DISCOUNTED

CASH FLOWS
METHOD
 In Financ ia l Ma na gement, it has been discussed that a way to
de termine the value of a n investment opportunity is by determining the
a ctual cash gene ra te d by a particular asset.

The Net Ca sh Flows refer to the amount of cash available for

distribution to both de bt a nd equity claims if the business or asset.

For GC BO, the net c ash flows generated will be based on the cash
flows from ope rati ng a nd investing activities, since this represents already
the amount e arne d from the business and the amount earned or will be earned
from the busine ss a nd the a mount that is required to be infused in the
operations to gene ra te more profit.
 Net Ca sh Flows is preferred to as basis of valuation if any of the
following c onditions are present:

• Company does not pay dividends.

• Company pays dividends but the amount paid out significantly differs from it’s capacity to pay
dividends.
• Net Cash Flows and profits are aligned within a reasonable forecast period.
• Investor has a control perspective. If an investor can exert control over a company, dividends can be
adjusted based on the decision of the controlling investor.
• EBITDA and EB IT are both metrics that are before taxes; cash flows that are available to investors
should be after satisfying tax requirements of the government.
• EBITDA and EB IT also do not consider differences in capital structures since it does not capture
interest payments, dividends for preference shares and funds sourced from bondholders to fund
additional investments.
• All these measures also do not consider reinvestment of cash flow s made into the firm for additional
working capital and fixed assets investment that are necessary to maximize long term-stability of the
business.
In valuation, analysts find analyzing cash flows and it’s sources helpful in understanding
the following:
• Source of financing for needed investments
• Reliance on debt financing
• Quality of earnings

There are two levels of Net Cash Flows :

(1) Net Cash Flows to the Firm -is the amount made available to both debt and equity
claims against the company.

(2) Net Cash flows to Equity - represents the amount of cash flows m ade available to
the equity stockholders after deducting the net debt or the outstanding liabilities to the
creditors less available cash balance of the company.
 NE T CASH FL OW TO THE
FIRM
Net cash flow to the firm refers to the cash flow available to the parties
who supplied capital (i.e.) lenders and shareholders) after paying all
operating expenses, including taxes, and investing in capital expenditures
and working capital as required by business needs.

Enterprise value of a company refers to the theoretical value of it’s core

business activities as reflected by it’s net cash flows.
 A. BASE D FROM NET INCOME (OR INDIRECT
APPROACH)

• Net In co me Av ailable to Co mmon Shareh o lders

Basic measure of a fi rm’s p rofitabili ty which refers to th e b otto m lin e in an in come
statemen t.
• Non -Cash Ch arg es (Net)
Pertains to n on -cash i tems that are inclu ded in the co mp ut atio n o f n et in come.
• Depreciation and amortization
• Restructuring chargers
• Provisions for Doubtful Accounts
• After-Tax Interest Expense Interest expense (net of any tax
savings)
• Working Capital Adjustment
• Investment in Fixed Capital
B. FROM STAT E ME NT OF CASH FLOWS

• Cash flo w from o perat ing activ ities

This represents h ow mu ch cash the co mp any generated fro m it’s op eratio ns.
• Cash flo w from in vestin g activi ties
This represents h ow mu ch cash is disb u rsed (receiv ed ) for inv estmen ts in (sal e o f) l on g-term
assets lik e p ro perty, p lant and eq u ipmen t an d st rategic inv estmen ts in o ther co mp an ies.

• Cash flo w from finan cing activ ities

This represents h ow mu ch cash was rai sed (o r repaid ) to finan ce th e compan y.
C. FROM E ARNINGS BEFORE INTERE ST, TAXES,
DE PRECIAT ION AND AMPRTIZAT ION (E BITDA)

• EBITDA or Earning Before Interest, Taxes, Depreciation and Amortization

pertains to income before deducting interest, taxes, depreciation and amortization,
net of taxes.

• Tax Savings on Non- Cash Charges

Non-cash charges are not typically adjusted if NCFF starts with EBITDA.
NE T CASH FL OW TO EQUITY

• Proceeds fro m Bo rro wi ng - th is refers to th e amo u nt of cash received b y th e compan y as a result

o f bo rro wing of lo n g-term d ebt.
• Debt Service - is the total amount used to service the loans or debt financing.
• Proceeds fro m Issu an ce o f Preferred Sh ares- same with d eb t, p referred sh ares as an oth er form of
finan cin g, ot her th an the issu ance o f o rdin ary eq uity, mu st also b e facto red in th e calcu lation of
n et cash flows availab le to eq uity.
• Dividends on Preferred Shares - since payments made to preferential shareholders in the
form of dividends are outflows .This must be incorporated in the calculation as a reduction
of the net cash flows to the equity.
A. BASED FROM NE T INCOME (OR INDIRECT
APPROACH)
B. FROM STAT E ME NT OF CASH FLOWS
C. FROM E ARNINGS BEFORE INTERE ST, TAXES,
DE PRECIAT ION AND AMORTIZATION (EBITDA)
TERMINAL VALUE
Terminal Value represents the value of the company in perpetuity or in a
going concern environment. In practice, there are several ways on how to
determine the terminal value.
 BASIS OF TERMINAL
VALUE
1.Liquidatio n Val ue
2.Estimated Perp etual Val ue

For example, a Filipino company is expecting for

15% returns for a venture and assumes that their
net cash flows for the next five years are as
follows:
In the given illustrat ion, you m ay not e that the net cash flows are growing annually. Assuming this is a
GCBO, and it is expected that the net cash flows will behave on a normal trend. The growth rate (g) is
computed using com pounded annual growth rate formula:

Subst i t ut i ng t he given figures, the growth is com puted as :

Since the growth rate is 10%, it will be applied on the farthest cash flows i.e. on the 5th
year equivalent to Php 7.32, thus the farthest cash flows is now Php 8.05 or will substitute
the CFn+1. It is now assumed that the cash flows will continuously growth at the rate of
10% per annum. thus, the formula can now be applied.
In some cases, that the historical growth pattern undetermined, some analysts only consider
the cost of capital or their required return to determine the terminal value. In the given
illustration, you may note that difference on the terminal value:

You may observe that the terminal value in this case is more conservative by about Php107.
 BASIS OF TERMINAL
VALUE
3. Constant Growth

4. Scientific Estimates

OTHER INPUTS IN THE NET CASH

FLOWS
DCF Analysis is most applicable to use when the following are available:

• Validated Operational and Financial Information

• Reasonable appropriated cost of capital or required rate of return
• New quantifiable information
Illustrative Example No. 1
Bagets Corporation has projected to generate revenues, cash operating expenses, and the corresponding tax
payments for the next five years:

The investment in fixed capital that was purchased and invested in the company amounted to Php100 million. To
be financed by:
• 60% from loan borrowing with an annual interest of 10% payable equally in five years. First payment will be
due after 1 year, and
• 10% preferred shares with 8% coupon rate.
If you are going to purchase 50% of Bagets Corporation, assuming a 15% required return, how much would
you be willing to pay?
Bagets Corporation Discounted Cash Flows Analysis
Financial Models in Discounted Cash Flows
Analysis

1. Gather historical information and references

2. Establish drivers for growth and assumptions