01 THE VALUATION SCHOOL | PARTH VERMA

Walk me through

DCF Model Simplest Explanation Ever!

02

Let’s start with the basic principle

of Compounding
Compounding means putting the interest you
earn back into your investment.

This makes your money grow faster as you

earn interest on interest.

Coumpounding
Growth
Orignal
Growth

Years
03 THE VALUATION SCHOOL | PARTH VERMA

+CAGR
Money Invested Money Recieved
Today in Future
Returns
Present Value Future Value
of Money of Money

But why do we Invest?

Imagine buying a 100-rupee
coffee today. But as time passes,
₹100
prices go up.

If you keep that 100 rupees

without using it, its value
goes down.

So, later, you might not be able to

buy the same coffee with it.
04

So whatever we have learned till now

we come to this equation >>>

10% p.a
100 110
That the INR 100 will become 110
after 1 year at 10% CAGR.

How much you should pay

today for the opportunity to
receive Rs. 110 in one year,

Ensuring that you still earn 10% p.a

a 10% return on your
investment.
100 110
05 THE VALUATION SCHOOL | PARTH VERMA

Just like asking for a discount on

something expensive, in finance,
we discount future money.

This helps us understand how

valuable future cash is to us
today.

This brings us to our main topic

DCF = Discounted + Cash Flow

Discounted + Cash Flow

DCF
Future ke paiso ki
value ko kitna
Same as the
Kitna paisa/nagdi/ discount kare jisse
discount we got
rokda aa ya ja raha pata chale ki aaj
in supermarkets.
hai unn future value
paiso ke liye at
present mujhe kitna
paisa dena hai
06

Why do we need DCF?

To Val
anythi ue
that p ng
roduce
Cash F s
low

To Value a
Bond
To Value Shares
in a company
To Val
Entire ue an
Busine
ss

To Value a
Project or an
Investment

To V
Incom alue an
e Pro
Prope ducing
To Value the
rty

benefit of a
Cost Saving
in a company
It Basically helps to calculate how much
an investment is worth today based on the
return in the future.
07 THE VALUATION SCHOOL | PARTH VERMA

You might be wondering that for

companies we don’t have the data
of future value then,

how do we calculate the

present value?

Let me teach you

how to do it
Abhi Btata
hun Mai !
08

STEP 1
Calculating free cash flow
(Current year)

Operating Capital
Free Cash
Flow (FCF) = Cash Flow
(OCF)
- Expenditure
(Capex)

OCF = Net Income + Depreciation and

Amortization + Changes in Working Capital

Capex = Expenditures on property, plant

and equipment (PP&E) to maintain/expand
the company's operations

Let’s look at an example to

understand this more clearly
09 THE VALUATION SCHOOL | PARTH VERMA

This is the Cash Flow Statement of a company

FCF = OCF - CAPEX

FCF= 41,965 - 2532

=39,433
In Crores (Cr.)
10

STEP 2
Calculating free cash flows
for the upcoming years.

Some Assumptions
Observe and calculate previous free cash flow growth rate
Check the growth rate of the sector/industry
Study about the main growth factors of the business
and its impact on cash flows
Check revenue growth rate, profitability margins, etc.

Let’s take an example

of the Automobile
industry >>>
11 THE VALUATION SCHOOL | PARTH VERMA

For example, for the automobile industry & company,

We can check for sales of vehicles and their growth

with future plans and past free cash flow growth rate,
etc.

CAGR 8.10% TATA Motors Domestic

Free Cash Flow (FY24 YTD)

7841 (4609)

2024 2029
Cash Profit Capex
Analysis of Automobile
Domestic Business (CV+PV)
Industry in India India AS, INR Crores

*source- Mordor Intelligence *source- Mordor Intelligence

Automobile Industry Major Players:

12

STEP 3

Calculating Terminal Value

Terminal value represents the value of an
investment at the end of the forecast period
to infinity.

Last year of
Forecast Duration

0 ∞
Forecast Period Steady Period

Present Value of FCF of Forecast

Duration = Terminal Value
13 THE VALUATION SCHOOL | PARTH VERMA

STEP 4

Calculating Discount rate

Now that we have free cash flows and the
terminal value,
we simply need to discount them to
determine the present value of the business.

*assuming a forecasting duration of 10 years

0 1 2 3 4 5 6 7 8 9
10 yr of
∞
Terminal Value

The cash flows are discounted using the

weighted average cost of capital (WACC)

WACC= E/V × Ke + D/V × Ke × ( 1-Tc )

14

STEP 5

Sensitivity Analysis
"Sensitivity analysis" is like testing the waters
with different scenarios.
We play around with key factors like growth
rates and discount rates to see how they shake
up our valuation.

It's like trying out different ingredients in a

recipe to see how they change the taste.

Helps us understand the flexibility and

reliability of our valuation model.

Discount
Rate

Growth
Rate
15 THE VALUATION SCHOOL | PARTH VERMA

STEP 6

Analysing the result

If you pay less than the DCF value, your
rate of return will be higher than the
discount rate

If you pay more than the DCF value,

your rate of return will be lower than
the discount
16

Conclusion,
DCF is a popular tool for valuing businesses,
but it's quite complicated.

Predicting future cash flows, especially for

the long term, is tough.

It's all based on guesses about the future,

so we need to stay grounded.

Be smart with DCF! It's helpful, but

don't rely on it blindly.
17 -
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