DCF Valuation Masterclass - FCFF, FCFE & Residual Income Models

1

Introduction to DCF Valuation

Understanding the gold standard of intrinsic value estimation

What is DCF Valuation?

Discounted Cash Flow (DCF) valuation is a method used to estimate the intrinsic value of an investment based on its expected future cash flows. It's based on the principle that a company's value equals the present value of all its future cash flows.

Fundamental DCF Principle

Value = Σ [CFₜ / (1+r)ᵗ] for t = 1 to ∞

When DCF Works Best

Companies with predictable cash flows
Mature businesses with stable growth
When you have quality financial data
Long-term investment horizon

DCF Limitations

Highly sensitive to assumptions
Difficult for high-growth startups
Terminal value drives 60-70% of result
Garbage in, garbage out (GIGO)

Three DCF Approaches Compared

Model	Cash Flow	Discount Rate	Best For
Free Cash Flow to Firm (FCFF) (Firm)	Cash to all providers of capital	WACC	Most companies, levered firms
FCFE (Equity)	Cash to equity holders only	Cost of Equity (Ke)	Stable leverage, dividend-paying
Residual Income	Income above required return	Cost of Equity (Ke)	Banks, negative FCF firms

2

Free Cash Flow Fundamentals

Understanding FCFF and FCFE calculations from financial statements

FCFF: Free Cash Flow to Firm

FCFF represents cash flow available to all capital providers (debt holders + equity holders) after operating expenses and investments.

FCFF Formula (from EBIT)

FCFF = EBIT × (1 - Tax Rate) + Depreciation - CapEx - Δ Working Capital

FCFF Formula (from Net Income)

FCFF = Net Income + Interest × (1-Tax) + Depreciation - CapEx - ΔWC

Key Components Explained

EBIT(1-Tax): After-tax operating income (NOPAT)
Depreciation: Non-cash expense, add back
CapEx: Capital expenditures, subtract
ΔWC: Change in working capital (increase = outflow)

Exercise: FCFF Calculation Using Both Methods

Problem: Calculate FCFF using BOTH the EBIT method and Net Income method. Verify that both give the same result.

?Given Data for ABC Manufacturing Ltd. (₹ Crores):

Income Statement Items	Amount
Revenue	50,000
Operating Expenses (excluding depreciation)	35,000
Depreciation & Amortization	4,000
EBIT (Operating Income)	11,000
Interest Expense	1,500
Earnings Before Tax (EBT)	9,500
Tax Rate	25%
Net Income	7,125

Balance Sheet Items	Amount
Capital Expenditure (CapEx)	5,500
Change in Working Capital (ΔWC)	+2,000 (increase)

1METHOD 1: FCFF from EBIT (Recommended)

Formula: FCFF = EBIT × (1 - Tax Rate) + Depreciation - CapEx - ΔWC

Step-by-step:
NOPAT = EBIT × (1 - Tax) = 11,000 × (1 - 0.25) = 11,000 × 0.75 = ₹8,250 Cr
Add back Depreciation (non-cash expense) = +4,000
Subtract CapEx (cash outflow) = -5,500
Subtract ΔWC (working capital increase = cash outflow) = -2,000

FCFF = 8,250 + 4,000 - 5,500 - 2,000 = ₹4,750 Crores

2METHOD 2: FCFF from Net Income

Formula: FCFF = Net Income + Interest × (1-Tax) + Depreciation - CapEx - ΔWC

Step-by-step:
Start with Net Income = 7,125
Add back After-tax Interest = 1,500 × (1 - 0.25) = 1,500 × 0.75 = +1,125
(Why add interest? Because FCFF is pre-debt cash flow)
Add back Depreciation = +4,000
Subtract CapEx = -5,500
Subtract ΔWC = -2,000

FCFF = 7,125 + 1,125 + 4,000 - 5,500 - 2,000 = ₹4,750 Crores

3VERIFICATION: Both Methods Reconciled ✓

Method	Calculation	FCFF
From EBIT	8,250 + 4,000 - 5,500 - 2,000	₹4,750 Cr
From Net Income	7,125 + 1,125 + 4,000 - 5,500 - 2,000	₹4,750 Cr

FCFF = ₹4,750 Crores (Both methods give identical result ✓)
Key Insight: The after-tax interest (1,125) bridges the gap between NOPAT (8,250) and Net Income (7,125)

Practice Exercise: Calculate FCFF Using Both Methods

Problem: Calculate FCFF for XYZ Technologies using both EBIT and Net Income methods.

1First, derive missing values:
EBIT = Revenue - Operating Expenses - Depreciation = 80,000 - 58,000 - 6,000 = ₹16,000 Cr
EBT = EBIT - Interest = 16,000 - 2,000 = ₹14,000 Cr
Tax = EBT × 25% = 14,000 × 0.25 = ₹3,500 Cr
Net Income = EBT - Tax = 14,000 - 3,500 = ₹10,500 Cr

2METHOD 1: From EBIT
FCFF = EBIT × (1-T) + Dep - CapEx - ΔWC
FCFF = 16,000 × 0.75 + 6,000 - 8,000 - 3,000
FCFF = 12,000 + 6,000 - 8,000 - 3,000 = ₹7,000 Cr

3METHOD 2: From Net Income
FCFF = NI + Interest × (1-T) + Dep - CapEx - ΔWC
FCFF = 10,500 + 2,000 × 0.75 + 6,000 - 8,000 - 3,000
FCFF = 10,500 + 1,500 + 6,000 - 8,000 - 3,000 = ₹7,000 Cr

FCFF = ₹7,000 Crores (Both methods confirmed ✓)
Note: After-tax interest (1,500) = Difference between NOPAT (12,000) and Net Income (10,500)

Why Use EBIT Method Over Net Income Method?

