Analytical insights from DCF value analysis

DCF based values can be analysed between a current operating value and the value created by short-term growth, medium-term investment, and long-term franchise factors. We provide an interactive value analysis model and explain how this can help in understanding and refining DCF valuations, particularly if combined with adjustments in respect of intangible investment.

DCF value analysis gives more insight than the common split between the present value of cash flows in an explicit forecast period and the present value of the ‘terminal value’ at the end of that period. We demonstrate the approach by analysing the enterprise value of UK retailers Tesco and Ocado.

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DCF terminal values: Using the right exit multiple

If a valuation multiple, such as EV/EBITDA, is used to calculate a DCF terminal value, the multiple should reflect expected business dynamics at the end of the explicit forecast period and not at the valuation date. This is best achieved by basing the exit multiple on forward-priced multiples for the selected group of comparable companies.

We explain and illustrate with an interactive model the use of forward-priced multiples in DCF. We also discuss the choice of multiple (including why EV/EBITDA may not be the best) and whether to apply the exit multiple to reported or adjusted profit.

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DCF terminal values: Returns, growth and intangibles

If DCF terminal values are based on continuing forecast cash flow, it is important that the reinvestment assumption is consistent with long-term return expectations. We provide an interactive DCF model that demonstrates four alternative cash flow growth-based terminal value calculations, along with related returns analysis.

One of the challenges when using returns in equity valuation is the limited recognition of intangible assets. Adjustments to capitalise intangible investment do not change cash flow but can help in ensuring that the assumptions that drive forecast cash flows are realistic.

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