Ringo Guide: DCF

Can mid year convention be used with the perpetuity growth method or the exit multiple method?

It can be used with both for your perpetuity growth method. The mid-year convention just moves the cash flows to the middle of the year when you're discounting it back to reflect the fact you receive cash flows throughout the year. This is just affected by how you discount it. With the exit multiple method you're using financial metrics that are inherently end of year already so you can use the mid-year convention to discount back your cash flows. It will only matter because your valuation is not based on those cash flows.

A company decides to increase its debt to equity ratio from 1x to 2x. How is your DCF impacted?

Unlevered DCF: Interest doesn't hit unlevered FCF, so the effect runs entirely through WACC. Accretive only if the added debt moves the company toward its optimal capital structure and lowers WACC. If leverage is seen as too risky, cost of debt and levered beta rise, WACC goes up, and value falls. → Depends on position vs. optimal leverage.

Levered DCF: Discounted at cost of equity (not WACC). Higher interest lowers levered FCF, and more leverage raises beta → higher cost of equity. Both a lower numerator and higher denominator push value down. → Directionally negative to equity value.

The conventional accounting definition of working capital is current assets minus current liabilities and includes cash and marketable securities in current assets and short term debt in current liabilities.

a. Should you consider all cash, operating cash or no cash at all when you compute working capital?

b. Should you consider short term debt as part of current liabilities?

So the goal of a DCF is to find out the value of the business's core operations.

To answer Part A, typically you're going to include no cash at all in competing working capital because cash is not considered operating. It's most related to financing and it can earn a return so it doesn't really fit the criteria of working capital. Now technically you will have some cash helping run the business day-to-day as part of those core operations but this is going to be hard to estimate and not reported by the company. It's also going to be small relative to the overall cash balance usually so you just leave it out.

****Alt (Damodaran) framing: Working capital represents cash tied up in "wasting" assets that don't earn a fair return (e.g., inventory sitting on shelves, or cash in a low-yield account), which is the lens for why it matters at all.

To answer Part B, short-term debt is interest-bearing and that is also more financing than it is operational. You're going to leave that out of current liabilities to get an accurate look at the company's operating working capital, which is what you essentially want in a DCF.

Depreciation and amortization includes a number of different items. Some of them are tax deductible (like conventional depreciation on assets) but some are not (like amortization of goodwill). In computing depreciation, should you include all depreciation and amortization or onl y tax-deductible depreciation and amortization?

Well the purpose of a valuation is to record the actual cash flow, so what cash is going in and out of the business. Non-tax-deductible items like the amortization of goodwill aren't going to affect the cash balance of your company so you don't have to reflect them. You only need to reflect the tax-deductible portions of DNA.

Describe a recent DCF that you did?

GSIF something

Describe how you use the iteration function in Microsoft excel to arrive at FDSO in a DCF

The existence of in-the-money options and warrants, creates a circular reference in the basic formula between the company's fully diluted shares outstanding count and implied share price. In other words, equity value per share is dependent on the number of fully diluted shares outstanding, which, in turn, is dependent on the implied share price. This is remedied in the model by activating the iteration function in Microsoft Excel. It is under tools, then options, then the circulation tab, then manual, and then iteration. Select maximum iterations to 1000

Difference between IRR and compound annual growth rate?

IRR is a metric that measures your average annual returns based on an initial investment and is flexible to account for multiple cash flows over multiple years.

CAGR measures the average annual growth based on a start and end point, just 2 values.

Do dividend discount models cause us to have too high or too low of a valuation?

Too low as we assume all excess cash is paid out in dividends and not put to other uses, which could boost the FCF or value through things like share buybacks or reinvestment of earnings.

Do we use real or nominal use dollars in our DCF valuation?

We use nominal dollars because that is typically how investors and management teams think about dollars. Also to use real dollars we would have to project out inflation or we could use TIPS as the “real risk free rate” no matter what country the company is based in.

Equation for Retention Ratio?

(1-PayOut Rate), which you could then multiply by ROE to get the EPS growth

Equation for ROE?

Net Income/Average Book Value of Shareholder’s Equity

Equation for ROIC?

NOPAT/Invested Capital

Invested Capital = Equity + Debt + Other Debt-like investment (preferreds) - cash

Equation for total beta. What does total beta assume?

Total beta can be found by dividing the unlevered beta of a company’s peer group by the square root of R squared.

This assumes you are not diversified at all as an investor

***Captures a company's total risk (systematic + unsystematic), not just market risk like regular beta.

Formula: Total beta = Market beta ÷ Correlation with market (correlation < 1, so total beta > market beta).

