Discounting Workout
- 03:31
Understand how to discount free cash flows and terminal value for DCF purposes.
Glossary
Discount Factor FCF PV Terminal ValueTranscript
In this workout we need to calculate enterprise value.
We've been provided with the free cash flows for years one two and three.
the terminal value at the end of year 3 and the WACC which we will be using as the discount rate of 10% The first thing we need to do is enter our year account and we have got three years of detailed forecasts.
Next we need to calculate the discount factor.
The formula for calculating the discount factor is 1 divided by 1 plus the discount rate.
The power of whatever year we are in.
Now I'm going to want to copy this formula to the right. And so I need to lock on to cell C9 where my discount rate is.
And if we copy that to the right we will see that we have a discount factor of 90.9% in year one decreasing in years 2 and year 3 If we do a sense check, it does make sense that our discount factors should be decreasing.
A cash flow that happens in year 3 is less valuable in today's terms than a cash flow that happens in year 1.
Now that we have our discount factors. We need to take each year's cash flow and multiply it by that use discount factor.
So if we do year 1 free cash flow times the discount factor for year 1 and copy that to the right.
We have the prison value of years one two, and three's cash flows.
So we're going to sum those up to get the total value of those cash flows today.
But we are not done yet, what about this terminal value? That terminal value reflects all of the cash flows that happen after year 3 so from year 4 into Infinity.
But that terminal value has been calculated as at the end of year 3.
And we are calculating enterprise value today.
So we have to discount that terminal value by multiplying it with the year 3 discount factor.
Giving us a present value of 69139.7.
To get the enterprise value we need to sum together yhe individual years cash flows together with that terminal value and that gives us enterprise value of 15798.3.