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1.
Assume you have created a DCF model that estimates a company's value to be $50 per share, but the stock trades at $90 per share. The stock is _______.
Overvalued. Because the stock trades above its estimated fair value, the stock is overvalued, and we should probably not buy the shares. Being able to compare a stock's market price to its fair value is where the effort put into creating the DCF pays off.
2.
A company's future cash flow can be determined exactly.
False. Future cash flow can never be determined exactly. At best, it can be estimated based on a number of financial and economic factors.
3.
If we were to increase a company's cost of equity assumption, what would we expect to happen to the present value of all future cash flows?
A decrease. Raising the company's cost of equity assumption would lower the present value of all future cash flows.
4.
Assume a company had $1 billion in free cash flow last year, and it is expected to grow that cash flow at 3% into perpetuity. Assuming a 9% cost of equity, what is the value of the company?
$17.2 billion. All we need to do is plug the assumptions into our perpetuity formula: ( $1 billion x (1 + .03) ) / (.09 - .03) = $17.2 billion.
5.
Fictional company Mobar is expected to generate $125 million per year over the next three years in free cash flow. Assuming a discount rate of 10%, what is the present value of that cash flow stream?
$311 million. The cash flow stream would look like this: 125.00 x 0.9090 = 113.63; 125.00 x 0.8264 = 103.30; 125.00 x 0.7513 = 93.91. The sum of the three is $310.84, or $311 million.
