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QuestionsCategory: Investor PsychologyTerminal value in DCF
Tony asked 1 year ago

Hi everyone,
 
The module on DCF does not appear to touch on the concept of terminal value. Does anyone know why? Is it because we are assuming that the company would exist for the next 10 years and may not exist thereafter, so we would pay only for the next 10 years of cashflow or earnings?
 
If you would take the terminal value into the calculation, how would you calculate it? Do you simply multiply the cashflow or earning of the last year (e.g., year 5) by, for example, 10?
 
In addition, for the discount rate, can we use Weighted Average Cost of Capital, WACC, instead of the 10 year treasury rate?
 
Thanks
Tony

Jieren Zheng replied 1 year ago

I would think that can barely predict about a company for 5 years, 10 years is a stretch already.

For the discount rate, you can use WACC with no issues I think.

Victor Chng replied 1 year ago

Thanks JR

Tony replied 1 year ago

Thanks Jieren! Is this why I never see forecasts for more than 5 years on the Internet? For example, those provided on Yahoo Finance are for 5 years only.

Jieren Zheng replied 1 year ago

Welcome both!

@Tony: I would guess so. With digitisation and advancement of tech, I think we are seeing changes even faster and faster than a long time ago.

Tony replied 1 year ago

Thanks!

1 Answers
Victor Chng answered 1 year ago

Hi Tony,
 
As mentioned by JR, DCF model is very subjective to the person using it. Forecasting the future earning is very hard as business are dynamics. Yup, you can go ahead to use WACC just that when using DCF you have to be super conservative.
 
To be honest. after 11 years of investing, i found DCF to be highly inaccurate and I have more missed than hit. If you have been to the workshop, I will teach only the PE, PB, PCFO for valuation because they are serve us well and we have more hit than missed.

Tony replied 1 year ago

Thanks Victor. I’ll be more conservative when using DCF.

I have also encountered difficulty with DCF. My experience has been that If I calculate the intrinsic value from only five years, the value I get is often unrealistically low, in fact much lower than those calculated by analysts. When this happens, I would be tempted to add more years and/or a terminal value to the calculation to try to match my calculated intrinsic value to those provided by analysts.

Victor Chng replied 1 year ago

Hi Tony,

You are right. I also have that issue when I just started out investing. Trying to adjust the DCF to match the figure I want to see.

Valuation using multiple will serve you better in valuing companies.

Tony replied 1 year ago

Thanks Victor. I’ll rely more on multiples!

Tony replied 1 year ago

Victor, have you ever considered implementing the Q&A on another platform, especially that facilitates the insertion of images?

Victor Chng replied 1 year ago

Hi Tony,

you can upload image on this platform also.

Below the answer box, there is a choose file button. You can upload the image from there.

Tony replied 1 year ago

Oh I see! Thanks