Advantages of EBIT Method:

Separates operating and financing decisions
Not affected by capital structure changes
Better for comparing companies with different debt levels
Preferred by analysts for valuation

When to Use Net Income Method:

When EBIT is not directly available
For quick calculation from reported net income
When analyzing dividend-paying capacity

FCFE: Free Cash Flow to Equity

FCFE represents cash flow available to equity holders after all obligations (debt payments, reinvestment) are met.

FCFE Formula

FCFE = FCFF - Interest × (1-Tax) + Net Borrowing

FCFE Formula (Direct)

FCFE = Net Income + Depreciation - CapEx - ΔWC + Net Borrowing

When FCFE = FCFF

When company has no debt (Net Borrowing = 0, Interest = 0), FCFE equals FCFF.

Net Borrowing

Net Borrowing = New Debt Issued - Debt Repaid. Positive when company raises debt.

Comprehensive Exercise: FCFF and FCFE for Reliance Industries (Both Methods)

Problem: Calculate FCFF using both EBIT and Net Income methods. Calculate FCFE using both FCFF-based and Direct methods. Verify all calculations reconcile.

?Given Data for Reliance Industries (₹ Crores):

Income Statement Items	Amount
EBIT (Operating Income)	65,000
Depreciation & Amortization	18,000
Interest Expense	8,000
Tax Rate	25%
Net Income (derived)	51,000

Cash Flow & Balance Sheet Items	Amount
Capital Expenditure (CapEx)	35,000
Change in Working Capital (ΔWC)	+5,000 (increase)
Net Borrowing (New Debt - Debt Repaid)	12,000

PART A: FCFF Calculation (Two Methods)

1METHOD 1: FCFF from EBIT

Formula: FCFF = EBIT × (1 - Tax) + Depreciation - CapEx - ΔWC

NOPAT = 65,000 × (1 - 0.25) = 65,000 × 0.75 = ₹48,750 Cr
FCFF = 48,750 + 18,000 - 35,000 - 5,000
FCFF = ₹26,750 Crores

2METHOD 2: FCFF from Net Income

Formula: FCFF = Net Income + Interest × (1-Tax) + Depreciation - CapEx - ΔWC
First, calculate Net Income:
EBT = EBIT - Interest = 65,000 - 8,000 = ₹57,000 Cr
Net Income = EBT × (1-Tax) = 57,000 × 0.75 = ₹42,750 Cr

FCFF = 42,750 + 8,000 × 0.75 + 18,000 - 35,000 - 5,000
FCFF = 42,750 + 6,000 + 18,000 - 35,000 - 5,000
FCFF = ₹26,750 Crores

PART B: FCFE Calculation (Two Methods)

3METHOD 1: FCFE from FCFF

Formula: FCFE = FCFF - Interest × (1-Tax) + Net Borrowing

After-tax Interest = 8,000 × (1 - 0.25) = ₹6,000 Cr
FCFE = 26,750 - 6,000 + 12,000
FCFE = ₹32,750 Crores

4METHOD 2: FCFE Direct (from Net Income)

Formula: FCFE = Net Income + Depreciation - CapEx - ΔWC + Net Borrowing

FCFE = 42,750 + 18,000 - 35,000 - 5,000 + 12,000
FCFE = 42,750 + 18,000 - 35,000 - 5,000 + 12,000
FCFE = ₹32,750 Crores

5VERIFICATION: All Methods Reconciled ✓

Metric	Method	Result	Status
FCFF	From EBIT	₹26,750 Cr	✓ Match
FCFF	From Net Income	₹26,750 Cr	✓ Match
FCFE	From FCFF	₹32,750 Cr	✓ Match
FCFE	Direct from Net Income	₹32,750 Cr	✓ Match

Final Results:
FCFF = ₹26,750 Crores | FCFE = ₹32,750 Crores
Key Insight: FCFE > FCFF by ₹6,000 Cr because Net Borrowing (12,000) > After-tax Interest (6,000)
This means Reliance raised more debt than it paid in after-tax interest, benefiting equity holders

Quick Reference: FCFF vs FCFE Formulas

Cash Flow	Starting Point	Formula
FCFF	From EBIT	EBIT × (1-T) + Dep - CapEx - ΔWC
FCFF	From Net Income	NI + Int × (1-T) + Dep - CapEx - ΔWC
FCFE	From FCFF	FCFF - Int × (1-T) + Net Borrowing
FCFE	From Net Income (Direct)	NI + Dep - CapEx - ΔWC + Net Borrowing

Note: All methods should give identical results. Choose the method based on available data.

3

DCF Model: FCFF Approach

The most widely used DCF methodology

FCFF DCF Framework

Step 1: Forecast FCFF

Project FCFF for 5-10 years based on revenue growth, margins, and investment needs.

Step 2: Calculate WACC

WACC = Ke × (E/V) + Kd × (1-T) × (D/V)

Step 3: Terminal Value

TV = FCFFₙ₊₁ / (WACC - g) or Exit Multiple

Enterprise Value Formula

EV = Σ [FCFFₜ / (1+WACC)ᵗ] + [TV / (1+WACC)ⁿ]

Equity Value Formula

Equity Value = Enterprise Value - Net Debt = EV - (Total Debt - Cash)

Step-by-Step: Building WACC

Weighted Average Cost of Capital (WACC) is built from three components. Let's understand each one:

Step 1

Cost of Equity (Ke)

Using CAPM Model

Step 2

Cost of Debt (Kd)

After-tax cost

Step 3

Combine to WACC

Weight by capital structure

Exercise 1: Calculating Cost of Equity (Ke) using CAPM

Problem: Calculate the Cost of Equity for Tata Steel using the CAPM model.