Assumes: the investor is undiversified — holds the company as a large share of their wealth, so they're exposed to all its risk. (Standard CAPM beta assumes a diversified investor compensated only for systematic risk.)

Used in: private/small-company valuation, where owners can't diversify → higher cost of equity → lower valuation.

Equation for WACC

WACC = Cost of Equity(%Equity) + Cost of debt(%debt)X(1-TaxRate) + Cost of Preferred(%preferred)

Formula for savings in taxes from NOLs?

NOL * TaxRate = DTA

For what kind of companies would a DCF not be important?

So a DCF would not be very important for a company that is in terminal decline or a startup company where its cash flows are farther into the future. It also won't be very useful for a company with very unpredictable cash flows because a DCF is supposed to eventually reach steady state and if you don't know what that is, you can't really project it.

How are preferred dividends treated in a levered DCF?

Preferred dividends are a deduction from levered free cash flow that reduces the overall value of your equity.

How are revolving credit facilities factored into the cost of debt?

The cost of debt is a function of what interest you would be charged on long term debt you acquired TODAY. Therefore, companies with higher debt drawn down from their revolvers would likely be viewed as more risky than companies that didn't have a higher draw down, causing their cost of debt to be higher. Plus, there’s typically a fee you have to pay to have the money sitting there for you to draw down from.

How can you check the validity of your terminal value if you are using the exit multiple method?

You can essentially back out the implied growth that your exit multiple method is implying and compare that to a realistic range or compare it to what you get using your perpetuity growth method to sanity check.

(TV*WACC - FCF in terminal year) / (TV + FCF in terminal year)

How can you check the validity of your terminal value if you are using the perpetuity growth method?

You can calculate the implied exit EBITDA multiple that your growth rate corresponds to.

Implied EBITDA multiple is equal to your terminal value / EBITDA in your last year in your projection period

How do capital leases affect ROIC vs operating leases?

Not identical — they converge on the balance sheet but differ on the income statement.

Invested capital (denominator): ~the same — both put a ROU asset + lease liability on the balance sheet, both captured in invested capital.

NOPAT (numerator): differs. Finance lease splits expense into depreciation (above EBIT) + interest (below EBIT), so only depreciation hits operating profit → higher EBIT/NOPAT. Operating lease books the whole payment as operating expense → lower NOPAT.

Result: similar denominator + higher NOPAT → finance lease gives higher ROIC than an operating lease.

Note: under IFRS 16 the distinction disappears (all leases finance-style); this gap is US GAAP only.

How do Convertible bonds affect your WACC?

As debt (pre-conversion): Treated as debt in the capital structure. Debt is the cheaper source of capital — lower required return than equity (senior claim) and tax-deductible interest (× (1 − tax) shield) — so while it's outstanding, it holds WACC down relative to the all-equity case. Note: cost of debt is the company's current market borrowing rate, not the bond's coupon — so the convertible's low coupon doesn't lower cost of debt; the added leverage, if anything, nudges cost of debt (and cost of equity) up.

On conversion (debt → equity): The cheap, tax-shielded debt is retired and replaced with more expensive equity (no tax shield, junior/higher required return). The capital-structure weights shift toward the costlier source → WACC rises.

Conclusion: Convertibles keep WACC lower while they sit as debt; once they convert to equity, WACC increases.

How does a change in interest rates impact a DCF?

Cost of debt: ↑ — new borrowing is more expensive. (Separately, the market value of existing fixed-rate debt falls.)

Cost of equity: ↑ — a higher risk-free rate flows straight through CAPM (Rf + β × ERP).

Weights: ambiguous on both sides — rising rates lower the market value of debt and equity, so neither weight cleanly rises or falls. Don't anchor the conclusion on the weights.

Net: the decisive factor is that both cost components rise → WACC ↑ → higher discount rate → valuation ↓.

How does a mid-year convention affect a DCF?

The Mid-Year Convention increases the value of your DCF because you're receiving cash flow sooner, which means that the time value of money is deteriorating them less.

How does a mid year convention impact a company if they use the exit multiple method or if they use the Gordon Growth Method?

A mid-year convention will impact a company if they use the Gorin growth method because again it's going to affect the periods that you're discounting back in that exclusive forecast period. It's also the Gorin growth method is based on your cash flows, which use the mid-year convention. The exit multiple method is based on LTM financials and the end-of-period financial metrics like EBITDA, which does not factor in mid-year convention at all.

How does LIFO vs FIFO accounting impact a DCF in an environment where prices of inventory are falling over time?

If prices are falling over time, FIFO is going to lead to a higher cost of goods sold, a lower net income, and higher cash flow, which is going to increase the value of your DCF. Whereas LIFO was going to do the opposite. It's going to have a lower cost of goods sold and a higher net income but it's going to lead to a lower cash flow and a lower valuation.

