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Stocks 404: Putting Discounted Cash Flow into Action

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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 _______.
Choose wisely. There is only one correct answer.
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.
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?
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A decrease. Raising the company's cost of equity assumption would lower the present value of all future cash flows.
3.
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?
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$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.
4.
When projecting future cash flow of a company in order to determine the fair value of its stock, where should you start?
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With past data gotten from financial statements. To look forward, you first have to look backward. That way, you will see important patterns.
5.
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?
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$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.