?Given Data:

Parameter	Value	Source/Notes
Risk-free Rate (Rf)	7.0%	10-Year Indian Government Bond Yield
Beta (β)	1.4	Tata Steel's volatility vs Nifty 50
Market Risk Premium (Rm - Rf)	7.0%	Historical equity premium for India

1CAPM Formula:

Ke = Rf + β × (Rm - Rf)

2Step-by-step Calculation:
Ke = 7.0% + 1.4 × 7.0%
Ke = 7.0% + 9.8%
Ke = 16.8%

3Interpretation:

Beta of 1.4 means Tata Steel is 40% more volatile than the market
Investors require 16.8% return to invest in Tata Steel equity
This is higher than market return (14%) due to higher risk

Cost of Equity (Ke) = 16.8%

Exercise 2: Calculating After-Tax Cost of Debt (Kd)

Problem: Calculate the after-tax cost of debt for Tata Steel.

?Given Data:

Parameter	Value	Source/Notes
Interest Expense (FY24)	₹8,400 Cr	From Income Statement
Total Debt	₹84,000 Cr	From Balance Sheet
Credit Rating	AA-	CRISIL Rating
Corporate Tax Rate	25%	Effective tax rate

1Step 1: Calculate Pre-tax Cost of Debt

Kd (Pre-tax) = Interest Expense / Total Debt

Kd (Pre-tax) = 8,400 / 84,000 = 10.0%

2Step 2: Calculate After-Tax Cost of Debt

Kd (After-tax) = Kd (Pre-tax) × (1 - Tax Rate)

Kd (After-tax) = 10.0% × (1 - 0.25)
Kd (After-tax) = 10.0% × 0.75 = 7.5%

3Why After-Tax?

Interest expense is tax-deductible
Government effectively subsidizes 25% of interest cost
True cost to company is lower than coupon rate

After-Tax Cost of Debt (Kd) = 7.5%

Exercise 3: Calculating WACC (Combining Ke and Kd)

Problem: Calculate WACC for Tata Steel using the Ke and Kd from previous exercises.

?Given Data (Summary):

Component	Value	From
Cost of Equity (Ke)	16.8%	Exercise 1
After-tax Cost of Debt (Kd)	7.5%	Exercise 2
Total Equity (E)	₹1,20,000 Cr	Market Capitalization
Total Debt (D)	₹84,000 Cr	Balance Sheet
Total Capital (V = E + D)	₹2,04,000 Cr	E + D

1Step 1: Calculate Capital Structure Weights

Equity Weight (E/V) = 1,20,000 / 2,04,000 = 58.8%
Debt Weight (D/V) = 84,000 / 2,04,000 = 41.2%

2Step 2: Apply WACC Formula

WACC = Ke × (E/V) + Kd × (D/V)

3Step 3: Calculate
WACC = 16.8% × 0.588 + 7.5% × 0.412
WACC = 9.88% + 3.09%
WACC = 12.97% ≈ 13.0%

4Verification:

Component	Weight	Cost	Weighted Cost
Equity	58.8%	16.8%	9.88%
Debt (After-tax)	41.2%	7.5%	3.09%
Total	100%	-	12.97%

WACC = 13.0% (rounded)

Exercise 4: Calculating Terminal Value (Both Methods)

Problem: Calculate Terminal Value using both Gordon Growth and Exit Multiple methods.

?Given Data:

Parameter	Value	Notes
Year 5 FCFF	₹15,000 Cr	From projection
Year 5 EBITDA	₹22,000 Cr	From projection
Terminal Growth Rate (g)	4%	Long-term GDP growth
WACC	13%	From Exercise 3
Industry EV/EBITDA Multiple	7x	Comparable companies

1METHOD 1: Gordon Growth Model

Step 1a: Calculate FCFF₆ (Year 6 FCFF)
FCFF₆ = FCFF₅ × (1 + g) = 15,000 × 1.04 = ₹15,600 Cr

Step 1b: Calculate Terminal Value

TV = FCFF₆ / (WACC - g)

TV = 15,600 / (0.13 - 0.04)
TV = 15,600 / 0.09
TV = ₹1,73,333 Crores

2METHOD 2: Exit Multiple Method

TV = EBITDA₅ × Exit Multiple

TV = 22,000 × 7
TV = ₹1,54,000 Crores

3Comparison & Selection:

Method	Terminal Value	Difference
Gordon Growth	₹1,73,333 Cr	Base
Exit Multiple	₹1,54,000 Cr	-11.2%

Analyst Note: Gordon Growth gives higher value. Cross-check assumptions. If growth rate seems optimistic, use lower g or use Exit Multiple as sanity check.

Gordon Growth TV = ₹1,73,333 Cr | Exit Multiple TV = ₹1,54,000 Cr
Use average (₹1,63,667 Cr) or conservative (₹1,54,000 Cr) based on judgment

Exercise 5: Calculating Enterprise Value (Complete DCF)

Problem: Calculate Enterprise Value by discounting FCFFs and Terminal Value.

?Given Data:

Year	FCFF (₹ Cr)	WACC
Year 1	10,000	13%
Year 2	11,500	13%
Year 3	13,225	13%
Year 4	14,547	13%
Year 5	15,000	13%

Terminal Value (from Exercise 4): ₹1,73,333 Cr (Gordon Growth)

1Step 1: Calculate Discount Factors

Discount Factor = 1 / (1 + WACC)ⁿ
DF₁ = 1/1.13 = 0.885 | DF₂ = 1/1.28 = 0.783 | DF₃ = 1/1.44 = 0.693
DF₄ = 1/1.63 = 0.613 | DF₅ = 1/1.84 = 0.543

2Step 2: Calculate PV of FCFFs

Year	FCFF	Discount Factor	PV of FCFF
1	10,000	0.885	8,850
2	11,500	0.783	9,005
3	13,225	0.693	9,165
4	14,547	0.613	8,917
5	15,000	0.543	8,145
Sum	-	-	44,082

Sum of PV of FCFFs = ₹44,082 Crores

3Step 3: Calculate PV of Terminal Value
PV of TV = TV × DF₅
PV of TV = 1,73,333 × 0.543 = ₹94,140 Crores

4Step 4: Calculate Enterprise Value

EV = PV of FCFFs + PV of Terminal Value
EV = 44,082 + 94,140
Enterprise Value = ₹1,38,222 Crores

5Value Composition Analysis:

Component	Value	% of EV
PV of FCFFs (Years 1-5)	₹44,082 Cr	31.9%
PV of Terminal Value	₹94,140 Cr	68.1%
Enterprise Value	₹1,38,222 Cr	100%

Key Insight: Terminal Value accounts for 68% of total value - this is why terminal assumptions are critical!