***Ultimately, you will have the same tax burden in the long run but because your are paying less in taxes today and having high FCF TODAY rather than having higher FCF in the future, the time value of money will result in a higher valuation for the company using FIFO accounting instead of using LIFO accounting.

How does LIFO vs FIFO accounting impact a DCF in an environment where prices of inventory are rising over time?

So life is going to give you a higher value because higher costs get sold at lower net income by higher cash flow, meaning you're receiving cash higher cash flows in the near term. This, due to the time value of money, is going to increase your valuation compared to getting those higher cash flows in the long term with FIFO accounting. Assuming that eventually there's a reversal and that your ultimate tax obligations are still the same, since by the way life over FIFO is a timing difference

How does owning assets vs renting them impact a DCF?

Typically renting is going to increase your valuation relative to owning an asset because if you own assets you incur depreciation, which you get to add back, but you have to subtract capex. If you're continuously buying assets, that capex is going to be higher than your depreciation and so your cash flow is going to decrease. Whereas if you rent assets, it's just an expense on your income statement and this will affect your cash flow but you won't have that big capex draw down.

How does the terminal value calculation change when we use the mid-year convention?

Depends on whether you are using the multiples method or the Gordon Growth Method

Multiples Method: Add 0.5 to the final discount number to reflect the fact the company gets sold at the end of the year

Gordon Growth Method: You use the final year discount number as is because you are assuming the cash flows extend into perpetuity and that they are still received throughout the year rather than just at the end of the year

How does your DCF differ between a car manufacturer and a tech company?

So for the tech company you're likely going to see more stock-based compensation. You're going to probably see R&D although you might see R&D with the car manufacturer as well. With the car manufacturer you're probably going to see more capex and depreciation.

Tech companies are probably going to have higher margins because it's less capital intensive and less fixed expense to some extent. Potentially it will spread across a lot of customers as the car manufacturer has very high fixed expenses and operating leverage. This high operating leverage and cyclicality is likely going to make the beta a bit higher. Although because the car manufacturer has more assets, it might be able to get a more favorable cost of debt using those assets as collateral. Whereas the tech company is probably pretty asset light and so its cost of debt is going to be high, which is why it's going to be using mostly equity to probably fund its operations, which will likely make its WACC higher, especially since it will probably have a high beta.

Tech company beta is high because their value sits far in the future usually so they are more susceptible to changes in the discount rate.

How do NOLs affect a DCF?

NOLs needed to be valued separately in your DCF. You need to find out the PV of your NOLs based off of when they will be exercised (when operating income will be positive). This value should then be discounted at WACC to its PV. The PV of your NOL will then be added to the normal FCF of the company. You are overall taking the PV of your future tax savings from NOLs and adding them to the PV of the normal cash flows of a company. Any future negative operating income would add to your NOL balance.

Using NOLs lowers your effective tax rate, which increases your cash flow so it increases the valuation that DCF gets.

How do operating leases vs capital leases impact a DCF?

Capital leases have D&A (Interest Expense won't affect your NOPAT!!!). This decreases your pre-tax income and your taxes. The D&A is then added back to NOPAT, ultimately leading to a higher unlevered FCF. Your cost of debt and equity will likely remain the same since the leases will already be reflected in your default spread of your debt and in the beta of your cost of equity. Your WACC may actually be lower depending on how much debt you originally had on your balance sheet. This is because debt has a lower cost of capital that equity. You will have to subtract a higher amount of debt when moving from implied enterprise value to implied equity value Your ROIC will be lower with capital leases though Operating leases decrease your pre-tax income due to the rent expense. This leads to lower FCF and leads to a lower valuation for your company. You won't have to subtract out any additional debt when moving from implied enterprise value to implied inequity value ROIC will be higher with operating leases

How do you account for a company in a DCF that ends its fiscal year in August or September rather than December 31st?

It would just change the length of the period used in your stub period calculation based off of where you are in the year relative to August or September. So if it was the beginning of May, you would have a stub period of .25

How do you account for convertible bonds in WACC?

Convertible bonds are first a liability that increases your cost of debt, then when they get converted into shareholder’s equity, they decrease you proportion of debt, and increase your proportion of equity, meaning your WACC will become higher.

How do you arrive at a company's optimal capital structure?

Optimal capital structure is when WACC is lowest. A company should continue to add debt to its capitalization until the negative affects of leverage begin to overshadow the positive affect of the tax deductible nature of interest payments.

How do you arrive at cash flows available to equity investors from net income?

