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1.
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.
2.
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.
3.
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.
4.
When calculating discounted cash flow, why are we discounting it at all?
Because the further out a cash flow is, the less it is worth in today's dollars. The math will bear this out.
5.
Suppose Company A has a long history of profitability, and its outlook is stable, and Company B has yet to make a profit in its short history, and its outlook is much more uncertain. Company A's cost of equity should be _______.
Less than that of Company B. This is because estimated cash flow in the future from Company A is much more certain than it is from Company B. Risk and assumed cost of equity (the return equity investors require) should be concurrent. Lower risk should mean a lower cost of equity assumption, and vice versa.
