How to model out a discounted cash flow (DCF) is a must for investment banking interviews: this is the heart and soul of most technical interview questions. I can guarantee you that you will be asked to walk through a DCF at some point in your banking interviews.
Here’s a quick screen-shot of a real-life DCF Model:
What does a DCF Model do?
- A DCF values a company based on the Present Value of its future Cash Flows and the Present Value of its Terminal Value.
What do you usually use for the discount rate?
- WACC is the most common: Weighted Average Cost of Capital.
- Depending on how you setup your DCF you might also use Cost of Equity.
How do you calculate WACC in a DCF model?
- Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 – Tax Rate) + Cost of Preferred * (% Preferred)
How do you calculate Cost of Equity in a DCF model?
- Cost of Equity = Risk-Free Rate + Beta * Equity Risk Premium
What is Beta? What are the formula’s for un-levering and re-levering Beta?
- Beta describes the relation of a stock’s return with that of the financial market as a whole.
- Un-Levered Beta = Levered Beta / (1 + ((1 – Tax Rate) x (Total Debt/Equity)))
- Levered Beta = Un-Levered Beta x (1 + ((1 – Tax Rate) x (Total Debt/Equity)))
Take a deep dive into DCF and other valuation questions in the Investment Banking Technical Guide.
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