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# What is DCF?

Interview maths MBB practice
New answer on Sep 10, 2020
3.8 k Views

Hello

What is the DCF equation? I came across a case and they solve for DCF value to decide whether the investment is attractive or not. They used DCF = (profits/year)/Discount Rate however according to some resources available online shouldn't be
DCF = cash flow / (1+discount rate) ? assuming 1 year.

How common is it to get DCF in a real case for non-MBA?

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• Date ascending
• Date descending

Hi,

The case is a simplified version of the real-life problem. Thus a lot of approaches are simplified for the sake of saving time

In the case of DCF, usually, you will calculate a very simplified version of it:

• You will use net profit instead of cash flow
• You will calculate the NPV in perpetuity, that is Net Profit / discount rate

Best

Hi there,

First, DCF and NPV are very common so make sure you understand them (how to calculate, when to calculate, how to interpret)

NPV = Cash inflow(s) value - Cash outflow(s) value

In essence, your DCF is the difference between the present value (NPV) of cash inflow(s) and the present value (NPV) of cash outflow(s).

Note, you may be asked to calculate the NPV of EDIBTA, Income, etc...don't get confused by this...it's all the same concept!

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I highly doubt you will get a detailed question on DCF. It is not typical of the work done in MBB and is typically used by investment banks to come to a valuation for a company. Understand the concept at a basic level and you will be okay

The one exception could be if you are applying specifically for PE roles in MBB

Hi there,

In terms of case interviews, the equation you should use for DCF is the following

• V=FCF/(r-g)

Where

V = Value of the company

FCF = Free cash flow

r= Discount rate

g= Growth rate of FCF

Usually g=0 and FCF is approximated with profits for simplicity.

The second formula you presented is also correct: the value of the free cash flow today for a single year is indeed FCF/(1+r). However, that doesn’t represent the value of the company, but just the value today of the cash flow generated in one year.

A DCF estimation is quite common in M&A/PE cases, which are usual cases, in particular in companies that specialize in due diligence such as Bain.

Best,
Francesco

Hello,

I think there is a bit of confusion between:

• Present value of a cash flow planned for year Y: DCF= Profits / (1 + discount rate) ^ Y
• Value of a perpetuity: DCF = Annual profits / Discount rate

I would suggest to take a look at this website to fully understand the second option:

https://www.investopedia.com/terms/p/perpetuity.asp#:~:text=find%20its%20value.-,Perpetuity%20Formula,flows%20by%20some%20discount%20rate.&text=It%20is%20the%20estimate%20of,capital%20and%20the%20growth%20rate.

Feel free to write me if you want to discuss this further.
Best,
Luca

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