7. Calculating the Discounted Cashflows

 
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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.

Lesson Notes

Calculating WACC for MarkerCo

- MarkerCo has no debt so the WACC = Cost of Equity
- Risk-free rate is assumed to be 2.3%
- Expected market return is 8%
- Beta is 1.3
- These inputs produce a WACC of 9.71%

Calculating Enterprise Value

- Our discounted cashflow projections contribute directly to Enterprise Value
- However, they only represent 5 years of discounted cashflows
- We need to provide cashflows for all future years to calculate Enterprise Value
- We will do this using the terminal value method

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.