Enterprise Value = ₹1,38,222 Crores
TV contributes 68% of total value - validate terminal assumptions carefully!

Exercise 6: From Enterprise Value to Equity Value per Share

Problem: Calculate the fair value per share from Enterprise Value.

?Given Data:
Enterprise Value (from Exercise 5): ₹1,38,222 Cr
Total Debt: ₹84,000 Cr | Cash & Equivalents: ₹12,000 Cr
Minority Interest: ₹2,000 Cr | Shares Outstanding: 950 Cr

1Step 1: Calculate Net Debt
Net Debt = Total Debt - Cash & Equivalents
Net Debt = 84,000 - 12,000 = ₹72,000 Crores

2Step 2: Calculate Equity Value

Equity Value = EV - Net Debt - Minority Interest

Equity Value = 1,38,222 - 72,000 - 2,000
Equity Value = ₹64,222 Crores

3Step 3: Calculate Fair Value per Share
Fair Value = Equity Value / Shares Outstanding
Fair Value = 64,222 / 950
Fair Value = ₹67.61 per share

4Complete Bridge: EV to Equity Value

Item	Amount (₹ Cr)
Enterprise Value	1,38,222
Less: Total Debt	(84,000)
Add: Cash & Equivalents	12,000
Less: Minority Interest	(2,000)
Equity Value	64,222
Shares Outstanding (Cr)	950
Fair Value per Share	₹67.61

Fair Value per Share = ₹67.61
Compare with current market price to determine if stock is over/undervalued

Complete DCF Valuation Flow: Summary

Step	Calculate	Formula/Method	Exercise
1	Cost of Equity (Ke)	Rf + β × (Rm - Rf)	Exercise 1
2	Cost of Debt (Kd)	Interest/Debt × (1-T)	Exercise 2
3	WACC	Ke × (E/V) + Kd × (D/V)	Exercise 3
4	Terminal Value (TV)	FCFF₆/(WACC-g) OR EBITDA×Multiple	Exercise 4
5	Enterprise Value (EV)	PV(FCFFs) + PV(TV)	Exercise 5
6	Equity Value/Share	(EV - Net Debt) / Shares	Exercise 6

Terminal Value: Two Methods

Terminal Value often represents 60-70% of total DCF value. Two approaches:

Gordon Growth (Perpetuity)

TV = FCFFₙ₊₁ / (WACC - g)

Where:
FCFFₙ₊₁ = FCFFₙ × (1 + g)
g = Terminal growth rate (usually 2-4%)

Best for: Stable, mature companies

Exit Multiple Method

TV = EBITDAₙ × Exit Multiple

Where:
Exit Multiple = Industry EV/EBITDA
(typically 8-15x for Indian companies)

Best for: Comparables-based valuation

Critical Pitfall: FCFₙ vs FCFₙ₊₁

Common Error: Using FCFFₙ (Year 5) instead of FCFFₙ₊₁ (Year 6) in terminal value formula.
Correct: TV = FCFF₆ / (WACC - g) where FCFF₆ = FCFF₅ × (1 + g)
Incorrect: TV = FCFF₅ / (WACC - g) ← This understates value!

Illustration: TCS FCFF DCF Valuation

Problem: Calculate intrinsic value per share using FCFF DCF.

?Given Data:
Current FCFF: ₹40,000 Cr | Growth (5Y): 8% | Terminal Growth: 4%
WACC: 10.5% | Net Debt: -₹25,000 Cr (Cash) | Shares: 370 Cr

1Step 1: Forecast FCFF & Calculate PV

Year	FCFF	Discount Factor	PV
1	43,200	0.905	39,096
2	46,656	0.819	38,211
3	50,388	0.741	37,338
4	54,419	0.671	36,515
5	58,773	0.607	35,675

Sum of PV = ₹1,86,835 Cr

2Step 2: Calculate Terminal Value
FCFF₆ = 58,773 × 1.04 = ₹61,124 Cr
TV = 61,124 / (0.105 - 0.04) = ₹9,40,354 Cr
PV of TV = 9,40,354 × 0.607 = ₹5,70,955 Cr

3Step 3: Calculate Enterprise Value
EV = 1,86,835 + 5,70,955 = ₹7,57,790 Cr

4Step 4: Calculate Equity Value & Per Share
Equity Value = EV - Net Debt = 7,57,790 - (-25,000) = ₹7,82,790 Cr
Fair Value = 7,82,790 / 370 = ₹2,116 per share

TCS Intrinsic Value = ₹2,116 per share

4

FCFE Model: Direct Equity Valuation

Valuing equity directly without going through enterprise value

When to Use FCFE Model

FCFE is Preferred When

Company has stable leverage ratio
Dividend policy aligns with FCFE
Direct equity valuation needed
Financial institutions (sometimes)

Avoid FCFE When

Leverage is changing significantly
Negative FCFE due to high debt repayment
Unpredictable net borrowing patterns

FCFE DCF Formula

Equity Value = Σ [FCFEₜ / (1+Ke)ᵗ] + [TV / (1+Ke)ⁿ]

FCFE Terminal Value

TV = FCFEₙ₊₁ / (Ke - g)

Key Difference: Discount Rate

FCFF: Discount at WACC (includes debt cost)
FCFE: Discount at Cost of Equity (Ke) only
Since FCFE is already after debt payments, we use higher discount rate (Ke > WACC typically).

