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# Discounted Cash Flow (DCF) Tutorial Part II - PowerPoint PPT Presentation

Discounted Cash Flow (DCF) Tutorial Part II. Wednesday, February 7th, 2007. Recap from Last Week. Basic Underlying Principles Time Value of Money (A dollar today is worth more than a dollar tomorrow) Present/Future Value PV=FV/(1-i)^n FV=PV(1+i)^n Opportunity Cost

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Wednesday, February 7th, 2007

• Basic Underlying Principles

• Time Value of Money (A dollar today is worth more than a dollar tomorrow)

• Present/Future Value

• PV=FV/(1-i)^n

• FV=PV(1+i)^n

• Opportunity Cost

• What is a business worth?

• A business is worth the present value of the expected future cash flows of the business.

• Ex. Target Corp (TGT):

\$60 Share Price

x 858.89 Shares Outstanding (mm)

= \$51,533 Market Capitalization or Market Value of Equity

• What is Free Cash Flow?

Net Income

Less: Capital Expenditures (CAPEX)

= Free Cash Flow to Equity

• Basics of DCF Analysis

• Compostion

• Computation

• Forecasting

• Screening for companies

• Where do you find the financial data

• Introduction to the DCF Model

• Example of ‘how to use’ the model

• Dell Inc.

• Currently trading at \$23.90/share, with a

52.42b Market Cap

• Web-site to use: Yahoo Finance

• Web Address: finance.yahoo.com

• On the left margin click on ‘Stock Research -> Screener’

• Initial Screen Criteria

• Price to Earnings (P/E) ratio no greater than 20

• The Company’s Return on Equity (ROE) should be greater than or equal to 10%

• On-line

• Edgar

• (http://www.sec.gov/edgar/searchedgar/companysearch.html)

• Yahoo Finance, or Reuters

• File Looking for?

• 10-K: Annual Filing

• 10-Q: Quarterly Filing

• Important Sections

• Part I: (Business/Risk Factors)

• Part II:

• Management Discussion and Analysis of Financial Condition

• Consolidated Statements of Financial Position

• Four main sections of the DCF Model

• Historical Values

• Future Projections

• Discount Rate & Perpetuity Growth

• Comparison of the Fair Value to the Current Market Price

• Variables to change within the Model

• ‘Blue’ cells change

• ‘Black’ cells DO NOT change

• Six Step Process

• Screen for the company

• Find the financial data

• Input the historical data into the model

• Make future projections based upon research and information within the 10-K/10-Q

• Apply the Discount Rate & Perpetuity Growth

• Compare the Fair Value to the Current Market Price

• Go to Yahoo Finance

• Website: finance.yahoo.com

• On the left margin click on ‘Stock Research -> Screener’

• Screen initially for:

• Price to Earnings (P/E) ratio no greater than 20

• The Company’s Return on Equity (ROE) should be greater than or equal to 10%

• Secondary Screen

• Price to Book less than 1.5 – 2.0

• Debt to Equity Ratio less than 1.5 – 2.0

• Current Ratio greater or equal to 1.0

• Use:

• Edgar

• (http://www.sec.gov/edgar/searchedgar/companysearch.html)

• Yahoo Finance, or Reuters

• Search for the 10-K/Annual Data

• 10-K

• Financial data found in Part II of ‘Consolidated Statements of Financial Position’

• Want to input historical data for the past five years

• Historical Data that we are looking for:

• Revenues

• Net Income

• Depreciation

• Capital Expenditures (CAPEX)

Note: Revenues and Net Income will be found on the Income Statement and Depreciation and CAPEX will be found on the Cash Flow Statement

• Need to forecast in the areas of (blue text):

• Revenue Growth Rate

• Net Income Margin

• Depreciation as a % of Sales

• CAPEX as a % of Sales

• Dell Example

• Revenue Projection facts to consider

• Historical Revenue Growth: 5 year average of 15.8%

• Too high to use for a five year forecast?

• 41% of sales in 2006 came from outside the U.S.

• In 2007 are looking to expand their sales outside U.S.

• Desktop PC sales growth continues to decline, as a result of

cheaper laptop prices, while mobility products sales are increasing

as a percentage of sales

• ‘Servers’ business continues to grow as a percentage of sales

• As they expand outside the U.S. ‘enhanced services’ business may

increase sales

• Michael Dell will take the position of CEO once again

• Will he realign the company back to their core business?

• Is the industry saturated from a domestic and international

perspective?

• Growth rates based off of sectors of Dell’s business

• Generally assumed that Revenues would grow for the next two years, then slowly

decrease

• Net Income Margin

• Assumed that over time Dell will keep their margin in line with their historical average

• Used the historical five year average of 5.8%

• Depreciation as a % of Sales

• Used the historical five year average of 0.7%

• CAPEX as a % of Sales

• Used the historical five year average of 1.3%

• Question: Why forecast Depreciation and CAPEX as a % of Sales?

• Discount Rate:

• Will assume a 10% Discount Rate as the opportunity cost of my money

• Perpetuity Growth

• Assumed the company is a ‘Going Concern’

• Use a rate at or below the rate of inflation

• Used: 2.5%

Step 6: Compare the Fair Value to the Current Market Price

*Note: This tells you that according the DCF Model, we can buy 1 share of Dell for \$23.52 today, while the NPV of their future cash flows are valued at \$26.14 per share.

• Screening for companies

• Where do you find the financial data

• Introduction to the DCF Model

• Example of ‘how to use’ the model

• Dell Inc.

• 6 Step Process