| ign="center"> | | | | The growth rate g of Free Cash Flow after the |
| DCF Analysis is one of the most popular valuation | | | | Terminal year. |
| methodologies in use today. | | | | Advantage nr. 4: Ability to perform valuation analysis |
| DCF Analysis offers several advantages over other | | | | which is almost totally independent from the |
| valuation methodologies: | | | | prevailing capital market conditions |
| Advantage nr. 1: Ability to customize the financial | | | | Since DCF Analysis considers business model of a |
| model which is the basis for the valuation to any | | | | company being valued in great detail and only based |
| given business situation. | | | | on specific business metrics, it is possible to capture |
| DCF Analysis is most universal and can be used to | | | | the âtrueâ value of a company |
| value any business, provided a reasonable financial | | | | being valued with reference only to its specific |
| forecast can be created. | | | | situation and without regard for the overall capital |
| Knowledge of financial modelling techniques allows to | | | | market conditions. |
| customise the financial model for any business | | | | This is very important as sometimes the capital |
| venture and business development scenario. As such, | | | | markets are influenced heavily by prevailing |
| using the DCF Analysis we can value any business no | | | | macroeconomic conditions, e.g. during recession years |
| matter how unique the business model is. This is in | | | | valuation of companies fall in general. This way some |
| sharp contrast to the Comparable Trading Analysis | | | | good companies are âpunishedâ by |
| which can be used to value a given business only if | | | | the markets without good reason. This is one of the |
| comparable public companies do exist and if financial | | | | most important limitations of Comparable Transaction |
| forecasts are available for these comparable | | | | methodology. |
| companies. | | | | Main disadvantages of the DCF Analysis include: |
| Advantage nr. 2: Ability to select an appropriate | | | | Disadventage nr. 1: High dependence on the chosen |
| discount rate wacc which specifically addresses a | | | | assumptions |
| unique circumstances of a given capital market | | | | Outcome of the DCF Analysis is highly dependent on |
| Since the applicable discount rate wacc is individually | | | | several key assumptions. Some of the most |
| calculated for each DCF valuation analysis, a high level | | | | important assumptions where judgement is exercised |
| of flexibility exists to capture the reality of a given | | | | include the wacc components, the Free Cash Flow |
| capital market. Wacc calculation includes the following | | | | growth rate âgâ after the Terminal |
| main factors:a) risk free rate of interest of a given | | | | Year, the revenue growth rate, the EBIT, EBITDA |
| capital market (e.g. T-Bills in the USA)b) risk premium | | | | and Net Income margin assumptions and the Working |
| commended by equity investors over risk free | | | | Capital assumptions. This limitation can be addressed |
| investments in a given capital marketc) Beta of a | | | | by running sensitivity analysis. |
| given business (Beta measures how sensitive the | | | | Disadventage nr. 2: The necessity to prepare a |
| equity return of a given company is in relation to the | | | | financial model |
| market return (e.g. return of S&P 500 index) Beta = | | | | Unfortunately DCF Analysis requires preparation of a |
| 0 means that the returns are not correlated at all | | | | comprehensive financial model of a company being |
| (Beta can be negative) Beta = 1 means that the | | | | valued. It is an intensive and labour consuming |
| return of a company is 100% correlated with the | | | | process which requires a considerable technical |
| return of the market. | | | | expertise. |
| Advantage nr. 3: Ability to run sensitivity analysis | | | | In summary it seems that advantages of the DCF |
| Sensitivity analysis is the analysis which tests how | | | | methodology outweigh the disadvantages, and DCF |
| sensitive the outcome of the valuation is to the | | | | Analysis will remain in the foreseeable future one of |
| changing values of the key inputs and assmptions. | | | | the most important and universal company valuation |
| Since valuation is more of an art than science, | | | | methodologies. |
| sensitivity analysis is highly useful in negotiating and | | | | DCF Analysis is extensively used for: |
| agreeing what the value of a given company is, as it | | | | Company valuations for the Merger and Acquisition |
| allows to position the valuation as a range of values, | | | | transactions |
| rather than a single value. | | | | Compliance valuations |
| Most popular inputs which are being tested in the | | | | Investment analysis for the venture capital and |
| sensitivity analysis for a company being valued | | | | private equity investors |
| include: | | | | Restructuring valuation analyses |
| Growth rate of revenues, EBITDA, EBIT and Net | | | | Specialized reports required by the IFRS (intangible |
| Income margins, Level of corporate synergies (esp. | | | | asset valuations and purchase price allocations; |
| In M&A transactions), Working capital assumptions, | | | | goodwill impairment analysis) |
| CAPEX levels, Obtaining new debt, paying faster | | | | Reports supporting litigation and dispute resolution |
| existing debt, Obtaining funds through an IPO or an | | | | (e.g. |
| SPO, Wacc inputs (risk free rate, risk premium, Beta), | | | | |