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What is DCF?

Interview maths MBB practice
New answer on Sep 10, 2020
6 Answers
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Anonymous A asked on Sep 03, 2020

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?

(edited)

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Vlad
Expert
replied on Sep 03, 2020
McKinsey / Accenture Alum / Got all BIG3 offers / Harvard Business School

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

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Ian
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updated an answer on Sep 04, 2020
#1 BCG coach | MBB | Tier 2 | Digital, Tech, Platinion | 100% personal success rate (8/8) | 95% candidate success rate

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!

NPV Annuity formula

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Antonello
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replied on Sep 10, 2020
McKinsey | NASA | top 10 FT MBA professor for consulting interviews | 6+ years of coaching
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Udayan
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replied on Sep 10, 2020
Top rated Case & PEI coach/Multiple real offers/McKinsey EM in New York /12 years recruiting experience

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

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Francesco
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replied on Sep 04, 2020
#1 Coach for Sessions (4.500+) | 1.500+ 5-Star Reviews | Proven Success (➡ interviewoffers.com) | Ex BCG | 10Y+ Coaching

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

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Luca
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updated an answer on Sep 04, 2020
BCG |NASA | SDA Bocconi & Cattolica partner | GMAT expert 780/800 score | 200+ students coached

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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Vlad gave the best answer

Vlad

McKinsey / Accenture Alum / Got all BIG3 offers / Harvard Business School
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