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Stocks 403: Introduction to Discounted Cash Flow

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1.
A company's cost of capital is the return that investors get for their investments in the company.
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True. This includes interest and dividends.
2.
As a rule, and all else being equal, the riskier a company is, the _______ its discount rate will likely be.
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Higher. Also, the lower the value of its future cash flows will be, all else equal.
3.
When it comes to finding a stock's intrinsic value, what is the problem with simply counting up all the future dividend payments a company is expected to make and expressing them in today's dollars?
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Some companies do not pay dividends. That is why cash flow is used.
4.
Suppose we're using a DCF model with 10 years' worth of projections for a company with a 9.5% cost of capital. We estimate that the company's free cash flow in Year 10 will be $350 million, and that its cash flow will grow at 4% in perpetuity after that. The present value of the perpetuity value will equal _______.
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$2.7 billion. Step 1 is to calculate the value of the perpetuity. Plugging the values into the equation: 350,000,000 x (1 + .04) / (.095-.04) = $6,618,181,818, or $6.6 billion. Step 2 is to express the value of the perpetuity in today's dollars, using the perpetuity value as a single cash flow: $6,618,181,818 / (1.095^10) = $2,670,530,254, or $2.7 billion.
5.
When calculating discounted cash flow, why are we discounting it at all?
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Because the further out a cash flow is, the less it is worth in today's dollars. The math will bear this out.