that influence the discount rate) is given by

WACC = E *{ rf +β(rm-rf )}/(D+ E) + D*i*(1-t)/(D+E)

Where E is the equity and D is the Debt. Using current figures for beta, risk-free rate, credit spread, and interest costs leads to a fair approximation for the discount rate, but for an exact value, the company’s future WACC is used.

Calculations

From the above equations and using the values from the tables Walt Disney Company Value

For year 1

                               5                                               5

Company Value =∑ {FCFF1/(1+WACCsep11)t} = ∑ {7.512(1+9.74.70)1} = 6.497%

                             t =1                                            t = 1

For year2

                             5                                              5

Company Value =∑ {FCFF2/(1+WACCsep12)t} =∑ {8.216(1+9.29)2} = 6.135%

                           t =2                                          t = 2

year3

                                 5                                                 5

Company Value  = ∑ {FCFF3/(1+WACCsep13)t}  = ∑ {9.048(1+10.63)2} = 5.838%

                               t =3                                             t = 3

Year4

                             5                                              5

Company value=∑ {FCFF4/(1+WACCsep14)t} =∑ {10.030(1+9.59)2} =  5.592%

                           t =4                                         t = 4

Year 5

                             5                                               5

Company value=∑ {FCFF5/(1+WACCsep15)t} = ∑ {11.930(1+12.71)t} = 5.393%

                           t =5                                           t =5

 Conclusion                         

DCF analysis is an excellent tool to analyze what assumptions and conditions have to be fulfilled to reach a certain company value. This is helpful in the case of capital budgeting and where there is the need to create feasibility plans.  The valuation based on DCF  is a valid method to assess company’s value with particular precaution is put on the validity of the assumptions made.  DCF  results depend on depends on the quality and validity of the data that used. When used well, the DCF valuation is an excellent tool to evaluate the values of a broad range of assets. It can also be used to analyze the effects of different economic scenarios on a company’s value.

Reference

Brealey, R., & Myers, S. (1995). FUNDAMENTALSOFCORPO-RATEFINANCE7/e.

http://www.gurufocus.com/term/total_freecashflow/DIS/Free-Cash-Flow/Walt-Disney-Co

http://financials.morningstar.com/valuation/price-ratio.html?t=DIS&region=usa&culture=en-US

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