Take net income + D&A +- changes in NWC - CapEx - Mandatory Debt repayments + new debt issued - preferred dividends

How do you calculate a equity risk premium for a foreign country?

Can add default spread for a specific country to US equity risk premium (default spread is the same spread used for the risk free rate) Can also take... US equity risk premium * (std dev of Brazilian equity market / std dev of US equity market) -This method can be a problem though if a equity market has low liquidity and therefore low std deviation but is still risky

How do you calculate a risk premium?

Look at the difference between what investors will require to invest in equity markets vs what they will require to invest in a risk free security. Look at what S&P is today. Then estimate average dividends and stock buybacks will be going forward for entire S&P based on estimated growth in earnings. Looks at what investors EXPECT dividends and share buybacks will be. Then solve for the discount rate that will make these dividends and stock buybacks equal to the price of the bond. From here, subtract out the risk free rate and you get your implied equity risk premium.

How do you calculate a terminal value?

Two ways: Gordon Growth and Exit Multiples

For exit multiples method, you’ll want to take a financial metric like EBITDA from the final year of your explicit forecast period and apply a multiple based on comps

For gordon growth, You take the final year of cash flow from the explicit period and project it out one more year based on your PGR. Then, you take this cash flow and divide it by the discount rate minus your PGR to get the terminal value.

How do you calculate beta for a private company?

Would get an unlevered beta from comparable public comps, then relever this beta to the private company's capital structure. Could then divide this by the "r" of the industry beta to arrive at "total beta" since private investors lack diversification and liquidity unlike diversified public equity investors. Could also calculate it based off of an accounting beta or use some type of circular function to back solve the equity value of the company and then plug this into your beta debt to equity formula

How do you calculate beta for a private company if it has no comparable companies?

Run a regression of historical revenue and S&P revenues. Could also do a bottom-up beta for companies that have earnings that are correlated with your company's earnings, therefore making them comparable Circular equation in DCF that solves for market value of equity and plugs it back into your WACC calculation

How do you calculate cost of debt?

Cost of debt is the interest rate the company would have to pay for any additional issuances. You can calculate this through, typically, the default spread method, where you take the risk-free rate and you add the default spread implied by the company's credit rating. That will give you the interest rate. The other way you could do it is to look at a blended interest rate of the debt that the company is already servicing and that would be a proxy for it.

then whatever you get that rate to be, you have to multiply by one minus the tax rate to get the after-tax cost of debt.

***If the company is not rated you can create a synthetic rating by looking at relative interest coverage ratios between your company and rated companies. In addition to this you can add a country specific default spread over your risk free rate

How do you calculate cost of debt for a private company?

Use interest coverage ratios to get an implied credit rating if the company doesn't already have a credit rating and get a default spread from this

How do you calculate the cost of equity?

Use the Capital Asset Pricing Model.

CoE = RFR + re-levered Beta(ERP-RFR)

How do you calculate the " fair value" of an asset?

Look at the returns that assets is expected to generate over its life, and discount it back to PV.

Look at what similar assets valued at

Look at what people paid to acquire similar assets

How do you calculate the reinvestment rate for operating income?

(Net Capex + Change in Net working Capital)/ NOPAT

You then Multiply this by ROIC to get Growth in Earnings

How do you calculate the risk free rate for a company in a foreign country?

• Look at where their debt is currently trading, and subtract the default spread implied by their credit rating.

• Look at the cost of debt for the largest and safest firms in the country

• Can also just value the company in US dollars

How do you calculate the risk free rate in the US?

Typically, you are going to look at what the 10yr treasuries are yielding, but ideally you’ll line up your explicit forecast period length with the bond trading at that duration

How do you calculate the risk free rate of a multinational firm?

Could get a weighted average risk free rate by looking at what $ of their cash flows or revenues are generated int he different countries and then using that discount rate, basically doing a SOTP

Could also just use the risk free rate of the country whose currency the company’s financial statements are denominated in

How do you calculate Wacc for a private company?

WACC = (E/V)(cost of equity) + (D/V)(cost of debt)(1 − tax). The challenge: a private company has no stock price, so no market cap and no observable beta. Workarounds:

Cost of equity (CAPM): Can't use the company's own beta (none exists). Instead:

1. Take public comps' levered betas.

2. Unlever each: βU = βL / [1 + (1 − tax)(D/E)].

3. Take the median, then relever to the private company's target structure.

4. CAPM: Rf + β × ERP. Often add a size/illiquidity premium.

Cost of debt: No traded bonds, so approximate from the company's credit profile — leverage (debt/EBITDA), interest coverage, size → synthetic rating → yield spread over Rf. Or use the rate on its existing loans. Apply the (1 − tax) shield.

