Definition of discounted cash flaw

Valuation: Cash Flow Discounting  February 1, 2011 – 09:39 am
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The discounted valuation technique (DCF) is the backbone of modern finance and even modern business. DCF permits to measure investments, analysing in and out cash flows, and when applied to company valuations defines the intrinsic value of a company (as an alternative to market valuations like comparable companies and precedent transactions). To understand DCF, is important to have a perspective of the company based on the following variables:

  • 4 variables from the Balance Sheet: any investment can be seen as an increase the assets, net working capital or net fixed assets, and will be financed with liabilities, debt or equity
  • 6 variables from the P&L: the net profit derives from the following variable, Sales, Cost of Good Sold, Selling/General/Administration, Depreciation/Amortization, Interest/Non Operating Expenses,  and Taxes

Now that we have defined the 10 variables that define the finance story of a company, we can combine them to define different types of cash flows:

  • Equity Cash Flow: we know that, Cash + NWC + NFA = D + E. The differential format of the previous formula is: ∆Cash + ∆NWC + ∆NFA = ∆D + ∆E. If we assume that: 1) cash is going only to the stock holders, and not to the operations, ECF=∆Cash, 2) the ∆E is generated only by the NP. We have:  ECF= NP – ∆NWC – ∆NFA + ∆D

Source: Notes in the cloud

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