Chapter 18 · Day 18 — Intrinsic value: DCF, DDM and relative methods
Discounted cash flow, worked end to end
A rupee next year is worth less than a rupee today. DCF makes that explicit — and makes its own assumptions impossible to hide.
Every valuation method is a shortcut for the same idea: a business is worth the cash it will produce, discounted for time and risk.
How a fair value becomes a decision
Present value: PV = CF ÷ (1 + r)^n, where CF is the cash flow, r the discount rate and n the number of years away.
Worked — Illustrative Example
Free cash flow of Rs 12 crore next year, growing 8% for five years, then 4% for ever. Discount rate (WACC) 13%.
| Year | FCF (Rs cr) | Discount factor at 13% | PV (Rs cr) |
|---|---|---|---|
| 1 | 12.00 | 0.885 | 10.62 |
| 2 | 12.96 | 0.783 | 10.15 |
| 3 | 14.00 | 0.693 | 9.70 |
| 4 | 15.12 | 0.613 | 9.27 |
| 5 | 16.33 | 0.543 | 8.87 |
| **Sum** | **48.61** |
Terminal value (Gordon growth): TV = FCF₆ ÷ (WACC − g). FCF₆ = 16.33 × 1.04 = Rs 16.98 cr. TV = 16.98 ÷ (0.13 − 0.04) = Rs 188.7 cr. Discounted to today: 188.7 × 0.543 = Rs 102.5 cr.
Enterprise value = 48.61 + 102.5 = Rs 151.1 cr. Less net debt of Rs 33 cr → equity value Rs 118.1 cr. Over 4 crore shares → Rs 29.5 per share.
When to use which method
| Method | Suits | Struggles with |
|---|---|---|
| DCF | Stable, cash-generative firms | Early-stage or erratic cash flows |
| DDM | Reliable dividend payers | Non-payers |
| P/E or P/B relative | Comparing within a sector | Whole-sector mispricing |
| EV/EBITDA | Different capital structures | Capital-heavy firms |
| NAV | Investment and holding companies | Operating businesses |
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