So DCF fundamentals. What we're going to do today, we are going to talk about what it is obviously, what the steps are to achieve this.

We're gonna have a look at how to forecast the free cash flows.

We have a very brief look at weighted average cost of capital. There's actually a fantastic playlist in detail going through WACC.

But obviously you need to have a quick chat about this.

We're gonna have a look at the terminal value, which is, beyond our forecast horizon when we're forecasting, explicitly at some point we stop.

Because we're looking at companies the terminal value will capture anything beyond that forecast horizon.

Then we're gonna have a quick look at discounting and calculate the implied equity value and implied share price.

Okay, so let's get started.

Because I'm sure you all are very busy. So what is it? We call it DCF because we abbreviate everything in financial services.

And the idea really is that any asset is only worth the cash flows it can generate in the future.

Okay? That's true for a house, true for a car, it's true for a company.

So we are forecasting the cash flows.

Remember, these are your, this is your view in terms of what you think the performance of the company will be.

So we might have different opinions. So we have different outcomes in terms of valuation.

As long as you can defend your assumptions.

So you're thinking about, you know, growth, which which are not beyond the unachievable margins, which are not much higher than the rest of the sector, then that is the value you are generating.

The other thing to remember is it's an intrinsic valuation methodology.

So really focusing on the corporate strategy of the company and reflecting that in your forecast.

Whereas when we're doing trading comps or multiples analysis, we're really coming from the market and saying, okay, so the share price represents the view of all market participants and that will give me an idea on what the valuation will be.

And we're using multiples, to do so.

So when we are forecasting free cash flows, and we normally do this on an unlevered or unleveraged basis, which means it's before interest, which means it will give us that big green block, the enterprise value from that we take off the net debt at the time of the analysis, excuse me, which then gives us the implied equity value.

So that's an important thing to remember.

We can obviously discount different cash flows, we can discount leveraged cash flows to after interest.

We could discount dividends. That's one of the simplest way of doing effectively a discounted cash flow analysis just by looking at dividend forecasts and discounting them back to today's value.

We often use that in financial institutions if the bank or insurance company does pay any dividends.

So just forgive me, I just wanna make sure everyone is happy with what discounting means.

So we use the weighted average cost of capital as the discount rate.

The WACC really is the required rate of return, off the investors more than that in a minute.

So just imagine you have a hundred pounds, dollars, euros, whatever, and you investing this today at 10% per annum.

If we earn interest on interest, I we're not taking any of the interest out. Then at the end of year three we will have 133.1 dollars, sterling or euros.

Okay? Now discount is exactly the opposite.

What if I forecasted that by the end of year three, I'm generating in that year three 133 of cashflow.

I want to know what that is worth today. Okay? So I'm discounting now by 10% it will bring me back to the 100, right? The same thing would be to say, you know, in, in three years time I need 133 to pay for whatever a house, you know, university situation, whatever.

How much do I need to invest now if I can get 10% per annum.

So discounting is effectively the opposite of grossing up.

Really important to remember that 10% is the required rate of return of the actual investors.

So the cost of capital of the company.

If they do not achieve this cost of capital, then investors will be pretty unhappy. When I'm unhappy as an investor, I will normally sell the shares, okay? Or I'm, I'm selling the bonds and obviously if I'm selling a lot of shares, then the share price will go down because of supply and demand. So we've got a supply too much supply and we will then lose value in the share.

The returns will go up, okay? So discounted cash flows are discounted back to today's value because I wanna know what the value of the company is today.

So the steps are actually very straightforward.

The most difficult one is step number one, forecasting the free cash flows.

And we normally forecast around five or 10 years time.

The most important thing to consider is that you're forecasting until the company reaches steady state i.e. maturity.

So growth rates are at a normalized level and in general we would expect that the company can't really outgrow the economy.

Because ultimately, you know, you could take over the world, we would expect margins to be at a mature level, okay? So not exorbitantly high or very low, you know, because obviously as a relatively young company you're investing heavily in research development, marketing, you know, whatever your main cost drivers are and that your margins initially might not be very high.

So steady state, single most important thing in some sectors such as utilities, we might actually forecast for something like 15 years because we have very long term contracts.

Then we calculate the cost of capital or estimate it.

Because I always think that the word calculate sounds so precise, but actually you know, we are really estimating the cost of capital more than that in a minute.

Now remember we are looking at corporates here.

So rather than at a project which has a finite life, so for instance a project could be you're running an airport so you have the license to run that airport or a train line, you have the license to run that train line for a certain period and then at the end of this your license is over. You're not going to make any more cash flow.

In this case, we are looking at companies and we're assuming that companies are growing concerns.

I it will continue to exist beyond those five or 10 years or whatever your forecast rise most.

And that will then be captured in the terminal value.

So the company's not gonna die, okay? We are going to assume it will continue from year 6 or year 11 onwards.

Then we discount everything to today.

Because I want to know what the value is today if I want to buy the shares or if I want to buy the whole company.

And then ultimately again, go from enterprise value to the implied share price. If we're a public company or from the enterprise to the implied equity value. If we're looking at a private company where the number of shares isn't really sorted, right, you could have only two shares because you might have only two shareholders.

So generally we then talk in millions in terms of the actual equity value of thousands in terms of the active value of that company.

Okay? So those are the steps.

So let's go through these steps in detail.

First thing is the definition of free cash flow.

There are loads of definitions of cashflow cash flows, but in the context of DCF, when we talk about free cash flow, this is what we mean.

We start with EBIT earnings before interest in tax, which effectively is your adjusted operating profit.

