This is the PV of future cashflows - value of debt
Ok so this example is difficult but let's take it one step at a time..
PBT 80 (all cash)
Capital Investment each year 48
Debt 10 ($120)
Tax = 30%
WACC = 10%
The profits are expected to continue for foreseeable future (perpetuity)
What is the value of equity?
First of all you need to know how to calculate the value of something that lasts forever (like the profits here)
Well this is called a perpetuity
And calculating its PV is easy! Just Divide it by the discount factor!
So say it's a perpetuity of 60 at a discount rate of 4% = 60 / 0.04 = 1,500
In this question the income needs taxing remember!
Cash inflow 80 x 70% = 56 - 48 = 8 (in perpetuity)
Value of business = 8 / 0.1 = 80m
So the Equity is the value of all the cashflows less value of debt remember
Equity = 80m - (10 x 1.2) = 68m
Advantages of DCF Method
Theoretically best method
Can value part of a company
Disadvantages of DCF Method
Need to estimate cashflows and discount rate
How long is PV analysis for?
Assumes constant tax, inflation and discount rate