Discounting
- 02:09
Understand how to discount free cash flows and terminal value for DCF purposes.
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Glossary
Discount Factor FCF PV Terminal ValueTranscript
Here we have the five steps for discounting. We have five free cash flows. free cash flows one, two, three, four, five And we have a terminal value at the end of period 5.
Now we need to start discounting them. And the first thing to do is to calculate the discount factor. Our discount factor formula for period one is one divided by one plus the WACC all to the power of the period we're in.
And where we are is in period one, so it's to the power of 1. for period 2 similar formula divided by 1 plus the WACC but now to the power of 2. That gives us five discount factors. We can then multiply those discount factors by the free cash flows to get our present values of the free cash flow or the different time periods. I can now sum those five PVs up. And that will give me the sum of the present value of free cash flows. However, there's still one item we haven't discounted. And that's the terminal value. Because the terminal value is currently sitting in Period 5. I multiply the terminal value by the discount factor from year 5 to turn it into its equivalent value today. This is referred to as the present value of the terminal value. Now we can bring it all together and calculate the Enterprise Value by summing the two PVs that were just calculated.
Take the sum of the present value of free cash flows and add on the present value of your terminal value. And you've done it that is your Enterprise Value done.