How to Calculate Intrinsic Value using DCF Valuation: Step-by-Step Guide

Introduction to DCF Valuation

The Discounted Cash Flow (DCF) valuation method is a widely used approach to estimate the intrinsic value of a company. It involves calculating the present value of future cash flows using a discount rate. In this guide, we will walk you through the steps to calculate the intrinsic value using DCF valuation manually.

Prerequisites

Before you start, make sure you have the following inputs:

• Projected cash flows for the next 5-10 years
• Discount rate (cost of capital)
• Terminal value (perpetual growth rate and terminal growth rate)

Step-by-Step Calculation

To calculate the intrinsic value using DCF valuation, follow these steps:

Step 1: Gather Your Inputs

First, identify the projected cash flows for the next 5-10 years. This can be done by estimating the company's future revenue, expenses, and capital expenditures. Also, determine the discount rate, which is the cost of capital for the company. The discount rate can be calculated using the Weighted Average Cost of Capital (WACC) formula.

Step 2: Calculate the Present Value of Cash Flows

Next, calculate the present value of each cash flow using the formula: PV = CF / (1 + r)^n Where:

• PV = present value
• CF = cash flow
• r = discount rate
• n = year

Step 3: Calculate the Terminal Value

Calculate the terminal value using the perpetual growth model: TV = CFn / (r - g) Where:

• TV = terminal value
• CFn = cash flow in the last year
• r = discount rate
• g = perpetual growth rate

Step 4: Calculate the Intrinsic Value

Finally, calculate the intrinsic value by summing up the present value of cash flows and the terminal value: IV = ΣPV + TV

Worked Example

Let's use a real example to illustrate the calculation: Suppose we want to calculate the intrinsic value of a company with the following inputs:

• Projected cash flows: $100, $120, $150, $180, $200 (years 1-5)
• Discount rate: 10%
• Perpetual growth rate: 3%
• Terminal growth rate: 2%

Using the formula, we can calculate the present value of each cash flow:

• PV1 = $100 / (1 + 0.10)^1 = $90.91
• PV2 = $120 / (1 + 0.10)^2 = $99.17
• PV3 = $150 / (1 + 0.10)^3 = $122.97
• PV4 = $180 / (1 + 0.10)^4 = $146.02
• PV5 = $200 / (1 + 0.10)^5 = $164.84

Next, calculate the terminal value: TV = $200 / (0.10 - 0.03) = $2,857.14

Finally, calculate the intrinsic value: IV = $90.91 + $99.17 + $122.97 + $146.02 + $164.84 + $2,857.14 = $3,481.05

Common Mistakes to Avoid

When using the DCF valuation method, make sure to avoid the following common mistakes:

• Using an incorrect discount rate
• Not considering the terminal value
• Not using the correct perpetuity growth model

When to Use the Calculator

While calculating the intrinsic value manually can be a good learning experience, it can be time-consuming and prone to errors. For convenience, you can use a DCF valuation calculator to quickly estimate the intrinsic value. The calculator can save you time and reduce the risk of errors.