DCF-VALUATION

The purpose of DCF-Valuation is to determine the value of a company in terms of its future cash
flows. The cash flows are adjusted with certain items (e.g. those not related to company´s core
businesses or those with no cash effect) in order to make sure the flows reflect the actually
generated cash as good as possible.

This document describes DCF valuation in detail and in our valuation model. If you would like
to get an overview of valuation in general or practical examples (numerical and graphical)
about it, then you should look at our valuation tutorial. It approaches equity valuation first
with EVA instead of DCF but as the tutorial reveals EVA approach is only an another name for
the old familiar DCF valuation. Both end up to identical end result i.e. identical equity valuation.

The underlying idea of DCF-Valuation is to compute the fair value of a company i.e. the
intrinsinc value of the company´s share. The potential of the share price (which the investors are
particularly interested in) is then computed by comparing the fair value with the current market
price of the company´s share.
The basic formulation of Discounted cash flow valuation is as follows:

 Free cash flow to firm is discounted with WACC to the Year 0 (the forecast year) in order
to get the present value of free cash flows.
 Cumulative discounted free cash flow is a yearly item in which all the forecast years´
discounted cash flows are summed up. Hence, the first item is the sum of all forecast
years´ free cash flows at present value terms.
 Value of equity FCFF is divided by the number of shares outstanding to get the fair value
of the company´s share.

More detailed formulation of Discounted cash flow valuation is as follows:

    

 EBIT is adjusted with with Taxes and Share of associated companies´ profit/loss in order
to get Operating cash flow - the figure that reflects the cash actually generated by the
company much better than the EBIT (accounting figure).
 Operating cash flow is adjusted with Total depreciation to get Gross cash flow. This has
to be done because depreciation has no cash effect and thus does not really reduce the
cash generated.
 Gross cash flow includes cash tied up in investments. Hence, Change in working capital
and Gross capital expenditure have to be subtracted from it and Increase in non-interest
bearing liabilities added to it in order to get Free operating cash flow.
 Change in working capital appears in the calculation as minus-signed if more capital is
tied up in the business than in the previous year. Gross capital expenditure in turn is the
cash used for investments during the year. Increase in non-interest bearing liabilities is
plus-signed, since it has an opposite effect than Net working capital.
 Other items include extraordinary items, which have a cash effect even though they are
not important in a operational business sense.
 Interest bearing debt, Cash at bank and Investments' share price impact are to be
added/subtracted from the Cumulative discounted cash flow so that the result of the
valuation is Value of equity, not Value of firm.

All items except for EBIT, Share of associated companies´ profit/loss and Taxes on continuing
operations the model calculates automatically. Thus, you can freely change EBIT, Share of
associated companies´ profit/loss and Taxes on continuing operations (and naturally all the
subitems which are blue).