Capital structure (weights): No market cap, so use a target / industry-average D/E from the comps rather than book values.

Key idea: you borrow risk parameters (beta, structure) from public comps and adjust them to the private company, since its own market-based inputs don't exist.

How do you "capitalize" R&D?

Capitalize as an asset and amortize (straight line) over a 5 year period. Allows your company to look more profitable than you would have otherwise. The company's value will be higher if R&A is creating value and lower is R&D is not productive.

**I think the company would lose value and my reasoning for it is this.

Currently, you expense R&D through the balance sheet which increases the tax shield by (t)*R&D expense. Lets assume 100 R&D expense this means your tax shield is 20 assuming a 20% tax rate. Based on time value of money I get all of that benefit today.

Lets now say that I can't expense it and I have to amortize it. Instead of 100 expense in this year now I charge 20 (100/5) to my P&L assuming a 5 year amortization using straight line. Now my tax shield if only 4 (20%*20) the remainder of which will be discounted and we all know money today is worth more than tomorrow.

How do you choose the optimal debt ratio for a company?

See if it minimizes WACC

How do you compute taxes in a DCF for a country that operates in several different countries

Some people argue to calculate taxes based on a weight of where you get your income from. It makes far more sense to use the marginal tax rate of the country the company is domiciled in as a floor. After all, (***this is based on pre-2017 rules) income earned in countries with lower tax rates than the domestic tax rate eventually has to be repatriated back to the domicile at which point it will be taxed. It is a tougher call for countries with higher marginal tax rates than the domestic tax rate. Here, it does make sense to use a weighted average.

How do you "convert" operating leases into capital leases?

Post-ASC 842 update (effective 2019): Manually capitalizing operating leases — taking the PV of lease payments as a debt-like liability, creating a matching asset, and splitting the rent into depreciation + interest — was essential pre-2019, when operating leases sat off the balance sheet (footnotes only) and you had to build the liability yourself. Now ASC 842 (US GAAP) and IFRS 16 already report operating leases on the balance sheet as a ROU asset + lease liability, so the balance-sheet step is done for you. The reclassification still matters on the income statement: under US GAAP an operating lease is expensed as a single straight-line rent line, so if you want to treat it like a finance lease — splitting it into depreciation + interest to clean up EBIT/EBITDA or to compare a US GAAP company against an IFRS 16 filer (where all leases are finance-style) — you'd still strip out the rent and reclassify. (Note: the 2019 change is ASC 842 / IFRS 16 — not the 2017 TCJA, which was tax.)

How do you determine the number of years in the projection period of your DCF?

You typically want an amount of years that will allow the business to reach a normalized state, but also extended long enough to fully capture the effects of any business cycles or trends that it is caught up in today.

How do you do a DCF for a company whose fiscal year ends on a date other than December 31st?

You do everything the same except you create a stub period

How do you do a DCF for a private company?

Same process as valuing a public company except you don't have a market value for debt or equity and the financial statements are likely less comprehensive. You will not be able to arrive at WACC and beta and your valuation will only tell you an aggregate Enterprise / Equity value that is not on a per share basis. For your beta calculation, you could use the Hamada equations along with an average Debt/Equity ratio for comparable companies to calculate a bottom-up levered beta. To estimate cost of debt, we would have to create a "synthetic" credit rating by comparing the companies Coverage Ratios to that of the average Coverage Ratios of companies falling under different credit ratings. We would then find the default spread for companies with this rating and add this to our risk free rate to arrive at our cost of debt. To calculate WACC we would use the previously calculated cost of equity and debt along with the debt/equity ratio used in our beta calculation to arrive at a WACC.

How do you model in synergies from an acquisition into your DCF?

• Cost synergies would create higher margins

• Revenue synergies will create higher revenue

• Ultimately, you get a higher valuation

How do you move from levered to unlevered FCF?

The first thing you’re gonna need to do is subtract debt issuances, and add back principle repayments and preferred dividends. Then, from Net income you need to add back interest expense on the income statement as well as any other income or expenses to get to EBIT, which you then multiply by the tax rate to get Nopat

Also, add back NI attributable to minority interest

How do you project revenue in a DCF?

Three methods:

• Growth rate

• Units sold times average selling price

• Market share times market growth

• Revenue synergies from a recent acquisition

How do you select the appropriate Exit multiple when calculating the terminal value?

Typically, you look at comps, but may normalize depending on business cycles. Also, depends on whether you are doing levered or UFCF, because then you have to pair the result of that with a denominator that makes sense

How do you unlever / relever beta when a company has preferred stock?

Levered Beta / (1 + (D/E*(1 -t) + P/E))

How do you value synergies in a DCF?