Exercise 1: FCFE from FCFF (Formula 1)

Problem: Calculate FCFE from FCFF using the conversion formula.

?Given Data:

Parameter	Value
FCFF	₹12,000 Cr
Interest Expense	₹2,000 Cr
Tax Rate	25%
New Debt Issued	₹5,000 Cr
Debt Repaid	₹2,000 Cr

1Formula:

FCFE = FCFF - Interest × (1 - Tax) + Net Borrowing

2Step 1: Calculate After-tax Interest
After-tax Interest = Interest × (1 - Tax) = 2,000 × (1 - 0.25) = 2,000 × 0.75 = ₹1,500 Cr

3Step 2: Calculate Net Borrowing
Net Borrowing = New Debt - Debt Repaid = 5,000 - 2,000 = ₹3,000 Cr

4Step 3: Calculate FCFE
FCFE = FCFF - After-tax Interest + Net Borrowing
FCFE = 12,000 - 1,500 + 3,000 = ₹13,500 Crores

FCFE = ₹13,500 Crores
FCFE > FCFF because Net Borrowing (3,000) > After-tax Interest (1,500)

Exercise 2: FCFE Direct from Net Income (Formula 2)

Problem: Calculate FCFE directly from Net Income without first calculating FCFF.

?Given Data:

Parameter	Value
Net Income	₹8,000 Cr
Depreciation	₹2,500 Cr
Capital Expenditure (CapEx)	₹4,000 Cr
Change in Working Capital (ΔWC)	+₹1,500 Cr (increase)
Net Borrowing	₹3,000 Cr

1Formula:

FCFE = Net Income + Depreciation - CapEx - ΔWC + Net Borrowing

2Step-by-step Calculation:

Component	Calculation	Amount
Net Income	Starting point	+₹8,000
Add: Depreciation	Non-cash expense	+₹2,500
Less: CapEx	Cash outflow	-₹4,000
Less: ΔWC	WC increase = outflow	-₹1,500
Add: Net Borrowing	Cash from debt	+₹3,000
FCFE	Total	₹8,000 Cr

FCFE = ₹8,000 Crores

Exercise 3: Cost of Equity (Ke) for FCFE Model

Problem: Calculate the Cost of Equity to use as discount rate in FCFE model.

?Given Data:
Risk-free Rate (Rf): 6.5% | Beta (β): 1.1 | Market Risk Premium: 7.5%

1CAPM Formula:

Ke = Rf + β × (Rm - Rf)

2Calculation:
Ke = 6.5% + 1.1 × 7.5%
Ke = 6.5% + 8.25%
Ke = 14.75%

Cost of Equity (Ke) = 14.75%
Note: FCFE uses Ke, not WACC, because it's cash flow to equity holders only

Exercise 4: FCFE Terminal Value (Both Methods)

Problem: Calculate Terminal Value using both Gordon Growth and Exit Multiple methods.

?Given Data:
Year 5 FCFE: ₹18,000 Cr | Terminal Growth: 4% | Cost of Equity: 14%
Year 5 Net Income: ₹25,000 Cr | Industry P/E Multiple: 18x

1METHOD 1: Gordon Growth

FCFE₆ = 18,000 × 1.04 = ₹18,720 Cr
TV = FCFE₆ / (Ke - g) = 18,720 / (0.14 - 0.04)
TV = 18,720 / 0.10 = ₹1,87,200 Cr

2METHOD 2: Exit Multiple (P/E)

TV = Net Income × P/E Multiple = 25,000 × 18
TV = ₹4,50,000 Cr

3Comparison & Selection:

Method	Terminal Value	Difference
Gordon Growth	₹1,87,200 Cr	Base
Exit Multiple (P/E)	₹4,50,000 Cr	+140%

Analyst Note: Exit Multiple gives much higher value. Check if P/E multiple is appropriate (18x may be too high). Use conservative estimate or average.

Gordon Growth TV = ₹1,87,200 Cr | Exit Multiple TV = ₹4,50,000 Cr
Key difference: FCFE TV uses Ke (14%), not WACC. Exit Multiple uses P/E, not EV/EBITDA.

Exercise 5: Complete FCFE DCF Valuation

Problem: Perform complete FCFE DCF valuation for ICICI Bank.

?Given Data:
Current FCFE: ₹15,000 Cr | Growth (5Y): 6% | Terminal Growth: 3.5%
Cost of Equity (Ke): 13% | Shares Outstanding: 700 Cr

1Step 1: Forecast FCFE & Calculate PV

Year	FCFE	Discount Factor (13%)	PV
1	15,900	0.885	14,072
2	16,854	0.783	13,197
3	17,865	0.693	12,380
4	18,937	0.613	11,608
5	20,074	0.543	10,900

Sum of PV = ₹62,157 Cr

2Step 2: Calculate Terminal Value
FCFE₆ = 20,074 × 1.035 = ₹20,777 Cr
TV = 20,777 / (0.13 - 0.035) = 20,777 / 0.095 = ₹2,18,705 Cr

3Step 3: Calculate PV of Terminal Value
PV of TV = 2,18,705 × 0.543 = ₹1,18,757 Cr

4Step 4: Calculate Equity Value

Equity Value = PV of FCFEs + PV of Terminal Value
Equity Value = 62,157 + 1,18,757 = ₹1,80,914 Cr

5Step 5: Fair Value per Share
Fair Value = 1,80,914 / 700 = ₹258.45 per share

ICICI Bank Intrinsic Value = ₹258 per share
Note: FCFE DCF gives equity value directly, no need to subtract net debt

Illustration: Infosys FCFE Valuation

Problem: Calculate intrinsic value using FCFE model.

