It is not the first time that I insist in this blog on the importance of valuation through discounted cash flows. At the moment, we have only talked about cash flow discounting from a theoretical point of view, but to learn to invest it is necessary to go further. In this article we will see an example of cash flow discount valuation in Excel carried out following the steps we already saw in this blog.
Steps to follow for the cash flow discount valuation
These are the 5 steps that we must follow in practice for the cash flow valuation:
- Estimation of future free cash flows during "n" years.
- Choice of a discount rate that reflects the risk of the investment.
- Estimated residual value in year “n”.
- Carry out the discount of cash flows and residual value.
- The sum of the cash discount and the residual value will be the value of the company.
Next we will see an example of valuation by cash flows following these 5 steps.
Example of cash flow discount valuation in Excel from Value Investing SA
We are going to value the company Value Investing SA This company is dedicated to the management of investment funds following the principles of value investing, so it has a great future ahead of it. Its expected cash flows are as follows:
- 2.013: € 20 million
- 2.014: € 25 million
- 2.015: € 31 million
- 2.016: € 35 million
Its residual value in 2.016 is estimated to be 450 million euros. The discount rate that we will use will be 10%.
Now I recommend you try to do the calculation yourself in a spreadsheet, either in Microsoft Excel or Google Docs. The step-by-step assessment can be downloaded from the links below to check if your calculations are correct:
As you can see, the final result of the calculation of the valuation by discounting of cash flows that we saw in this example is 393,40 million euros. One way to interpret the result is that if we bought the company for 393,40 million euros, we would have a profitability of 10% compounded annually if we kept it until 2.016, collecting cash flows and sold it for 450 million euros in that year. .
I hope that with this practical example of cash flows you can do it yourself. You can leave me any questions in the comments.