Cost synergies could boost margins Revenue synergies would increase top line Would result in a higher valuation

How is a DCF impacted if a company does a share buyback funded by debt?

It depends on whether the incremental cost of debt lowers WACC or increases it by an amount that would exceed the benefit of less dilution.

How is beta related to the risk free rate?

As interest rates increase, bond PRICES fall. As a result, your market value of debt would decrease, causing your beta to fall (Hamada equations)

How is Capex impacted by acquisitions of other companies?

Have to be added to net capex and subtracted from Net Income to arrive at FCF. This is considered a re-investment in your business.

• The purchase price is added in Capex

• If you pay with shares it is still Capex!

  • It is calculated based off the number of shares issued and the stock price on the day they were issued

How is dividend yield factored into cost of Equity?

It's that CAPM uses total returns (price appreciation + dividends) throughout—both in the equity risk premium (market return over risk-free) and in how beta is measured. Because the whole model is built on total returns, dividend income is baked in and you don't add dividend yield separately.

How is interest expense factored in in an unlevered DCF

Interest expense isn’t factored in anywhere. Although, the interest rate is used to calculate the after-tax cost of debt

How is WACC affected by taxes?

Higher taxes = lower WACC and vice versa

Higher taxes create a higher tax shield on the debt, thus lowering the cost of debt. And, it lowers beta when you relever, because the impact of debt in the hamada equation will have a larger shield.

How is WACC affected when your company raises debt?

It depends.

if your proportion of debt and the cost of that debt outweighs the benefit of the tax yield, then your WAC is going to increase because a higher debt-to-equity ratio also increases your relevered beta. However if the increase in the proportion of debt and the cost of debt is such that you're moving closer to the optimal capital structure, then even though it raises cost of equity a little bit, the proportion of debt will overall weigh down your weighted average cost of capital and reduce it.

How is your WACC impacted if a company is acquired or makes an acquisition?

When companies make an acquisitions, they capitalize the acquired assets and liabilities at the fair market value. This will cause equity value to change accordingly, causing a change in our D/V and E/V weights in our WACC calculation. WACC will also be impact by the amount of debt the company takes on to make the acquisition or if the company issues shares to make the acquisition (issuing shares would increase our equity value). If a company is acquired, then the financial statements of the company would be combined with the acquired companies financial statements, causing you to have to recalculate WACC based on the newly combined company.

How long do you make a projection period in a DCF for a highly cyclical company vs a mature stable company?

The projection period for a mature stable company can typically be shorter, like 5 years, because it is already in a fairly normalized state.

For a highly cyclical company, you have to capture the cycles of a business. and get it to a point where it is roughly normalized before you can extend into your terminal period, so you have to have a longer projection period.

How should short term interest bearing debt be treated in a DCF?

Should NOT be included in working capital Should be included in your debt and cost of debt in your WACC calculation. Also should be subtracted out when moving from implied enterprise to implied equity value

How will a sudden drop off in the market affect your equity risk premium (assuming cash flows remain constant)?

It will increase it. Risk premiums move in the opposite direction of markets. If a market had a very bullish year, your risk premium would decrease! (straight from damodaran). If you have a big fallout in the market, it will "scare" investors and force them to have a higher rate of required return Also, if stock prices drop and you expect to receive the same cash flows through buy backs and stock dividends, then your discount rate increases

How will callable bonds affect cost of debt?

Callable bonds increase the cost of debt at issuance. The embedded call option benefits the issuer and hurts the investor (call/reinvestment risk—the bond gets called away right when rates fall and it's most valuable). To compensate for bearing that risk, investors demand a higher yield than on an otherwise-identical non-callable bond, so the issuer pays a higher coupon/yield upfront.

They're priced on a yield-to-worst basis—the lowest yield across all possible call dates and maturity—since the issuer will exercise the call in whatever way is least favorable to the investor. But that's a conservative pricing convention, not a reason the cost falls.

The offsetting benefit: the issuer is paying that premium for the flexibility to refinance. If rates drop, the company can call the bonds and reissue new debt at a lower rate—lowering its future cost of debt. So the trade-off is: a higher cost of debt now in exchange for the option to reduce it later.

How will capital leases affect an unlevered vs levered DCF?

Only the depreciation element would affect an unlevered DCF, and both the depreciation and the interest expense would affect the levered DC.

Cost of debt under WACC may be higher because the the cost of debt with your Unlevered DCF.

How will the WACC of an all equity firm differ with a firm who is extremely levered?

The difference is that the cost of debt impacts the cost of equity, but the cost of equity doesn’t impact the cost of debt. So, a highly levered firm will also have a high cost of equity, and wacc will be extremely high. Whereas, a company with all equity will have a high cost of equity, but that will be the only cost.

