1. Key Assumptions
So here are some key assumptions and drivers in a DCF,
and you can see that revenue, margins, taxes, working capital and capital
expenditures all combine to give us the components that then result in the
calculation of unlevered free cash flows. But let's go all the way back
to the forecast drivers on the left here.
We need to factor in things we discussed earlier. You will recall from
things like industry competition and macroeconomic factors that impact company
performance. So we have things like market size and market share,
sales and product mix, the pricing power of the business,
the material price inputs that might be affected by macro economic impacts,
staffing levels, wage rates, taxes, etcetera. Then we have things like accounts
receivable and accounts payable, collection or payment terms, which may
fluctuate. Then we have things like the useful life of property,
plant and equipment, the maintenance that's required to maintain these fixed
assets, and the capital investments that are required to scale those assets
up. So as you can see, they're a whole host of forecast drivers,
and we need to make assumptions for each of them.
They then flow through the diagram from left to right, and finally result
in the free cash flow on the far right of this diagram.
Which is what we need to value the target company.
2. Let's practice!