?Given Data:
Current FCFE: ₹28,000 Cr | Growth (5Y): 7% | Terminal Growth: 4%
Ke: 11% | Shares: 415 Cr (Infosys is debt-free, so FCFF ≈ FCFE)

1Step 1: Forecast FCFE & Calculate PV

Year	FCFE	Discount Factor (11%)	PV
1	29,960	0.901	26,991
2	32,057	0.812	26,030
3	34,301	0.731	25,074
4	36,702	0.659	24,185
5	39,271	0.593	23,288

Sum of PV = ₹1,25,568 Cr

2Step 2: Calculate Terminal Value
FCFE₆ = 39,271 × 1.04 = ₹40,842 Cr
TV = 40,842 / (0.11 - 0.04) = ₹5,83,457 Cr
PV of TV = 5,83,457 × 0.593 = ₹3,45,990 Cr

3Step 3: Calculate Equity Value
Equity Value = 1,25,568 + 3,45,990 = ₹4,71,558 Cr

4Step 4: Fair Value per Share
Fair Value = 4,71,558 / 415 = ₹1,136 per share

Infosys Intrinsic Value = ₹1,136 per share

FCFE Formulas Summary: All Methods

Formula Name	Equation	Exercise	When to Use
FCFE from FCFF	FCFE = FCFF - Int×(1-T) + Net Borrowing	Exercise 1	When FCFF is already calculated
FCFE Direct	FCFE = NI + Dep - CapEx - ΔWC + Net Borrowing	Exercise 2	Direct from financial statements
Cost of Equity (Ke)	Ke = Rf + β × (Rm - Rf)	Exercise 3	Discount rate for FCFE model
FCFE Terminal Value	TV = FCFE₆ / (Ke - g) or NI×P/E	Exercise 4	Terminal value for FCFE DCF
FCFE DCF Formula	Eq Value = Σ[FCFEₜ/(1+Ke)ᵗ] + TV/(1+Ke)ⁿ	Exercise 5	Complete equity valuation

Key Difference vs FCFF: FCFE uses Ke (not WACC) and values equity directly (no EV to equity conversion needed).

5

Residual Income Model

Valuing companies based on economic profit above required return

Understanding Residual Income

Residual Income (RI) is the income earned above the minimum required return. It measures economic profit - value created beyond the cost of capital.

Residual Income Formula

RI = Net Income - (Equity Capital × Cost of Equity)

Residual Income Valuation

Value = Book Value + Σ [RIₜ / (1+Ke)ᵗ]

When RI Model Works Best

Banks & Financial Institutions: FCF difficult to define
Negative FCF companies: Heavy capex phase
Asset-heavy firms: Book value meaningful
Private companies: Limited market data

Key Insight

If a company earns ROE > Ke, it creates positive residual income and should trade above book value. If ROE < Ke, it destroys value.

Exercise 1: Basic Residual Income Calculation

Problem: Calculate Residual Income for a company and determine if it creates or destroys value.

?Given Data for ABC Ltd. (₹ Crores):

Parameter	Value
Book Value of Equity	₹10,000 Cr
Net Income (FY24)	₹1,500 Cr
Cost of Equity (Ke)	12%

1Step 1: Calculate Required Return

Required Return = Book Value × Ke
Required Return = 10,000 × 0.12 = ₹1,200 Cr

2Step 2: Calculate Residual Income

RI = Net Income - Required Return
RI = 1,500 - 1,200 = ₹300 Crores

3Step 3: Calculate ROE and Compare with Ke
ROE = Net Income / Book Value = 1,500 / 10,000 = 15%

Analysis: ROE (15%) > Ke (12%) → Positive Residual Income (₹300 Cr)
Company creates value above required return for equity holders

Residual Income = ₹300 Crores (Positive)
Company creates value because ROE (15%) > Cost of Equity (12%)

Exercise 2: Multi-Year Residual Income Projection

Problem: Project Residual Income for 3 years and calculate present value.

?Given Data for XYZ Corp.:

Year	Book Value (Start)	Net Income	Dividends
Year 0	₹8,000 Cr	-	-
Year 1	-	₹1,200 Cr	₹400 Cr
Year 2	-	₹1,380 Cr	₹460 Cr
Year 3	-	₹1,587 Cr	₹530 Cr

Cost of Equity (Ke): 14% | Assume clean surplus accounting

1Step 1: Calculate Book Value Each Year

Clean Surplus: BVₜ = BVₜ₋₁ + NIₜ - Dividendsₜ

BV₁ = 8,000 + 1,200 - 400 = ₹8,800 Cr
BV₂ = 8,800 + 1,380 - 460 = ₹9,720 Cr
BV₃ = 9,720 + 1,587 - 530 = ₹10,777 Cr

2Step 2: Calculate Residual Income Each Year

Year	Book Value (Start)	Required Return (BV×Ke)	Net Income	Residual Income
1	8,000	1,120	1,200	₹80 Cr
2	8,800	1,232	1,380	₹148 Cr
3	9,720	1,361	1,587	₹226 Cr

3Step 3: Calculate PV of Residual Income

Year	Residual Income	Discount Factor (14%)	PV of RI
1	₹80 Cr	0.877	₹70.2 Cr
2	₹148 Cr	0.769	₹113.8 Cr
3	₹226 Cr	0.675	₹152.6 Cr
Total	-	-	₹336.6 Cr

PV of Residual Income (3 Years) = ₹336.6 Crores
Intrinsic Value = Book Value (₹8,000) + PV of RI (₹336.6) = ₹8,336.6 Cr

Exercise 3: Residual Income Valuation with Growth

Problem: Calculate intrinsic value using Residual Income model with constant growth in RI.

