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1.
Chicago Flames Fire Retardant, Inc. is expected to generate $1 billion in cash flow one year from now. If that company has a 10% cost of capital, what is that future cash flow worth today?
$909 million. $1,000,000,000/1.10 = $909,090,909, or $909 million.
2.
What is the basic idea behind discounted cash flow?
A stock's worth is equal to the present value of all its estimated future cash flows. Discounted cash flow is ultimately what analysts use to identify a stock's intrinsic value.
3.
If a company's perpetuity value for discounted cash flow purposes is, say, $4 billion, the present value of that $4 billion will be _______.
Less than $4 billion. The present value calculation should result in a number that is less than $4 billion, since we have to discount those future cash flows back to the present to account for the time value of money.
4.
Which cost is easier to calculate?
The cost of debt. The cost of debt boils down to the interest rate a company pays to borrow money. But the cost of equity is debatable and uses more factors.
5.
For the purpose of discounting a company's future cash flows, the term "cost of capital" means _______.
The rate used to discount the company's future cash flows backward to the present. The math will explain how it figures into the cash flows.