What is it adjusted for for your non-recurring items? So above the line, above the operating profit, you might find some non-recurring items such as a gain or loss on the disposal of assets, maybe a very large restructuring charge and obviously no company really is in the business of constantly restructuring.

Okay? So we call this EBIT or adjusted operating profit.

We are now pretending that the company has zero debt, okay? Which means my EBIT effectively becomes my pretax profit.

The debt we will deal with as part of the cost of capital.

So we are now saying let's tax EBIT because that is effectively our pretax profit.

We are here using normally the long run tax rate or also called the effective tax rate, which takes into account that a corporate will earn.

You know, if we're multinational profits around the world and the tax rates obviously around the world are different, that gives us something called NOPAT or EBIAT, which I can't say as fast as NOPAT.

So net operating profit after tax or normalized operating profit after tax.

Now that is not a cashflow figure, right? A cashflow figure we now need to arrive at by adding back D&A, which has obviously been taken off from EBIT.

So add that back. We deduct CapEx, which is the new investment in property, plant and equipment.

And if you think about those two numbers together, I CapEx and depreciation amortization, that's effectively your change in long-term assets, long-term operating assets.

Then we add or deduct a change in working capital, working capital being defined as current assets minus current liabilities.

And the current assets consist generally of inventories of accounts receivable and the current liabilities of accounts payable.

You might have accrued expenses in there.

You might have something like deferred revenue if you are a subscription business, okay? So the working capital really is needed to actually run the business.

If you think about debt and equity as being So the engine of the company allowing you to actually set up a company, the working capital is the oil that makes that engine run.

And then we might have some other long-term operating assets liabilities, which we forecasted, which is very unusual.

We tend to deal with those separately in the bridge such as pension liabilities for instance.

Which, but if we have forecast them, we would also include them in our free cash flow.

So ultimately this is the free cash flow defined for DCF purposes.

Question is what's it free for? Where it's free for paying dividends, doing a share buyback, paying interest after tax because we're already already after tax with without our NOPAT and also repaying debt.

So if you ever look at our content regarding debt sizing or debt capacity, then you will find this is exactly the same free cash flow as we would use in an LBO analysis, right? Where we're saying let's scrap the existing cap structure and let's start afresh with more debt.

So free cash flow really important in terms of numbers.

Let's do our first exercise.

So if you could please open for me the DCF workout empty. So that's one of the two files which were uploaded.

Then you will see in out number one, I'm just gonna wait a second until you all have that file out. Number one where it asks us to calculate the free cash flows in years one till three.

We always look at forecast free cash flow because obviously before year one we didn't own the company, okay, we're going to assume that we do a deal or we are valuing the business at the end of year zero.

So starting with EBIT, which I have above, I'm gonna start with my operating profit and then I can see there are no non-recurring items.

So my EBIT equals my operating profit in this case. Okay? I'm just gonna show you my formulate so that you can follow what I'm doing.

We are now pretending EBIT is our pretax profit because we're pretending we have no debt at this point.

So my tax rate at times my EBIT and I'm gonna make this negative because I'm in a cashflow model.

So I quite like to use the sum function to get to my, my sub sums.

I'm just going to multiply that with times minus 1 will give me the implied tax expense.

So if you have forecasted a model in detail and forecast with existing capital structure, you can't use the tax forecast in that income statement because it will be leveraged. It will include the tax shield on interest.

At the moment we're pretending we have no debt.

Okay, sum those two up that will give you the NOPAT.

I'm just gonna copy this thing down so I don't have to do this every two seconds.

So NOPAT is 216 million for this company.

Now let's make this into a cashflow.

So operating assets have an inverse relationship with cashflow.

So when assets go up, cash goes down and we can see the operating assets go from 31.2 to 34.

So roughly or exactly a 2.8 million change.

So I would want to show this as a negative or cash outflow because I am investing in more inventory, more accounts receivable, whatever is behind that number.

So change in operating as the easiest way of doing that in Excel. Just start with last year minus this year. You don't have to think about brackets or putting a minus sign around it, okay? It'll give you the right direction of the number because we have that inverse relationship with cash.

Then we have operating liabilities.

So these would be our accounts payable and here we have the same direction as the cash flow.

So as liabilities go up, cash goes up, you are waiting to pay your bills.

So I'm going to take this year's operating liabilities and deduct from this last year's operating liabilities.

I can see they've gone up by about 6 million or five and a half million in this case and therefore I would want to see a positive number and you can see it shows up positive if I say this year minus last year.

Then finally I have change in long-term assets.

Remember that's our net reinvestment in this case in property, plant and equipment. We've just lumped CapEx depreciation together.

And again, because I have an asset I will do last year minus this year and I can see that I have a cash outflow.

I.e. CapEx is bigger than depreciation of 23.2 million.

Sum this up from NOPAT down.

The shortcut for getting the sub function is all equal, equal.

But look at your screen please because we already have a sum up here.

We will then stop right below it. So you need to look at your screen.

Okay, so free cash flow for the company is 195.5 and you can see effectively the delta between the notepad and the free cash flow, which is in total 20.5 million is our reinvestment in the business.

So of that 216 million we are reinvesting 20.6 million in the business or 20.5 million.

Okay, copy that to the right and then you will see something quite odd because you can see our cash flow so it goes down a bit.

So we're clearly, you know, either losing, you know, we're probably losing some margin because you can see EBIT is coming down.

So you know, companies maybe not doing so well in this case and we have a massive investment in our long-term assets.

So clearly this might be a cyclical company or an industrial which has big investment programs every few years in capital expenditure.

