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Learn Financial Modeling : Discounted Cash Flow statement (DCF) Methodology

5. Discover our Intrinsic Value and its meaning

we could go ahead and calculate enterprise value which is the sum of our stage one Plus stage 2 but again we're concerned with equity value so we need to go from enterprise value to equity value how do we do that we need to subtract out net debt in other words equity value equals enterprise value less net debt okay so keeping this formula in mind we'll go ahead and calculate net debt

I know most of you are thinking well we'll just use plain vanilla debt the truth is you want to use all gross debt or all non equity claims so such items could include gross debt I mean debt as well as preferred stock minority interest really anything that's considered an on equity claim we want to subtract out from enterprise value to arrive at equity value in our case we're using a simple example all we have is debt and we're going to subtract out cash because we're dealing with net debt in other words net debt is equal to debt less cash and cash equivalents and the whole idea with net debt on Wall Street is that practitioners believe that if you have excess liquidity you can go ahead and pay off some of that debt so we're going to assume that so enterprise value less net debt provides our equity value now if we bring in our diluted share count 500 we can figure out on a per share basis what the equity value per share is

We see that our equity value is 192 so if we take a look at this question if the stock is trading at 174.72 bucks a share and we believe that the DCF analysis is accurate would we buy or sell the stock?

I believe that if if our DCF analysis is indeed correct what we're going to want to do is we're going to want to buy this stock well the reason is because if we believe that the stock should be valued at 192 dollars and it's valued at 174 a share then the stock is considered cheap so we would want to go ahead and buy it okay so now you can see how you can use this this really powerful analysis to make decisions for investments or trading or whatever it is you might be doing with the DCF so just to quickly recap what we did again we forecast it free cash flows into the future we discounted them back to the present using a discount rate that reflects the riskiness of the capital that gave a stage 1 we then went ahead and calculated stage 2 which is value beyond the explicit forecast period and that gave us a stage 2 after calculating stage one and stage two we calculated WACC we're using WACC because we want to use a discount rate that's available to all providers of capital so then we did worry about the discount stage one and stage two back to the present adding both together gives us enterprise value subtracting out all mod equity claims it gives us equity value and dividing by the looted share account gives us an equity value per share to which we can compare market value to make a decision