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00:00:00 – 00:13:11
The video by Mike from Financiable provides a comprehensive guide on how to effectively address the common finance interview question, "Walk me through a DCF (Discounted Cash Flow)." Mike introduces a concise five-step framework for performing a DCF analysis, emphasizing staying high-level but ready to provide detailed explanations when necessary. The steps include calculating stage one cash flows, determining terminal value using either the perpetuity growth method or the exit multiple method, discounting these values to the present using the weighted average cost of capital (WACC) to get enterprise value, deriving equity value by adjusting for debt and cash, and ultimately determining price per share by dividing equity value by the number of shares.
The video explains the distinction between unlevered free cash flow, used in DCF, and levered free cash flow, which is less common in interviews. It details the projection of cash flows during stage one (typically 5 to 10 years) and the calculation of terminal value for stage two. The concept of WACC is clarified as a weighted rate that reflects the blended costs of debt and equity, factoring in their respective proportions and risk profiles.
Finally, it explains the steps to convert enterprise value to equity value by subtracting debt and adding cash, and then to price per share by dividing by the fully diluted share count, with recommendations for simplifying this explanation during interviews. The video concludes with advice on maintaining a high-level summary while being prepared for deeper discussions and a call to subscribe for additional insights.
00:00:00
In this part of the video, Mike from Financiable addresses a common finance interview question: “Walk me through a DCF (Discounted Cash Flow).” He highlights that many people struggle with this question because they get bogged down in details. To prevent this, Mike presents a five-step framework for answering the DCF question, which includes:
1. Calculating stage one cash flows.
2. Calculating terminal value (stage two value).
3. Discounting stage one and stage two values using the weighted average cost of capital (WACC) to get enterprise value.
4. Deriving equity value by subtracting debt and adding cash from enterprise value.
5. Determining the price per share by dividing equity value by the number of shares.
Mike emphasizes staying high-level in responses while understanding finer details for when deeper questions arise. He also mentions focusing on unlevered free cash flow, starting with EBIT and adjusting for taxes, non-cash charges (like depreciation), capital expenditures, and changes in networking capital. This approach is the most common in interviews compared to the less frequent levered free cash flow method.
00:03:00
In this part of the video, the speaker discusses the concept of unlevered free cash flow, which is the excess cash flow generated by a business after taxes and reinvestments. The explanation then moves to the distinction between Stage 1 and Stage 2 in financial projections. Stage 1 involves projecting cash flows until the business reaches maturity, typically over a period of 5 to 10 years, while Stage 2 involves making simplifying assumptions beyond that maturity point.
Next, the video explains how to calculate the terminal value, which reflects the business’s value beyond Stage 1. There are two methods to calculate this: the perpetuity growth method and the exit multiple method. The perpetuity growth method uses a constant growth rate to project cash flows into infinity and then discounts them back to their present value. The exit multiple method, which is more commonly used in practice, values the business at the end of Stage 1 using a multiple-based approach, often involving EBITDA.
00:06:00
In this segment, the speaker explains two methods for calculating terminal value: the perpetuity growth method and the exit multiple method. Both methods ultimately provide the same value beyond stage one. The next step involves discounting these values back to the present using the weighted average cost of capital (WACC). The speaker clarifies that WACC is a weighted discount rate reflecting the cost and riskiness of the cash flows from multiple capital providers, such as lenders and investors, each having different risk profiles and expected returns. The formula for WACC blends the costs of debt and equity, accounting for their respective proportions in the company’s capital structure. The true cost of debt is adjusted for tax deductibility, and the combined result provides the business’s blended cost of capital. A separate video is mentioned for a detailed explanation of the cost of equity.
00:09:00
In this part of the video, the focus is on calculating the enterprise value and equity value of a business, as well as determining the price per share. First, projected cash flows and terminal value are discounted back to the present using the discount rate to determine the enterprise value, which represents the purchase price of the entire business. Next, to find the equity value, debt is subtracted from the enterprise value, and any excess cash is added, reflecting the owner’s stake in the business. Finally, the price per share is calculated by dividing the equity value by the fully diluted share count. The presenter advises simplifying this explanation during an interview by referring to the number of shares instead of delving into the complexities of fully diluted shares.
00:12:00
In this segment, the speaker outlines a high-level overview of the steps involved in performing a Discounted Cash Flow (DCF) analysis. They detail the process: starting with calculating stage one cash flows, then determining the terminal value for stage two, and discounting both to arrive at the enterprise value. From there, they explain how to derive the equity value by subtracting debt and adding cash, and finally, how to calculate the price per share by dividing equity value by the number of shares. The speaker emphasizes maintaining a high-level explanation in interviews, being prepared to delve into details if asked. Additionally, they encourage viewers to subscribe for more content.