?Given Data for PQR Industries:
Current Book Value per Share: ₹250 | ROE: 18% | Cost of Equity: 15%
Growth in Residual Income: 5% per year | Shares Outstanding: 200 Cr

1Step 1: Calculate Current Residual Income

EPS = Book Value × ROE = 250 × 0.18 = ₹45 per share
Required Return = Book Value × Ke = 250 × 0.15 = ₹37.50 per share
Residual Income = EPS - Required Return = 45 - 37.50 = ₹7.50 per share

2Step 2: Calculate Present Value of Growing RI

Growing Perpetuity Formula: PV = RI₁ / (Ke - g)

RI₁ = Current RI = ₹7.50
Ke = 15% | g = 5%

PV of RI = 7.50 / (0.15 - 0.05) = 7.50 / 0.10 = ₹75 per share

3Step 3: Calculate Intrinsic Value per Share

Intrinsic Value = Book Value + PV of Residual Income
Intrinsic Value = 250 + 75 = ₹325 per share

4Step 4: Calculate Total Equity Value
Total Equity Value = Intrinsic Value × Shares Outstanding
Total Equity Value = 325 × 200 = ₹65,000 Crores

Intrinsic Value = ₹325 per share | Total Equity Value = ₹65,000 Cr
Company trades at 1.3× book value (325/250) due to positive RI growth

Exercise 4: Bank Valuation using Residual Income

Problem: Value State Bank of India using Residual Income model (banks are ideal for RI).

?Given Data for SBI:
Current Book Value per Share: ₹400 | ROE: 14% | Cost of Equity: 11%
Shares Outstanding: 900 Cr | Assume RI grows at 3% for 10 years, then zero

1Step 1: Calculate Current Residual Income
EPS = 400 × 0.14 = ₹56 | Required Return = 400 × 0.11 = ₹44
Residual Income = 56 - 44 = ₹12 per share

2Step 2: Project RI for 10 Years with 3% Growth

Year	Residual Income	Discount Factor (11%)	PV of RI
1	₹12.36	0.901	₹11.14
2	₹12.73	0.812	₹10.34
3	₹13.11	0.731	₹9.58
4	₹13.50	0.659	₹8.90
5	₹13.91	0.593	₹8.25
6	₹14.33	0.535	₹7.66
7	₹14.76	0.482	₹7.11
8	₹15.20	0.434	₹6.60
9	₹15.66	0.391	₹6.12
10	₹16.13	0.352	₹5.68
Total	-	-	₹81.38

3Step 3: Calculate Intrinsic Value per Share
Intrinsic Value = Book Value + PV of RI
Intrinsic Value = 400 + 81.38 = ₹481.38 per share

4Step 4: Calculate Total Equity Value
Total Equity Value = 481.38 × 900 = ₹4,33,242 Crores

SBI Intrinsic Value = ₹481 per share | Equity Value = ₹4,33,242 Cr
Premium to book value = 20.3% (481/400) due to positive RI

Exercise 5: Complete Residual Income Model (Two-Stage)

Problem: Perform complete two-stage Residual Income valuation for a high-growth tech company.

?Given Data for TechNxt Ltd.:
Current Book Value per Share: ₹180 | ROE (Years 1-5): 22% | ROE (After Year 5): 16%
Cost of Equity: 14% | Shares Outstanding: 150 Cr
Stage 1: High growth for 5 years (ROE 22%)
Stage 2: Mature growth after Year 5 (ROE 16% = Ke + 2%, zero RI growth)

1Step 1: Calculate Book Value Progression

Clean Surplus: Assume all earnings reinvested (no dividends)
BVₜ = BVₜ₋₁ × (1 + ROE)

Year	BV (Start)	ROE	EPS	BV (End)
0	₹180.00	-	-	-
1	₹180.00	22%	₹39.60	₹219.60
2	₹219.60	22%	₹48.31	₹267.91
3	₹267.91	22%	₹58.94	₹326.85
4	₹326.85	22%	₹71.91	₹398.76
5	₹398.76	22%	₹87.73	₹486.49
6+	₹486.49	16%	₹77.84	-

2Step 2: Calculate Residual Income (Years 1-5)

Year	BV (Start)	Required Return (BV×14%)	EPS	Residual Income
1	₹180.00	₹25.20	₹39.60	₹14.40
2	₹219.60	₹30.74	₹48.31	₹17.57
3	₹267.91	₹37.51	₹58.94	₹21.43
4	₹326.85	₹45.76	₹71.91	₹26.15
5	₹398.76	₹55.83	₹87.73	₹31.90

3Step 3: Calculate PV of RI (Years 1-5)

Year	Residual Income	Discount Factor (14%)	PV of RI
1	₹14.40	0.877	₹12.63
2	₹17.57	0.769	₹13.51
3	₹21.43	0.675	₹14.47
4	₹26.15	0.592	₹15.48
5	₹31.90	0.519	₹16.56
Total	-	-	₹72.65

4Step 4: Calculate Terminal RI (Year 6 onwards)

EPS₆ = BV₅ × ROE₆ = 486.49 × 0.16 = ₹77.84
Required Return₆ = BV₅ × Ke = 486.49 × 0.14 = ₹68.11
RI₆ = 77.84 - 68.11 = ₹9.73

Terminal Value of RI (no growth): TV = RI₆ / Ke = 9.73 / 0.14 = ₹69.50
PV of Terminal RI: 69.50 × 0.519 = ₹36.07

5Step 5: Calculate Intrinsic Value

Intrinsic Value = BV₀ + PV of RI (Years 1-5) + PV of Terminal RI
Intrinsic Value = 180 + 72.65 + 36.07 = ₹288.72 per share

