7. Calculating the Discounted Cashflows

 
Subtitles Enabled

Next lesson: The Terminal Value Part 1

Preview next lesson

Overview

In this lesson, we calculate the weighted average cost of capital (WACC) for MarkerCo and discount the unlevered free cashflows for the next 5 years.

Summary

  1. Lesson Goal (00:00)

    The goal of this lesson is to calculate the discounted values for the unlevered free cashflows.

  2. Calculating WACC (00:04)

    Before calculating discounted cashflows, we need to calculate the WACC. This will give us the discount rate to use on our cashflows. In our case, MarkerCo has no debt, so the WACC will be equal to the cost of equity, which we can calculate using the CAPM formula. 

    To calculate the cost of equity, we need to know the risk-free rate, the expected market return, and the Beta value for MarkerCo. We can identify these values using an external data source, such as a Bloomberg terminal. Once we identify these numbers, we can calculate the cost of equity using the CAPM formula. The cost of equity equals the WACC in this model.

  3. Calculating Discounted Cashflows (01:12)

    After identifying the discount rate, we use this rate to find the discounted value of unlevered free cashflow for each future year in our model. To discount a cashflow, we divide the cashflow amount by one plus the discount rate. This denominator is raised to a power representing the number of years in the future. Using this formula, we calculate the discounted value of unlevered free cashflow for each future year.

    To calculate the enterprise value, we add all the discounted future cashflows together. However this calculation is not complete, as it only considers the period of our financial projection, which is five years in our case. We need to account for the cashflows in years beyond our projection to complete the enterprise value calculation.

Transcript

Now that we have our unlevered free cashflows ready, we can begin discounting, so I'll start by calculating the WACC. Because MarketCo has no debt, the cost of debt will obviously equal to zero, so when calculating the WACC, I simply need to calculate the cost of equity and my task will be complete. After consulting my Bloomberg Terminal, I can see that the interest rate on 10-year government bonds is 2.3%, and I'll add this as my risk free rate. My expected market return is 8%, and from my terminal, I can find that the beta is 1.3. Using these values, I can calculate the cost of equity and the WACC, so I'll take the risk free rate, and then I'll add the market premium, which is the expected market return minus the risk free rate, and multiply this by beta.

And this gives me a cost of equity of 9.71%, and of course the WACC will be the same value. I can now perform my discounted cashflow using this discount rate, and I'll start in 2016, which is this column H.

So I'll take the cashflow, and then divide by one plus the discount rate, which I'll anchor with F4, and put it to the power of the year in question.

This will be year one, and to calculate this, I'll take 2016 and subtract 2015, anchoring this cell, and this tells me my discounted cashflow is 10.7 for 2016.

I can then copy this formula for the remaining cells. To calculate my enterprise value, I'll simply sum discounted cashflows together, and my answer is 65.1 million.

Given that the unlevered free cashflows each year range between 12 and 24 million during this time period, this value seems quite low, and obviously the problem is we've only discounted cashflows for the first 5 years into the future. We now need to account for all the remaining cashflows that exist beyond our projection, and to do this, we need to calculate what's called the terminal value. I'll show you two methods of how to calculate the terminal value in the next lesson.

Financial Modeling Essentials
Performing Your First Company Valuation