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Discounted Free Cash Flow Model (Source Code)

The Discounted Free Cash Flow model calculates the value of a share based on the company's estimated future Free Cash Flow figures.

This model is not recommended for valuing financial service firms (banks, insurance companies, and investment banks). Check out Valuing financial service firms

Forecasting Free Cash Flow

To estimate future free cash flow, we use projected revenues (based on a linear regression curve of past revenues) along with the Operating Cash Flow Margin and Average Capital Expenditure Margin (calculated as the average capital expenditure margin over the past Historical Years).
The difference between the two is considered the free cash flow margin.

t ranges between 1 and Projection Years

Free Cash Flow(t) = Revenue(t) * (Operating Cash Flow Margin - Average Capital Expenditure Margin)

Next, we discount each Free Cash Flow to the present:

Discounted Free Cash Flow(t) = Free Cash Flow(t) / (1 + Discount Rate)t

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Calculating the Terminal Value

The Terminal Value represents the expected value of the company at the end of the projection period.
It is calculated using the Gordon Growth formula with Growth In Perpetuity(%) based on the final projected free cash flow (i.e., Free Cash Flow(Projection Years)).

Terminal Value = Free Cash Flow(Projection Years) * (1 + Growth In Perpetuity(%)) / (Discount Rate - Growth In Perpetuity(%))

We then discount the terminal value to the present:

Discounted Terminal Value = Terminal Value / (1 + Discount Rate)Projection Years

Calculating the Value per Share

The Enterprise Value is calculated by adding all Discounted Free Cash Flow values (from years 1 to Projection Years) and adding the Discounted Terminal Value:

Enterprise Value = Discounted Free Cash Flow(1) + ... + Discounted Free Cash Flow(Projection Years) + Discounted Terminal Value

Equity Value:

Equity Value = Enterprise Value + Cash and Equivalents - Total Debt

The Estimated Value per Share is the estimated value of one common share:

Estimated Value per Share = Equity Value / Shares Outstanding

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Description of Assumptions

Growth In Perpetuity(%):

  • The rate at which the company's free cash flow is assumed to grow indefinitely.
  • By default, this is equal to the Yield of the U.S. 10 Year Treasury Note.

Projection Years:

  • The number of years over which future values are projected.
  • Default: 5 years.

Historical Years:

  • The number of historical years used to calculate average margins.
  • Default: 10 years.

Revenue Growth Rate:

  • Future revenues are projected using a growth rate, which is applied to the next year's revenue figure derived from linear regression, as described in the following formula:
"income:revenue": f"""
    function:compound:{data.get('linearRegressionRevenue:1')} 
    rate:{assumptions.get('%revenue_growth_rate')}
    offset:-1
"""

Operating Cash Flow Margin:

  • The margin for future Operating Cash Flow (or Cash From Operating Activities).
  • By default, this is the average Operating Cash Flow margin over the past Historical Years.

Discount Rate (WACC - Weighted Average Cost of Capital)

Discount Rate:

  • The rate used to discount future free cash flow and the terminal value.
  • By default, this is calculated using the Weighted Average Cost of Capital (WACC) formula (source):

Discount Rate = Debt Weight * Cost of Debt * (1 - Tax Rate) + Equity Weight * Cost of Equity

Debt Weight:

  • The proportion of total debt relative to the company's market capitalization plus total debt.

Debt Weight = Total Debt / (Market Cap + Total Debt) = 1 - Equity Weight

Cost of Debt:

  • The company's effective borrowing cost.

Cost of Debt = Interest Expense / Total Debt

Tax Rate:

  • Taxes paid as a percentage of earnings before tax.

Tax Rate = Income Tax Expense / Income Before Tax

Equity Weight:

  • The proportion of equity relative to the company's market capitalization plus total debt.

Equity Weight = Market Cap / (Market Cap + Total Debt) = 1 - Debt Weight

Cost of Equity, Beta, Risk Free Rate(%), Market Premium(%):

Calculating Historical Table Values

Free Cash Flow(t) = Cash from Operating Activities(t) - Capital Expenditure(t)

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