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DCF Valuation: Getting it done!


If you are stuck here..

Try this..

And for more, go here…

1. I have not picked a company

Pick one (even randomly)

Project description (on website for class)

2. I cannot decide what currency to use in my analysis

Generally, pick the currency in which your financials are reported. This will be usually be the local currency though some non-US  natural resource companies report in US dollars. But check (3) ..

Session 3 of lecture

3. I cannot get a riskfree rate

The riskfree rate is a long-term default free rate. If there is no long term government bond rate in the currency, switch to a different currency. If there is a long-term government bond rate, but the government has default risk, net the default spread from rate.

Session 3 of lecture
Paper on riskfree rates under research/papers

Dataset on country ratings and default spreads

4. I am having trouble with estimating the equity risk premium.


For mature markets (AAA rated countries), you can use the historical risk premium for the US (4.79%).  For non-mature (<AAA) markets, you have to estimate a country risk premium. Alternatively, you can use the implied equity risk premium in any market.

Sessions 3-4  
Paper on equity risk premiums under research/papers
Spreadsheet to compute implied premium

Dataset on country risk premiums

5. I do not know whether I should estimate a lambda.

Estimate a lambda only if you have a company that is an emerging market and gets a substantial portion of its revenues from developed markets.

Session 4

Paper on company risk exposure to country risk (has average revenue exposure by country)

6. I do not know where to find a bottom-up beta.

You can use the betas that I have for different businesses on my site or come up with your own comparable firm list and estimate a beta. (Remember to lever up the beta using your company’s D/E ratio

Session 5

Ten Questions on bottom-up betas
Chapter 8 in investment valuation book
Datasets on betas on my site (for the US, Europe, Emerging Markets & Japan)

7. I am having some issues getting a cost of debt

The cost of debt is the current long-term borrowing rate. If your company is rated, use the default spread based on the rating. If not, use a synthetic rating. If you have a money losing company with no rating and debt, use a BB rating and move on.

Session 5
Spreadsheet for synthetic rating (has spreads from June)
Link to a site that has current default spreads (will cost you $29)

8. I do not know what to include in debt in the cost of capital.

Include all interest bearing debt and the present value of lease commitments. Do not include accounts payable or supplier credit or unspecified long term liabilities.

Session 6

Spreadsheet for converting operating leases

9. I am having trouble deciding which model – dividends, FCFE or FCFF – to use in valuation.

If you are working with a financial service company, go with dividends. For other firms, take a look at the current debt ratio. If you feel that it may change in the future or are unsure, go with FCFF. If you feel that the debt ratio is stable and will not change, go with FCFE.

Session 10
Spreadsheet to help you choose a model (Don't be a slave to it.. Use your best judgment)

10. I cannot find a spreadsheet to use.

You can build your own spreadsheet or use one of mine. If you are absolutely sure about model specifics (2-stage, 3-stage etc), you can go with a specific model. It is generally safer to go with one of the ginzu models.

Dividend ginzu spreadsheet
FCFE ginzu spreadsheet
FCFF ginzu spreadsheet
High Growth/ Negatve Earnings/ Changing margins spreadsheet

Video for FCFFginzu spreadsheet

11.  I am entering the numbers in the spreadsheet but I am having trouble deciding which numbers to use.

Always use the most current numbers you can get for every input, even if it means that they do not match up. For market numbers, this will be today’s numbers. For accounting numbers, it will be trailing 12-month for those inputs where you can get them and the last annual report numbers, where you cannot.

Sessions 7, 8 and 9

The spreadsheets will allow you to capitalize leases and convert R&D (in the firm value spreadsheets). You will have to decide whether you have to normalize some of the numbers to adjust for the volatility over time.

12. I now have a DCF value. I have no idea what to do about cash and cross holdings.

If you are doing an equity valuation, you may already have valued the cash and the cross holdings, if you used unadjusted net income. If you are doing a firm valuation or an equity valuation based upon adjusted net income, you should be adding the cash and marketable securities to it. You should also be adding the estimated market value of minority holdings in other companies and subtracting out the estimated marekt value of the minority interests.

Session 11
Paper on cash and cross holdings

13. My company has granted options to its managers over time, and there are millions of them outstanding. I am not sure wha to do with these.

Value the equity options outstanding and subtract from the overall value of equity. If your company is continuing to grant options, think of it as compensation expense and reduce your operating margins looking forward.

Session 12
Paper on management options

14. I have a value of equity but it look weird.

Revisit your inputs and make sure that your units are not off. Check your assumptions about growth, reinvestment and risk to make sure that they are consistent.

Checklist on valuation