Name all components that are in the discounted cash flow model. Which components might intrinsic value be the most sensitive to? You can consult GuruFocus to provide an example please.
The components of Discounted cash flow model are Cash Flows, required rate of return or cost of capital and number of years of cash flows or investment.
This method is used to analyse a project whether it would be able to generate positive cash flows in the lifetime of the project. In this all the cash flows are discounted or future cash flows are brought to present value given a required rate of return.
The formula for the same is:
Present Value of Cash Flows = CF1/(1+r)1 + CF2/(1+r)2 +.....+CFn/(1+r)n
From the formula itself, r or required rate of return affects the most the intrinsic value. Higher the rate of return lower would be the intrinsic value or present value of the project.
For example:
A project provides following cash flows and assuming required of return to be 10% in first case and 20% in second case:
Case I
Cash flows PVIF at 10% Present value of cash flows
CF for year 1 10000 0.909 9090
CF for year 2 20000 0.826 16520
CF for year 3 30000 0.751 22530
CF for year 4 40000 0.683 27320
75460
Case II
Cash flows PVIF at 20% Present value of cash flows
CF for year 1 10000 0.833 8330
CF for year 2 20000 0.694 13880
CF for year 3 30000 0.579 17370
CF for year 4 40000 0.482 19280
58860
Therefore from the above, it could be seen that required rate of return plays an important role in the intrinsic value calculation. The value of PV of cash flows decreased from 75460$ to 58860$ just by increasing required rate of return from 10% to 20%. This can be further used in NPV method.
Name all components that are in the discounted cash flow model. Which components might intrinsic value...
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