Though, to determine which WACC specifically would be most affected, we would have to run the exact numbers

How will WACC differ from a country domiciled in the US vs a company domicilied in Russia?

If we assume that the Russian markets are considered less stable and riskier than the US. markets, then the WACC is going to be higher. Investors will demand higher returns for the risk they are taking, which will be reflected in the equity risk premium.

Additionally, tax rates could be different, and the risk free rate my change as well.

How would accelerated vs. straight line depreciation impact your valuation in a DCF?

Accelerated depreciation would provide a significant near term boost in cash flow, while straight line depreciation will provide a more gradual boost, as they both shield from tax obligations as non-cash expenses. Both will have the same ultimate cash expense associated over time, however, due to the time value of money, we would prefer the accelerated depreciation.

How would a change minority interest impact a levered DCF?

higher minority stake reduces levered FCF attributable to the parent's common shareholders, because a larger share of the consolidated subsidiary's earnings belongs to minority holders rather than the parent.

How would a DCF be impacted if your company was acquired?

DCF looks for intrinsic value, and acquisitions pay a control premium above that, so you don’t really factor in getting acquired into your DCF. Instead, you would do a DCF on the combined entity, in which case revenue or expense synergies could increase cash flows, while the WACC may change due to the new capital structure, and you could see whether the acquisition creates or destroys value for the combined company

How would a DCF for an unstable international company be different for a DCF of company domiciled in the US, assuming it is the exact same company?

The unstable international company would likely have a longer forecast period, higher WACC due to the higher beta and potentially ERP, and potentially higher cost of debt, and ultimately a lower value. Additionally, there may be a different tax rate or the comps will be different based on the geographic region.

How would an increase in a deferred tax liability effect your FCF in a DCF?

An increase in a DTL means that your cash taxes are lower than your book taxes, which is reflected as a cash inflow on the CFS under working capital, which would then increase your FCF and increase the value.

How would a spin-off impact your DCF?

You don't project spin off's in a DCF. Would have to do two seperate DCFs and value the divisions seperatly (without synergies) and determine if their summed values equal the value the combiend stocks are trading at

How would a tax inversion enacted during your projection period impact your DCF?

Post-TCJA, an inversion lowers the projection-period effective tax rate, but GILTI, BEAT, and the Pillar Two global minimum tax claw back most of the benefit, so the reduction is modest. The critical move is to normalize the terminal tax rate upward—the advantage erodes through anti-inversion rules and the global minimum tax, so you don't run the depressed rate into perpetuity. The old 'deferred tax liability on unremitted foreign earnings' logic is largely obsolete under the current quasi-territorial system. I'd also revisit WACC for the new domicile's country risk, and I might lean on an exit-multiple terminal value to reduce reliance on a perpetual tax-rate assumption."

How would classifying assets as operating leases or capital leases impact a DCF?

Overall, there might not be much of a valuation impact in a DCF if a company uses capital leases instead of operating leases because: 1) With operating leases, the company's Unlevered FCF would be lower because of the rental expense and no D&A add-back. 2) However, at the end of the analysis you also don't need to subtract the operating leases when moving from Implied Enterprise Value to Implied Equity Value because they are not a Balance Sheet liability. As a result, the company's Implied Equity Value would be higher because there are fewer debt-like items to subtract at the end. With capital leases, Unlevered FCF would be higher because there is no rental expense and because the D&A add-back is higher. There is no interest expense in getting to Unlevered FCF. WACC will likely be lower since you are financing more of your business with debt with has a lower cost of capital than equity. Beta and cost of debt already reflected your operating leases and will likely not change if your reclassify leases as capital leases. Therefore, WACC will probably be lower. However, at the end of the analysis you also have to subtract the capital leases as a debt-like item when moving from Implied Enterprise Value to Implied Equity Value because they ARE now a Balance Sheet liability. So it's tough to say which one would produce a higher or lower value - most likely, the result would be about the same if the rental expense and D&A figures are reasonable.

How would negative interest rates impact your DCF?

increase valuation by lowering cost of debt and making WACC extremely low. Probably not negative because there’s still a default spread and the equity risk premium that will keep it somewhat elevated

How would raising additional debt affect WACC?

Depends where you are on the WACC curve. If you’re moving toward optimal, it will lower it, if moving away, it will heighten it

***Would cause your cost of debt and cost of equity (beta) to rise. According to madigliano and miller, in a tax free world it would not affect your WACC at all, however the tax shield from interest payments reduces you WACC up to a certain point

How would the beta of a luxury car manufacturer compare to the beta of a generic pharmaceutical company?

