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Stocks 403: Introduction to Discounted Cash Flow

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1.
Illini Widgets will earn $350 million in cash flow four years from now. Assuming an 8.5% weighted average cost of capital, what is that cash flow worth today?
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$253 million. $350,000,000/1.085^4 = $252,550,999, or $253 million. One hint: remember that future cash flow is always going to be worth less in today's dollars, so you could have automatically eliminated the choice of $380 million.
2.
What is the basic idea behind discounted cash flow?
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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.
For the purpose of discounting a company's future cash flows, the term "cost of capital" means _______.
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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.
4.
Which cost is easier to calculate?
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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.
The concept of perpetuity value involves estimating a company's future cash flows for a certain period and then estimating the value of all cash flows after that in what form?
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One lump sum. The perpetuity value will be expressed in one lump sum, then discounted for its present value.