Discounted Cash Flow (DCF) and Growth Models

Valuing equity from the cash flows it will pay: the inputs of dividend discount, FCFE, FCFF and residual income models, constant and multistage growth, their shortcomings, and preferred stock.

1. 1. Present value models: DDM and FCFEA share is worth the present value of the cash it will deliver: either the dividends expected (DDM) or the cash the company could pay out (FCFE), discounted at the required return on equity.Video · 5 minFree13 min
2. 2. Choosing the cash flow: dividends or FCFEDividends are the narrowest cash flow to equity and fit only steady, high-payout companies; FCFE adds buybacks, share issues and retained cash, so it fits most other companies but moves with every financing choice.13 min
3. 3. FCFF, EBITDA and residual incomeFCFF measures the cash available to all capital providers and barely moves when financing changes; EBITDA is a pre-tax, pre-investment shortcut that overstates cash; residual income values the profit earned above the cost of equity.14 min
4. 4. Preferred stock and the Gordon growth modelA perpetual preferred share is a perpetuity worth D/r, and a common share with dividends growing at a constant rate forever is a growing perpetuity worth $D_1/(r-g)$.Video · 6 min15 min
5. 5. Multistage dividend discount modelsWhen growth will change, forecast the dividends of the unusual period one by one, value everything after it with the Gordon model as a terminal value at time n, and discount both back to today.Video · 5 min14 min
6. 6. Growth assumptions for any cash flow: constant, implied and two-stageThe constant and two-stage growth models work for FCFE and FCFF as well as dividends; the market price can be turned into an implied growth rate, and growth itself is estimated from history (watch the base year) or from the sustainable growth rate.15 min
7. 7. The DCF process: discount rates, terminal values and rangesA DCF valuation follows five steps: choose the cash flow, forecast it, discount it at the rate that matches whose cash it is, add a terminal value, and turn the result into a point estimate or range to compare with the price.14 min
8. 8. Integrated cases: negative growth and reconciling FCFE with FCFFA declining cash flow still has a constant-growth value (the denominator becomes r plus the decline), a value range comes from a range of g, and an FCFE value converts into an FCFF model by adding debt and solving for the implied growth rate.16 min
9. 9. Integrated cases: two-stage FCFF with debt, and the effect of the debt ratioA two-stage FCFF model discounts at WACC to a firm value from which debt is deducted before dividing by shares; and when the target debt ratio changes, FCFE moves a lot while FCFF barely changes.16 min
10. 10. Shortcomings of constant and multistage growth modelsGrowth-based DCF models can mislead because the chosen cash flow may miss part of the value, the base year and static assumptions may not represent the future, the going-concern assumption can fail, and the cost of capital moves with the economy.12 min
11. 11. Preferred shares: required return and contingency featuresA plain preferred share is valued like a bond at a required return below the common equity rate, its market price reveals that return, and call, put and conversion features shift its value and the dividend it must offer.9 min