So important to remember, we want to stop forecasting when we believe the company is mature, okay? In this case I would definitely not stop in year three because I've got this huge investment in long-term assets.

I would probably forecast a couple more years until I come to sort of an average CapEx requirement and average margins to say at this point I'm probably as a mature business.

And obviously you would take these CapEx spikes into account as part of your numbers.

Okay? So that's the definition of free cash flow.

If you have any questions, please put them into the Q&A and I will obviously stop and answer them.

You can also unmute yourself if you want to and just ask the question, just interrupt me.

Okay? So that's the definition. Free cash flow.

Let's move on because there are no questions at the moment.

Let's talk about weighted average cost of capital.

So the way to think about this is, is the required rate of return of my shareholders, so equity holders and my debt holders, some textbooks will then show preferred equity separately.

You know, we'll maybe split up all of the debt, but in general in real life we tend to say it's either equity or it's debt.

Okay? We then, so the proportion of of of those two elements of long-term funding are then multiplied with their relevant costs.

Important for you to remember.

Cost of equity is always higher than the cost of debt because we have more risk being in equity.

If the company were to go bust, IE would become a restructuring case and maybe go bankrupt, then we would sell the assets and service the debt.

I repay the debt as much as possible, but there might not be anything left over for the equity holders, which means equity is more risky, therefore I want a higher return.

So, I had a great question how to forecast the way forward if I believe the BP.

Not sure what BP is not at a steady state yet.

So in terms of presum you mean the cash flow? Not as they said. So you continue to forecast and at some point, so business plan, thank you, thank you abbreviation, I'm German abbreviations in English for me are not great, thank you very much.

So what I would do is I would have a look at the average CapEx over time max you might have one year 10% of sales and then the other is you're just maintaining the assets.

You might have 2% of sales and then I would take an average over, you know, one cycle of investment and take that into the steady state.

Okay? So in terms of margins and growth rates, have a look at the sector because the sector obviously will give you an idea on more mature companies where they ha where they're standing at in terms of long-term growth rates.

And ultimately you can't outgrow the economy, right? So even a Coca-Cola with a fantastic brand name cannot outgrow the economy and it's really just growing at nominal growth, right? I.e. inflation plus real growth.

So you know, you bring it down.

If you don't know exactly how that's going happen, then you might say I have a competitive advantage for the next, let's say five years, right? Because I have some type of patent or whatever or technology, which I believe people can't copy that easily.

And you might say, okay, for five years, you know, in the next five years people are going come in, take that competitive advantage away so my growth will come down, my margins will come down.

So maybe today you're growing at 10%, you're saying long term, let's say we're growing 3% and you bring it down in even steps, right? Sometimes we can't be more explicit because we just don't know what's going to happen.

But what's really important is in that final forecast here you are reflecting a mature company's financials.

Okay? So it might mean that you have to forecast a little bit longer and do it in steps rather than saying exactly 3.35%, you're saying, you know, each year it's going down by 1% or something like that.

Have a look at competitors in the sector, how their ratios have developed over time.

Okay? So great question by the way, that's fantastic.

Okay, let me show you.

Within Felix you might have seen there's something called analyst on the right hand side. We're gonna have a look at Peloton in a minute anyway, so might as well have a look at their cost of capital.

So if you go into the valuation tab, you can see on the right hand side we have a WACC calculator. There are a couple of fields you can amend.

I'm just gonna leave it as it is.

Because in standard most people use 10 years and the equity risk stream around 5.5%, that's probably quite adequate at moment you can see their cost of equity is 9.38%.

This is based on the capital asset pricing model, okay? And their cost of debt is based is at the moment pre-tax 5.4%, which results in a WACC of around 9%.

Okay? This is up to date data as of third, 1st of May.

So obviously, you know, interest rates have changed a little bit, but not too much.

And the credit spread, which is the important one, right? That hasn't really changed an awful lot.

And that is based on, on the debt to capital structure of the company.

Okay? So we can have a look at the industry and then figure that out because we don't have a credit rating.

So cost of equity higher than cost of debt tick because it's more risky and the overall wac.

So our investors are expecting around 9% of an weighted average cost of capital from the company.

So the company really has to achieve that in terms of their investments.

Okay? Now let's go back into our exercises.

When do we need to use, so the question is when do we need to use the WACC classic formula or extended formula? How can we include, for example, associates in the WACC formula? So when you say extended formula, you mean when we are including the cost of preference shares and the cost of convertible debt, et cetera? First of all, you would never include associates in the wax formula because what you're valuing at the moment are the core operations of the business.

I would always value associates separately, okay? Because associates don't generate any EBIT Because you get the income from associates, which means we would value associates separately.

I think you probably mean they're not non-controlling interest.

So if a company has a subsidiary where we have a big, you know, where we don't only own let's say 60% and that subsidiary is worth an awful lot of money, i.e. that non-controlling interest is big at market value.

I would add the cost of equity of the non-con controlling interest.

If the preference share is really large, I would add the cost of preference share separately.

Now, on the non-con controlling interest, you will come across this particularly in Europe and in Asia where we have a lot of cross shareholdings, right? So, not having a hundred percent of your subsidiary is more common and obviously for some of the more complex companies.

So if your non-con controlling interest is 5% percent or more of your balance sheet, I would certainly look into this.

In terms of preference, frankly, there is no company I know that has a huge amount of preference.

Because preference are so expensive, right? That most companies will try and reduce that exposure as quickly as possible and refinance either with debt or with straight equity.

Super question. But the associates do not sit in the, in the WACC formula. Please don't include them in there because your EBIT doesn't include the return from the associate.

