What are the steps to conduct a discounted cash flow analysis?

Forecast Cash Flows: Project future cash flows for the investment over a certain period, typically 5-10 years. Estimate Terminal Value: Calculate the value at the end of the forecast period, often using the Gordon Growth Model or an exit multiple. Determine Discount Rate: Choose an appropriate rate, usually the weighted average cost of capital (WACC), to reflect the investment's risk. Discount Future Cash Flows: Use the discount rate to calculate the present value of each forecasted cash flow and the terminal value. Sum the Values: Add the present values of all forecasted cash flows and the terminal value to get the total DCF value. Sensitivity Analysis: Test how changes in key assumptions (growth rates, discount rate) impact the DCF value.

Key common mistakes to manage when projecting cash flows - Avoid overly optimistic revenue forecasts without considering market conditions, competition, and historical growth rates. - underestimating expenses through failing to account for potential increases in costs, unexpected expenses, and general inflation - ignoring working capital requirements which is often missed in cash flows. Examples are inventory levels, accounts receivable, and accounts payable. - not accounting for capex which is sometimes omitted or underestimated in cash flow projections. - neglecting economic and industry cycles can greatly affect both revenues and expenses, and not accounting for these can lead to inaccurate projections.

Expenses should exclude depreciations and amortizations, since those are non-cash items. However, the tax shield of tax depreciations or tax amortizations should be considered for the calculation of income taxes. Financial expenses and incomes shkuld be excluded from the calculation as well.

The most important and core step in a DCF analysis is to clearly identify all marginal cash in & out flows that will be generated by the project, namely capital investment, working capital movements, revenues, costs, operating margin and taxes. It is also critical to identify any impacts that the project will bring to existing parts of the business and include those in the overall net cash-flow projections. Once a business plan is established with clear cash-flow impacts, the next and final step is to assess its value and discount those cash-flows in order to measure its net present value (NPV). It is critical to use a relevant discount rate that genuinely reflects the risk of the project and the cost of its financing (see CAPM).

Certainly, projecting cash flows involves estimating the inflows and outflows of cash within a specific period. This typically includes revenue from sales, investments, loans, and other sources against expenses like operating costs, investments, and debt repayments.Sales Forecast,Expense Estimation,Capital Expenditures,Debt Servicing,Taxes,Other Cash Inflows and Outflows.Utilize financial models, historical data, industry benchmarks, and expert opinions to make these projections. Regularly reassess and adjust these projections based on actual performance and changing market conditions for more accurate planning.

A few things to watch when estimating the terminal value - Overly optimistic growth rates that exceed the long-term growth rate of the economy can significantly overestimate the terminal value. - Inappropriate discount rate either by not adequately reflecting the risk profile of the business or by failing to adjust the rate over time, can lead to a misvaluation. - Neglecting competitive/technological changes while assuming the company will continue to operate in the future as it does today - Not considering capex and working capital needs. - Failure to apply a terminal multiple appropriately if using the exit multiple method.

Tener en cuenta la fórmula VTt = CFn+1 /(K – g). Son muy comunes las equivocaciones en la línea temporal de los flujos de caja, anticipando o retrasando algunos de ellos incorrectamente. Para evitar este error, resulta muy útil dibujar una línea del tiempo con los distintos cash flows. También atentos con la tasa de crecimiento perpetua "g", utilizar sentido común, más analisis perpectivas del mercado.

Terminal value should only be used if the investment is assumed to have indefinite life. Growth rate should be at least as high as the inflation rate implicit in the discount rate. Anything less than that would equate to assume constant decrease of.the cashflow in real or constant terms. Relevant investments to replace fixed assets should be part of the calculation of the CAPEX in the terminal value, reflecting their impact on the average future investment (which may be different to the CAPEX of the last year of the core projection period).

If cashflow will be discounted using the WACC as discount rate, then it is important that said flows do not include any financial cost.

This definition is incomplete. An investor would also consider the impact of synergies. That is, the possibility that the acquired assets could generate additional cashflow in other assets owned by the investor. In that case the investor would be willing to pay an additional goodwill for the investment.

In conducting the sensitivity analysis it is important to recognize the additional value brought by real options. That is, the possibility of expanding or reducing the capacitynof the asset, or disposing it altogether under extreme cashflow scenarios (positvive or negative). Real options always increase the value of the assets.

As a rule, if the DCF value is far from the market value, the most likely explanation for that is using wrong assumptions for building the DCF model. In most cases, the market knows things better than an accountant who builds a model based on his/her limited knowledge of the project/industry.