# DCF Valuation Example

Let’s walk through a simplified example of a Discounted Cash Flow (DCF) valuation for a hypothetical company. In this example, we will estimate the value of the company based on its projected cash flows.

Assumptions:

• Year 0 represents the present year.
• We will consider a five-year projection period.
• We’ll assume a discount rate (required rate of return) of 10%.
• At the end of Year 5, we’ll assume a terminal value of \$10 million, calculated using a perpetuity growth rate of 3%.

Cash Flow Projections:

Year 0: \$1,000,000 (Initial Investment) Year 1: \$2,000,000 Year 2: \$2,500,000 Year 3: \$3,000,000 Year 4: \$3,500,000 Year 5: \$4,000,000

Discount Rate: 10%

Terminal Value Calculation:

Terminal Value (TV) = Year 5 Cash Flow × (1 + Perpetuity Growth Rate) / (Discount Rate – Perpetuity Growth Rate) Terminal Value (TV) = \$4,000,000 × (1 + 0.03) / (0.10 – 0.03) Terminal Value (TV) = \$57,142,857.14

Present Value Calculation:

Now, we’ll calculate the present value of each cash flow and the terminal value using the discount rate.

Year 0: \$1,000,000 / (1 + 0.10)^0 = \$1,000,000 Year 1: \$2,000,000 / (1 + 0.10)^1 ≈ \$1,818,182.00 Year 2: \$2,500,000 / (1 + 0.10)^2 ≈ \$1,652,892.56 Year 3: \$3,000,000 / (1 + 0.10)^3 ≈ \$1,364,485.98 Year 4: \$3,500,000 / (1 + 0.10)^4 ≈ \$1,149,570.24 Year 5: \$4,000,000 / (1 + 0.10)^5 ≈ \$931,773.88

Summation of Present Values:

DCF Value = \$1,000,000 + \$1,818,182.00 + \$1,652,892.56 + \$1,364,485.98 + \$1,149,570.24 + \$931,773.88 ≈ \$7,917,905.66

So, based on the assumptions and cash flow projections provided, the estimated value of the hypothetical company using the DCF valuation method is approximately \$7,917,905.66. This represents the present value of the company’s expected future cash flows and terminal value, given the chosen discount rate and assumptions. It’s important to note that this is a simplified example, and in practice, DCF valuations involve more detailed cash flow projections and often require sensitivity analysis to assess the impact of different assumptions on the valuation result.