Value them separately. Okay? So, if you look at the playlist on valuation complexities in in in Felix, it all goes through that.

Great questions guys. Keep them coming.

Okay, let's have a look at another exercise. We're gonna have a very quick look at workout number three.

As you can see, these are all very straightforward exercises because it's just maths once you have some numbers, right? So the number, you know, forecasting financials obviously depends completely on the sector, on your view.

Are you a buyer? Are you a seller of the shares or the company? You know, all of that will have an impact.

So we're gonna just do some quick discounting and work out. Number three, please. We have a forecast free cash flows, right? I mean I would, I would consider this like whoa, this is a lot of growth from one year to the next.

So, you know, and then obviously we're maturing again, you know, we've just chosen some numbers.

The cost capital for this company is 10%.

And what I'm gonna do is I'm actually going to quickly, um, calculate some discount factors using an explicit formula rather than using the NPV function.

Reason being in financial services, we often assume that cash flows occur in the middle of the period, right? So because a company might generate cash flows every single day, we don't really know when unless we're very seasonal business.

So rather than saying it all happens at the end of the year because we don't know, we say in the middle of the year.

Okay? So if I have a discount factor build, I can easily change that to oh 0.5, 1.5 and 2.5.

Obviously the net present value function also works here.

So the discount factor is 1 divided by 1 plus your discount rate.

Make sure you absolute reference that with F4, right? Because I want to copy in a minute and the WACC doesn't change to the power of the year count.

If I copy this to the right, you will get these numbers, show you the formula.

So that means if I expect let's say a 100 dollar cash flow in year one, then it would only be worth $90.90 in year zero, right? At my valuation date, I can then calculate the present value of the cash flows I forecast my cash flows times the actual discount factor.

Okay? So in this case, if I look at the final year, the 195.5 million is today at year zero.

At the end of year zero is today worth 146.9 million because of a discount rate of 10%.

Okay? So that's just how we use WACC and how we discount.

Okay, jumping straight back to the slides, let's talk about term wise. So we've identified what free cash flow is, we've identified what WACC is.

Now let's think about anything beyond the explicit forecast horizon.

So we've got here either five years or 10 years on the left hand side.

So you are really thinking about the business plan, okay? You're really thinking about what happens to margins, what happens to what happens to growth rates, et cetera.

And some point we say okay, we are now mature, let's stop. Because if we keep everything constant, we might as well just do this in one single calculation.

We call this the steady state which presented by the terminal value.

So if we forecast for five years, you will have year six into infinity.

Or if you've done 10 years year, year 11 into infinity, two different methodologies, number one, the growing perpetuity.

But basically we're saying on average the free cash will now grow at a constant growth rate.

Now let's say 3%, okay? Now that means one year it might grow at 1.5%. Another year maybe at 4%, but on average it will be around 3%.

That growth rate cannot be higher than the nominal long-term growth rate expectation in the country you are operating in.

Because otherwise you take over the country and you take over the world, okay? So that's really important.

It can't suddenly be 10% unless you're in a high high inflation country.

But even there, I would be very careful to assume this in infinity because we can see that, you know, fast growing emerging markets might have initially high inflation, but that tends to come down over time.

So nominal long-term forecast of the economic growth.

Alternatively I could use the enterprise for a, an enterprise value multiple, right? I need to be at enterprise level because my free cash flow results in an enterprise value because I'm before interest.

So I might use EBIT, I might use EBITDA.

Why do I assume this? Where at the end of year five I could sell the business for a certain multiple and whoever pays me will pay for the net present value of free cash flows from year six into perpetuity.

Okay? So an enterprise value multiple reflecting a mature business.

So please don't use an EBITDA multiple of 25 times if the sector today is trading on 25 because at the point you're cutting off, you're supposed to be steady state, mature and multiples are all always driven by growth expectations, profitability, expectations and risk.

So that growth, right? If I'm only growing at 3%, but today at let's say 10 or 15%, obviously the multiple needs to reflect that.

So look at your comms, look at two years forward, think about how multiples develop over time because they come down as our growth expectations diminish.

Okay, let's do a quick exercise. We're gonna have a look at workout number five. Okay? So workout number five asks us to calculate the terminal value.

So you can see we've got an income statement forecast, we've got our free cash flow already.

This is a really easy calculation and we've assumed 7.5 times EBIT, which is pretty low considering today's markets also even for mature businesses.

Okay? So 7.5 times the EBIT in year three.

Now my EBIT is the same as the operating profit because I have no non-recurring items.

So I can just say 7.5 times 195 will give me an implied value. Now that value I'm actually going to show here because it is a value at the end of year three.

Okay? So someone's gonna gimme a check for 1.4 billion, okay? And what they're paying for are all the cash flows beyond year three are year four into perpetuity.

I just calculated that as an employed multiple, okay? I 7.5 times EBIT.

Now let's move to workout number seven where we're using the perpetuity methodology.

Okay? And again, I'm actually going to calculate this.

How to calculate this in that year three column, Jessica had a great question in terms of how to determine the exit multiple.

So look at your comms as of today and look at the two year forward multiples, right? Because you will have calculated that as part of your, of your analysis. So your trading comms, sometimes that doesn't work particularly if you're in the tech sector or in biotech sector.

Now the tech sector has obviously over the last 10 days, you know, really seen a diminishing, you know, sort of stock values because because some of the results weren't that brilliant either they didn't beat expectations enough, but have a look at two year four and then if that doesn't work, have a look at how multiples in a more mature sectors have developed over time.

