Discounted Cash Flow Model Exam: Practice Questions

The primary purpose of the DCF model is to estimate the value of an investment based on its expected future cash flows, which are discounted to their present value.

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The formula for calculating the present value (PV) of a future cash flow (CF) is PV = CF / (1 + r)^n, where r is the discount rate and n is the number of periods until the cash flow is received.

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The discount rate is the rate of return used to discount future cash flows to their present value. It reflects the opportunity cost of capital and the risk associated with the investment.

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NPV is the sum of the present values of all future cash flows minus the initial investment, while IRR is the discount rate that makes the NPV of an investment zero.

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The key components of the DCF model include the forecasted cash flows, the discount rate, and the terminal value.

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The terminal value can be determined using either the perpetuity growth model or the exit multiple method. The perpetuity growth model assumes the business will grow at a constant rate indefinitely, while the exit multiple method assumes the business will be sold at a multiple of a financial metric, such as EBITDA.

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Free cash flow (FCF) is the cash generated by a company after accounting for capital expenditures necessary to maintain or expand its asset base. It is calculated as operating cash flow minus capital expenditures.

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Free cash flow is important in the DCF model because it represents the actual cash available to investors after the company has made necessary investments in its operations.

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