The pharma company would be less affected by the market cycle since its goods are inelastic and medicines are needed regardless of whether or not we are in a market boom or a recession. The luxury car company sells discretionary items and would be much more impacted by market volatility since less people would be able to buy nice cars

How would the market risk premium vary depending on what country you are in?

The market risk premium (MRP)—the extra return investors demand for holding equities over the risk-free rate—varies across countries because the underlying risk environment differs. Higher-risk countries carry a higher MRP; stable developed markets carry a lower one.

The drivers:

1. Country/political risk. Emerging or unstable markets (weaker rule of law, expropriation risk, political instability, currency volatility) require investors to demand more compensation → higher MRP. Stable developed markets (U.S., Germany, Japan) → lower MRP.

2. Sovereign/default risk. A country's own creditworthiness matters. This is often captured by a country risk premium (CRP), frequently proxied by the country's sovereign default spread—e.g., the yield spread between that country's dollar-denominated government bonds and U.S. Treasuries, sometimes scaled up for equity volatility. Higher sovereign risk → higher MRP.

3. Inflation and currency stability. High or volatile inflation and unstable currencies raise the required return.

4. Market maturity and liquidity. Deeper, more liquid, more diversified markets tend to have lower premiums; thin, concentrated markets demand more.

How would you calculate beta for a private company (4 ways)?

• Look at public comps, then re-lever at the peers or private firms optimal capital structure

• Regress revenue growth against S&P 500 revenue growth

• Could use a circular DCF function after you get equity value to back-solve for beta

How would you calculate cost of debt for a private company? What about preferred

• Look at their leverage and interest coverage ratios, and get an implied default spread from that

  • For preferred: look at what comparable companies pay on their preferred, or benchmark off spreads appropriate to where preferred ranks (Cost of preferred = preferred dividend/preferred stock price

• Could also use YTM of the companies most recent debt issuance

How would you calculate the terminal value for a private company?

For a large private company, we would use the traditional methods of the exit multiples method and the gordon growth model

With a small business it is questionable how long this business will last and if it is accurate to project this company into perpetuity. As a result, you could

• apply a "going concern" discount to your multiple

• project FCF further into the future until you believe the business will end

• or assume the companies future liquidation value as your liquidation value

How would you calculate the terminal value of a very small private company

Apply a going concern discount, forecast cash flows until they’re obsolete, or forecast to a point, then calculate their liquidation value (tangible assets - liabilities)

How would you calculate WACC for a private company?

• Cost of equity

  • normal risk free rate, find beta by looking at public comps, running regression vs S&P or circular DCF function, apply a slightly higher ERP due to the illiquidity premium of private markets

• Cost of debt

  • Apply implied default spread based on leverage and interest coverage ratios (or YTM on latest issuance)

  • Must get capital structure from comps as well

Could also just look at the WACC of public comps

How would you do a DCF for a recent tech start up with unstable cash flows?

Realistically, a DCF would not be very suitable because of the lack of stability. You may need to use another valuation method like comps. If I had to do a DCF mode, though, I would create a very long forecast period to get them to a steady-state by the time the terminal period hits, and create a very through sensitivity table at the end to reflect the fact that my assumptions have a much larger margin for error.

How would you factor a complete change in capital structure into your DCF during your projection period?

• If you are using current capital structure to calculate your WACC, then the change would be reflected in the WACC changing from that year forward in the DCF

• However, it is much more accurate to use the company’s optimal capital structure, since you are trying to make forward projections, so this may have no impact.

How would you move from levered FCF to Unlevered FCF?

A: Add back your principal repayments, preferred dividend payments and interest expense * (1-tax rate)

How would you project growth for a private company?

Look at consensus estimates for the company's sector, calculate the market share of the private company, and use this to calculate future growth rates

How would your cost of debt be affect if an operating lease is reclassified as an capital lease?

They usually don't affect your cost of debt by much. Credit rating agency already account for operating leases as capital leases in their ratings most of the time. Therefore, if a company reclassified operating leases as capital leases, their cost of debt would likely remain unchanged.

***no cash flows, no actual obligations change. Lenders and analysts look through the accounting to the real leverage and coverage. So nothing that actually drives credit risk has moved.

***One nuance the answer glosses over: while the economic cost of debt shouldn't change, reported credit metrics can shift optically. Moving a lease onto the balance sheet as a capital/finance lease adds debt and can worsen reported leverage ratios (D/EBITDA, etc.), while EBITDA improves because the lease expense splits into depreciation and interest rather than sitting entirely in operating expense. A lender relying mechanically on covenant calculations might react — but a sophisticated one who was already adjusting won't