Okay? So you might have started with a really high multiple, but you can then actually have see that, you know, a mature business, you know, which, which is not too cyclical and doesn't have anything funny.

I like a fantastic brand or whatever would probably trade today around 10 to 12 times EBITDA, maybe even slightly below 10 times.

Whereas a branded goods company might trade on something like 12 to 15 times if they have a really strong brand.

So a Coca-Cola, you know a Nike, et cetera. Okay? That's a difficult determination and you need to get some experience in terms of how valuations develop over time to figure out that exit multiple.

Now the cool thing is you can compare that to a long-term growth rate in terms of the output and basically say what does that imply as a long-term growth rate? And does the multiple make sense, right? You can just solve for the growth rate.

Hopefully that answers your question.

So work out number seven, we are given a WACC of 9.5% and a long-term growth rate of 2%.

So what I'm gonna do now is I'm gonna take my free cash flow in the final year.

I'm going to grow that out by one year by 2%. So I'm now in year four and then I'm going to capitalize this as a growing perpetuity.

Okay? So just divide by WACC minus the growth rate.

So in this case the terminal value.

Let me just make sure that's correct. Yep.

No that's not correct. I thought that was a bit low.

Because I used by accent tax expense.

Let me redo this for you please.

Talking and modeling my free cash is 168.5.

So I have a terminal value of 2.3 billion roughly.

If you are unfamiliar with the growing perpetuity formula, maybe Google this because it's a derivation of basically saying the first free cash flow of the future is year four, but I'm more at the end of year three and I've discounted that back already.

The second cashflow is year five, et cetera. Everything grows at at a constant growth rate of 2%.

In this case the derivation of the growing purpose here is about a page long.

I cannot remember this from my maths class, I just need to know how to apply it.

But do Google this because it will explain to you what actually happens in terms of that formula.

Okay? So the term the value is worth in this case 2.3 billion.

Cool. Okay, so I've done that.

So coming back to my slides, I then look at discounting and we've already talked about this. Basically calculate your discount factor, bring everything back to today's value.

And uh, we're also looking at the present value of the terminal value.

It's happening at the end of year five. That's our assumption. So basically we bring everything back with exactly the same discount factors depending in which period we're in.

Now important to remember, if I sum that all up, I get an enterprise value.

Enterprise value is nothing else than the market value of all operating assets.

So again, on the person who asks about the associates in the work formula, associates are not an operating asset, right? They're a non-core assets.

There are a couple of exceptions in the defense and auto industry.

We will look at associates being part of the core operations, okay? But if you are in that sector then, then stay behind later on and I can explain this.

Okay? So some of the president free cashless will give me on the term value, give me the value.

So let's go back into um, exercise number nine.

You can see we've just split everything up and we're gonna do Peloton in a minute.

And it asks us here to calculate the enterprise value with a given free cash flows and a given terminal value.

Okay? So just one more time, sorry, I've only just seen this questions. Should I take fourth year, 2026? Yeah, as a benchmark that would be really good, but make sure that your growth rates aren't still really high.

So make sure that you are, in terms of growth rates somewhat more mature now, right? And not still growing at 10% across the sector, right? So that's a really good approach.

You could also use an EBITDA multiple.

We tend to stay away from sales multiples as X in multiples because obviously I can easily increase my sales by spending loads and loads of money in terms of marketing, R&D, but actually that doesn't necessarily result in profitability.

Okay? So good approach. Okay? Right.

So, work out number nine.

We've been given the numbers, right? Free cash flow forecast as well as the terminal value.

We've got a whack of 9%.

So again, first thing we're gonna do is quickly calculate a discount factor.

So one divided by 1 plus the WACC of 9%.

Fix that again please. And then we are doing this to the power of the year count.

Just as before, I will show you my full name, okay? I can then calculate the present value of the free cash flows.

So multiply this with your discount factor because basically what you're now saying is divide by one plus WACC to the power of the year count.

Okay? And we get 755 in the final year.

I can then sum this up.

So the sum of those three, remember this brings my free cash flows back to today's value today. So the sum of the first three years is 1.9 billion.

So the first three years are worth 1.9 billion, okay? I then also have a terminal value 3.6 billion, however we arrived at that value.

Multiply this with a discount factor of 77.2%, that means year four inter perpetrator worth 2.8 billion.

You will find the shorter your forecast rise and the bigger the impact of the terminal value, which is obviously dangerous, right? Because with one multiple or one assumption growth rate, you've valued the majority of the company.

So a longer forecast is better to be more explicit and really think about margins, growth rates and reinvestment.

And then if I sum those two up, I will get the enterprise value or the market value of operating assets for this business.

So this company is worth 4.7 billion on an enterprise value basis.

Okay? Not equity value but enterprise value. Okay? So hopefully everyone is happy with that.

So I've got one more slide because obviously ultimately I actually want to know what is the equity value.

Okay? And we're back to the bridge. Okay? So for corporates we always, we always value frankly the enterprise way and then go back to the bridge for financial institutions. We focus really on the equity value. The concept of enterprise value doesn't really exist in, in in banks or insurance companies because our main capital is the equity.

So the big green blob on the left hand side is the enterprise value. We've calculated right through our DCF, we have not included non-core assets yet because they don't, we have not included the cash flows they generate in our free cash flow forecast.

So always ask yourself what is in my free cash flow forecast? Is there any asset this company has that hasn't been reflected in that free cash flow forecast such as investments in other companies or your associates? Moving to the right hand side, the bridge, I start with the enterprise value based on the DCF I add the market value of those non-core assets.

