Valuation using Discounted Cash Flow

This method holds that a business is worth the present value of all cash flows flowing to its owner during the future plus the final company value that can be sold. It involves forecasting the company’s fee cash flows for the next 5 to 10 years and its terminal value, and sum up the present value of the cash flows and terminal value to get the intrinsic value of the business. You can use this method when a business produces regular operating cash flows with steady capital expenditures.

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Valuing "WPP WPP PLC"

Valuation Assumptions

Latest quoted share price	£
Number of ordinary shares

Number of years to project
Required annual rate of return	%

Latest reporting financial year
Total cash & cash equivalents	£
Total interest-bearing debts	£

Net operating cash flow	£
Medium-term growth	%
Long-term growth	%
Capital expenditure	£
Capital expenditure growth	%

Terminal value method	Growth in perpetuity
	Residual yield %

Valuation Results

£16.70 Highest price you can pay to get 10% annual return	2.6% Your annual return if you pay at market price £7.95
12.3% Your annual return if you pay at intrinsic value £14.10	+77.4% Value Vs Price variation

Projection Horizon

Year	Growth	Net Operating Cashflow	Capex	FV Free Cashflow	PV Free Cashflow
2020	8.2%	£1,815,091,067	£371,989,333	£1,443,101,733	£1,311,910,667
2021	8.2%	£1,963,928,534	£394,308,693	£1,569,619,841	£1,297,206,480
2022	8.2%	£2,124,970,674	£417,967,215	£1,707,003,459	£1,282,496,964
2023	6.5%	£2,155,659,562	£443,045,248	£1,712,614,314	£1,169,738,620
2024	4.7%	£2,114,628,136	£469,627,963	£1,645,000,173	£1,021,415,684

* PV - Present Value FV - Future Value

Calculations

Free cash flow in year 2025	£1,680,261,340
Terminal value in year 2025, (£1,680,261,340/[10% - 3%])	£24,003,733,423
Present terminal value discounted at 10%	£14,904,429,916
Sum of present value of free cash flows	£6,082,768,415
Value of company operations (£6,082,768,415 + £14,904,429,916)	£20,987,198,330
+ Add cash & cash equivalents	£2,969,000,000
- Less total interest-bearing debts	£6,231,000,000
Business intrinsic value	£17,725,198,330
Business intrinsic value per share	£14.10

+Tips & Advice

Free cash flow to a business is similar to an individual’s net salary, less their committed expenditure. Because all essential spending has been deducted, free cash flow indicates the discretionary spending power of management; in investment terms; it represents option value, allowing management to either reward shareholders with dividends or buybacks, expand the business by raising capex or alternatively, reduce risk and interest costs by paying debt. Free cash flow is also a good indicator of risk because unless it is positive, expansion can only be financed by increased debt or equity. High free cash flow yield is an indicator of potential value.
Residual yield can be chosen by taking the current market average cash flow yield or may be twice the average dividend yield perhaps.
If “Growth in perpetuity” model is used, the terminal rate should always be below the expected growth in nominal GDP, may be perhaps at 4%.
The investor’s annual rate of return from investing in the company can be determined in three ways. You can calculate the weighted average cost of capital (WACC) of the firm as the rate of return; the built-up method using inflation, risk-free rate and equity-risk premium as the components in arriving at an appropriate rate of return or simply the minimum hurdle rate you would require for investing in the business. Most venture capital firms demand a compound annual return of 25% to 30% and many leveraged buyouts have been risky enough to warrant interest rate of 20% to 25% on their secured borrowing.
The law of diminishing returns dictates that over time, returns on capital inevitably revert to the cost of capital. Successful businesses will make high returns but their comparative advantage period is finite as determined by Porter’s Five Forces: strength of current competition, threats from new entrants, threats from substitutes, bargaining power of suppliers and bargaining power of customers. Although these cannot be objectively determined but a useful estimate can be used. Perhaps, 5 years for technology business, 10 to 15 years for most mature companies and 20 years for utility.