So I might apply multiple to the income from associates net income, but I might have a listed company.

So if you look at someone like Nestle, they own 20% of L'Oreal.

So I can just take 20% of L'Oreal's market cap and that gives me the market value of the non-core asset.

If the non-core are quite small, so below that 5% of balance sheet, then I would just use the book value unless I know it's an investment in OpenAI.

Okay? Because obviously OpenAI is a private company but the market value of OpenAI is much higher than what I would show in my books.

Then we take off the net debt as of today.

So that means we add cash, deduct debt and any other debt like items as of today because I'm buying the business as of today.

Okay? Debt like items might be underfunded pension liabilities, you won't find a lot of those at the moment because of high interest rates and markets are relatively highly valued.

So it's a bit unusual to have a lot of debt like items that gives you the implied equity value note.

We are not calling it the market capitalization because market cap is always at the current share price.

If I'm a private company, I stop, right? So I'm saying okay, this is the value of the company.

So if I'm for instance thinking about buying this business, I have my starting point.

But remember this is a standalone value only because I haven't included any synergies yet.

Divide by shares outstanding.

If I have a public company and I get to the implied share price, I can then compare this to the current share post. So if I'm an equity research, this is what I will do.

If I am an investor and I want to buy whatever a thousand shares in the company, this is what I would do.

And obviously again, if I want to buy the whole company, I will compare it to the current share post and then say, you know, I feel you know, we might have to pay something extra to actually get this business.

A hundred percent of it. So one last exercise in my simple exercises.

If you go to work out number, which one are we gonna do? Number 11. Okay, so we have the sum of the present value of the free cash flows, which is the explicit time horizon where we forecast it explicitly.

We have the terminal value. You can see what a monster that is in this case, right? So clearly our forecast horizon is either very short or we have a company which has grown initially quite fast.

I.e. had very little free cash flow and then sort of matured.

But I suspect we just have quite a short forecast horizon.

If you keep everything constant, you might as well calculate the term of value. We'll give you the same number. Got some current cash.

So this is as of today, okay, really important.

We're not, you know, I'm not valuing the company in five years time.

I want to know what I have to pay today, then I have marketable securities, I have short term debt, et cetera.

So I can calculate first of all the enterprise value, which is the sum of the explicit forecast horizon plus the terminal value which has also been discounted back to, to today's value.

Okay? So I have a value of 241,000.

Then to get to the equity value, I take the enterprise away and do the bridge as we just discussed. So I will add cash.

We haven't included any interest income in ebit.

I will add, oops, I will add marketable securities because the return from those coupons I received, dividends I received have not been included in EBIT.

I take off from this the debt i.e.

what belongs to the debt holders.

Because in the end I want to know what is the value of this childers equity.

And I will also take off my long-term liabilities because I'm going to assume in this exercise these are underfunded pensions, okay? It's just an assumption I'm making.

So I have a value of 304,000.

You can see higher than the active value, but it's really easy to see why because I have a whopping nearly 100,000 or 100 million whatever it is, marketable securities in here, okay? And obviously there hadn't been valued through my free cash flow.

So they will increase the value of the business and that ladies and gentlemen is, are basically the steps to do a DCF.

Now that's all good, nice and good, but what about a real company? So open the other Excel spreadsheet you've been given, which is called Felix DCF challenge. And what we're quickly gonna do, so we're gonna quickly going to do the DCF on Peloton.

Okay? So in this, in this file you have a model at the end, I'm just gonna zoom in a bit so I can show you this a bit better.

Have a model at the end which gives us forecast income statement, balance sheet and cash flow.

We don't actually need a full model to be able to do a DCF. We just need the value drivers of the free cash flow itself.

Okay? I've got some really good questions coming through. So I'm gonna stop for a second.

What are examples of non-core assets? So your associates right, I will have an investment between 20 and 50% investments in general, right? Long term investments. So anything below 20% you might have some real estate which is not part of your operation. So for instance, a supermarket company in this country called Tesco in the UK has got an investment property which they identify separately from their property plan equipment. They also show the rental income from that rental property.

And I would treat that as a non-core asset. Okay? So anything that doesn't belong to your core operations and they are particularly the investments and then we find them in the balance sheet, right? So have a look at other long-term assets.

They will be called financial assets. Sometimes they dump them into other long-term assets.

Look at the note and you will find them.

Okay, super questions. Keep them coming.

Okay, coming back to Peloton. Hopefully everyone has found the fire and has opened it. So we've got a full model here at the end. Okay? But we don't actually need all of this but we, let's assume we've got the model from a research analyst. Maybe I've built the model based on my assumptions in terms of forecast.

What we're gonna do now in the remaining few minutes, um, I'm going to just quickly do a discounted cashflow analysis, okay? Ignore the stuff on the top.

The important thing is that we are valuing the business as of 1st of July, 2024.

We're assuming an exit multiple of 12 times EBITDA, which comes from our comms, right? So the longer term numbers, Peloton obviously has a pretty strong brand name even though I would say 12 times might still be a little bit rich and I'm going to use the cost of capital we saw earlier on in our Felix, right? I'm just gonna show you this again on the right hand side, 8.99% or 9% rounded.

Okay? So first thing we're gonna do, we're going to, and I'm going to actually split my screen so you can see all of my years easily.

So first thing I need is EBIT. Okay? So I'm just going to quickly redo what we've done in those simple exercises.

We are valuing at the end of the financial year ending June, 2024.

Because their year end is actually June. Okay? So our first full, full forecast year is June 25.

So I'm going to get the EBIT for the company, which I will find in my income statement and just need to make sure I've got the right year, which I think this one, yes.

So column E refers to 2025. In both sheets we have, so-called matrix integrity. Okay? So that's my, but you can see Palton is not doing particularly well. Company did super well during COVID and pre-Covid actually during Covid when we all bought our own gym equipment because we couldn't go to the gyms, okay? But since Covid, as we're being able to go back to gyms and also obviously high inflation people have sort of pulled back a bit from buying Peloton products.

Then you will have seen that they've been discounting quite heavily over the last couple of years and they're actually really restructuring their business at the moment.

Then I'm going to apply tax. So tax on EBIT, okay? Now because we are making a loss, you will find that we've assumed in the first couple of years we are not going to pay any tax, okay? But it then moves to the 21% tax rate, corporate tax rate in the United States US company and we've assumed 21% across.

But initially on a loss you don't pay any tax.

I mean that'd be a bit unfair if the tax authority said oh we want a bit more money from you now but you know, we already have made a loss.

So I can then calculate NOPAT, okay NOPAT as being my EBIT before tax times 1 minus the tax rate.

Actually I said tax on EBIT. So I should really not actually let me call this the tax rate, okay? And then I can continue this otherwise after reformat, so times 1 minus the tax rate, the same as calculating the tax separately.

In this case I just do it in one go.

If I copy this to the right, you will see in the final year we have notepad of 159.1 million at a tax rate of 21%.

Okay? Makes sense 'cause we're forecasting at the company is going to improve.

If you gave me this model, I would probably question, wow, this is a huge improvement in terms of EBIT. You know, we're clearly coming out of the restructuring.

I would probably forecast a couple more years to get to something which is not quite as extreme in terms of my forecast final year in terms of margins. That makes sense. But in terms of that improvement, that's quite a big jump, right? We're gonna leave the numbers as they are.

Then I need to add back D&A.

Okay then I need to take off CapEx and I have a change in working capital in OWC.

Remember working capital, I'm just gonna call it working capital, working capital being defined as your accounts foreseeable, plus your inventory is minus accounts payable in this case.

Okay? So D&A I'm gonna get from the cashflow because I have a full cashflow on the bottom of my financials.

So again, column E is the 2025 June year ending financial year. So I'm going to take that D&A and just hook it up.

I'm just gonna share this. I'm just gonna do one year and then copy to the right.

Then I will have the CapEx for this year. Again, I'm staying column E.

It is a cash outflow so it should be shown as negative.

Finally, I have my change in working capsule, okay? And you can see forecasted this and the signs are all correct.

So might as well use the cashflow numbers of 6.8 million negative, which means I can now calculate my free cashflow for this company.

Okay? I Peloton, which is the sum of my notepad and my cashflow items, okay? We don't have, we haven't forecasted any changes in other long-term operating assets or other long-term liabilities, which we often don't, right? Because that's really difficult to forecast.

We tend to deal with those separately if they are important, in terms of valuation, okay? If I copy this to the right, then just quick crosscheck in the final year, you should have 140 million of free cash flows.

And I think that compared to the actual, NOPAT certainly makes sense, right? Because we are reinvesting in the business a total of 18.6 million, okay? And um, and you know, as we're maturing that reinvestment will slowly come down because I don't need as much working capital as I'm growing the business.

I don't need as much money in terms of CapEx. Okay? So that's our free cashflow forecast for Peloton.

So let's value our business.

The first thing I'm gonna do is I'm gonna go and do a year count.

Okay? Because it's so much easier just doing it this way.

So one, and this needs to be a absolute number. Here we go.

Can we get a proper number please? So one, and I'm just gonna get rid of the decimals and then, and I'm gonna make this one blue so I know this has been an input and then just quickly calculate the rest of them.

And our formatting is all a little bit screwed up.

Here we go. And just copy that to the right. What happens is we create a solution and we take out the numbers, but we forget sometimes to take out the formatting.

So that's your year count. Then I can calculate my discount factor as we did for our exercises before.

Okay? So 1 divide by 1 plus the WACC, which is the 8.99% up here if I can get to it.

F4 to the power of the year count, right? We're assuming everything happens at year end. Okay? So just copy that to the right.

So the year the discount factor for the final year is 65% because we're five years out and we've got a relatively high cost of capital of 9%, right? So then I can calculate the present value, present value of free cash flows.

It's exactly same as we did before.

Take your free cash flow forecast times the discount factor. Obviously that loss is, has a slightly less impact now because it is a loss we're predicting in 12 months time.

Copy that to the right. Okay, I'm just gonna show you my formula.

And then the other thing I'm going to calculate just up here is the terminal value, right? So I'm just going to put the terminal value into my forecast and we said we would sell at 12 times ebitda.

Okay? So if I just get the and I need to unfreeze my pains 'cause I can't get to it.

So hang on. So my terminal value, I will freeze again in a minute.

Is 12 times EBITDA. Okay? So 12 times EBITDA, I've got EBIT on this page, so might as well use this.

And I've got the depreciation, which I think is in this row.

Yep. D&A. So that will give me my EBITDA.

You can also link this to the underlying model and let me just freeze my screen again.

Okay, so we've got a terminal value of three and a half billion.

Let me know if you have any questions on what I'm doing at the moment, okay? More than happy to answer them because the questions so far have been absolutely phenomenal.

Okay, so then I'm gonna calculate the sum of the free cash flows. So some of present value of free cash flows.

Okay, well, I'm just going to say some and then highlight those cash flows.

And that is 146.4 million.

So the first five years are actually only worth 146 million.

It's not much, huh? Because we obviously have a company which is somewhat underperforming at the moment, i.e.

that loss and then stabilizing towards the end of our forecast horizon.

Okay? Let's hope that that will actually happen with Peloton and that should say some and not dumb, whatever that is supposed to mean. That word doesn't exist. And then I'm gonna calculate the present value of the terminal value.

Remember, we are assuming that at the end of year five, I'm selling this business to someone that gives me three and a half billion.

And that reflects the net present value of all free, future free cash flows from year six onwards.

Okay? So I need to discount this back to today's value for which I will use the same discount factor of 65%.

Okay? So that gives you your terminal value or present value of terminal value.

That means I have the components for the enterprise value.

So enterprise value or remember this is the marked value of all operating assets.

Just sum these two up, okay? And we get 2.4 billion.

So on an enterprise value basis, the company's worth 2.4 billion.

But I want to know the equity value, okay? So I need to do my bridge and my bridge really important as of today because we're, we're assuming we're standing at the end of June, 2024, which we're not that far away from, okay? And we're valuing the company as of today. So on the latest net debt, I want the latest non-core assets, et cetera.

So what I'm gonna get is my cash.

I'm gonna get my debt and I'm going to get my investments if the company has anything I in non-core assets.

And here I'm going to use Felix, okay? Because we, you know, we could dig around the financials, but actually we might as well use Felix because you can see in the middle of that page on valuation, we have an enterprise value bridge, okay? And I can see that their cash position is 794.5.

By the way, if you click into this, it will take you into the underlying filing of Peloton, okay? And we'll show you where the number comes from, which is just super in terms of just figuring out where, where the numbers are coming from.

I'm just going to link this, because I'm going to upload, upload this file so that you can then see where the numbers are coming from. So you can just click straight through from the Excel into Felix.

Okay, so this is from Felix.

You can also just type in the number.

Then my debt, if I go back to Peloton, right, again, back to the bridge, you can see we have our debt of 1619. If you click into this, then you can see we have two elements.

I'm actually just going type this in because I can't be bothered to link this to two.

So 1691 is our total debt and equivalence, 1691.

Okay? As I said, they have done some restructuring and as part of that, they've actually raised some more debt, which means that's why they have so much cash, right? Because that's a huge amount of cash if we think about it.

And then I'm gonna have a quick look at my enterprise value bridge.

Is there anything in here that I need to have a look at separately? And I can see the investments are 0. Okay? So I can ignore this and I have nothing else. There's no pension ability, no nothing.

So my investments are 0.

So I can now, again, this is from Felix.

I can now calculate the equity value of the business as of today.

Okay? Start with my enterprise value.

Add my cash, deduct my debt because the cash hasn't been valued yet.

I haven't got any interest in income in ebit.

I haven't looked. I need to take my debt off to actually get to my equity value and I have no investments. But if I had any, I would just add them up. Okay? And here, ideally market value. If they're really small, just use the book value.

So my implied equity value is 1.5 billion for a Peloton.

So if it's a private company, I stop. Okay? And I have a starting point for the valuation of my private company.

Remember when we value, it's a crystal ball, right? We're always looking into the future and we don't necessarily know what the weather's gonna be like in a week's time.

So how do we know what the company's gonna do in a week's time? So we normally use multiple valuation methodologies to effectively really sort of triangulate the value of that business. So I would never just use a DCF, but I would actually look at look at, you know, both trading comms and the DCF and maybe some industry specific valuation methodologies.

So last step, it is a public company, so we're gonna get the shares outstanding.

Okay? Shares outstanding. Again, I'm gonna get from here.

We've got fully diluted shares outstanding of 352.8.

So 352.8, okay? Which means it implies a share price, current share price of 4.36.

Okay? Let me compare this to the current share price, which is 3.45. That's the share price as of last night, okay? Which means we believe the company is currently undervalued by 26%.

I am not making the recommendation that you should buy Peloton shares, right? First of all, our forecast slightly out of date.

Secondly, Peloton is having some issues at the moment.

So I think that shareholders are probably not certain if this company is going to really survive its restructuring, right? Or if they potentially gonna sell that technology.

Because in the end, you know, what is really important is the technology rather than just the treadmill.

Treadmills, you know, you can get from anywhere, but actually the connection to the app, et cetera.

So I think that the market is probably marking them down at the moment due to the underperformance plus that 12 times EBITDA is, has quite a big impact, right? We could run a quick data table, but if I just use 10 times, then you can see we're actually roughly at the current share price, right? So if we are looking at a range between 10 and 12, then suddenly the company doesn't look that overvalued any longer.

So I'm just gonna put the 12 back in here.

And, um, and you can see, um, you know, our numbers as this as, calculated and that ladies and gentlemen is how we do a DCF. The maths behind is relatively straightforward.

The single most important thing, actually three things.

Get your free cash flow to work, make sure you can defend your assumptions. So calculate some ratios. I what's the EBIT margin? What's the reinvestment, what's the return risk capital Number two, your cost of capital.

Okay? And obviously we normally look at ranges.

And number three, the assumption on the terminal value.

Those three are the most important items to really think hard about and be able to defend when you're doing your DCF.

Anyway, hopefully this has given you a good idea on how to do a DCF, okay? You don't need a full model, you just need the drivers of the free cash flow.

And I hope that we will see you in one of our upcoming sessions. Next week we're gonna talk about comparable transactions, which is obviously an M&A valuation methodology.

If there are no further questions, then I wish you all a fantastic weekend, wherever you are in the world, and see you soon on one of our next sessions.

Thank you very much for attending and goodbye.