Total Equity Value = 288.72 × 150 = ₹43,308 Crores

TechNxt Intrinsic Value = ₹288.72 per share | Equity Value = ₹43,308 Cr
Premium to book value = 60.4% (288.72/180) due to high ROE in growth phase

Residual Income Formulas Summary: All Methods

Formula Name	Equation	Exercise	When to Use
Basic RI	RI = NI - (BV × Ke)	Exercise 1	Quick RI calculation
Multi-Year RI	BVₜ = BVₜ₋₁ + NIₜ - Divₜ	Exercise 2	Multi-period projection
RI with Growth	PV = RI₁ / (Ke - g)	Exercise 3	Constant growth in RI
Bank RI Valuation	Value = BV + Σ[RIₜ/(1+Ke)ᵗ]	Exercise 4	Bank/financial valuation
Two-Stage RI Model	Value = BV + PV(RI₁₋ₙ) + PV(TV)	Exercise 5	High-growth companies

Key Insight: RI model separates value into book value (assets) and present value of future economic profit (goodwill). Works best when ROE ≠ Ke.

Illustration: HDFC Bank Residual Income Valuation

Problem: Calculate intrinsic value using Residual Income model.

?Given Data:
Book Value per Share: ₹550 | ROE: 17% | Cost of Equity: 12%
Current EPS: ₹93.50 | Shares Outstanding: 549 Cr
Assume constant ROE for 10 years, then ROE = Ke (terminal)

1Step 1: Calculate Annual Residual Income
EPS = Book Value × ROE = 550 × 0.17 = ₹93.50
Required Return = Book Value × Ke = 550 × 0.12 = ₹66
Residual Income per Share = 93.50 - 66 = ₹27.50

2Step 2: Calculate PV of Residual Income (10 Years)
PV of RI = 27.50 × [1 - (1.12)⁻¹⁰] / 0.12
PV of RI = 27.50 × 5.65 = ₹155.38

3Step 3: Calculate Intrinsic Value
Value = Book Value + PV of RI
Value = 550 + 155.38 = ₹705.38 per share

HDFC Bank Intrinsic Value = ₹705 per share (simplified)
Note: This is a simplified single-stage model. Multi-stage models would be more accurate.

6

Interactive DCF Calculator

Build your own DCF model with real-time calculations

FCFF DCF Valuation Calculator

Current FCFF (₹ Cr)

Growth Rate - Explicit (%)

Terminal Growth (%)

WACC (%)

Net Debt (₹ Cr)

Shares Outstanding (Cr)

7

Case Studies

Real-world DCF applications with Indian companies

Case 1: HUL - Stable FMCG (DDM + DCF Hybrid)

Hindustan Unilever is a mature FMCG company with stable cash flows and consistent dividend payments.

Key Assumptions

Current FCF: ₹10,500 Cr
Growth Rate: 8% (5Y) → 5% terminal
WACC: 9.5% (low beta ~0.45)
Dividend Payout: ~80%

Valuation Summary

DCF Value: ₹2,100 - ₹2,400
DDM Value: ₹1,800 - ₹2,000
Current Price: ~₹2,400
Verdict: Fairly Valued

Key Learning

FMCG companies often trade at premium valuations (P/E 50-70x) due to predictability. DCF may show "overvalued" but quality commands premium. Use DDM as cross-check for dividend payers.

Case 2: Infosys - 2-Stage DCF

Infosys is transitioning from high growth to mature growth, requiring a 2-stage DCF model.

Stage 1: High Growth (5 Years)

Revenue Growth: 8-10%
Margin: Stable at 20-22%
FCFF Growth: ~7-8%

Stage 2: Mature Growth

Terminal Growth: 4%
Margin: 18-20%
ROIC approaching WACC

2-Stage DCF Approach

Value = PV(FCFF in high growth) + PV(Terminal Value at maturity)
Key: Terminal value uses lower growth and potentially higher WACC as company matures.

Case 3: Tata Motors - Sensitivity Focus

Tata Motors has volatile cash flows due to JLR cyclicality and EV investments - sensitivity analysis is crucial.

DCF Challenges

JLR cash flows highly cyclical
EV business burning cash currently
Terminal value assumptions critical
Wide range of fair values possible

Scenario	WACC	Terminal g	Fair Value
Bull Case	10%	4.5%	₹1,050
Base Case	10.5%	4%	₹850
Bear Case	11%	3%	₹650

Key Learning

For cyclical/turnaround companies, always present a RANGE of values. Single point estimates are misleading. Sensitivity analysis is not optional - it's essential.

8

Hands-On Exercises

Practice DCF valuation with structured problems

Exercise 1: FCFF Calculation

Problem: Calculate FCFF from the following data.

?Given: EBITDA = ₹5,000 Cr | Depreciation = ₹1,000 Cr | Tax Rate = 25%
CapEx = ₹1,500 Cr | Change in WC = +₹500 Cr

1 EBIT = EBITDA - Depreciation = 5,000 - 1,000 = ₹4,000 Cr
NOPAT = EBIT × (1-Tax) = 4,000 × 0.75 = ₹3,000 Cr
FCFF = NOPAT + Depreciation - CapEx - ΔWC
FCFF = 3,000 + 1,000 - 1,500 - 500 = ₹2,000 Cr

FCFF = ₹2,000 Crores

Exercise 2: WACC Calculation

Problem: Calculate WACC for a company.

?Given: Risk-free Rate = 7% | Beta = 1.2 | Market Risk Premium = 7%
Cost of Debt = 8% | Tax Rate = 25% | Debt/Equity = 40/60

1Step 1: Calculate Cost of Equity
Ke = Rf + β × (Rm - Rf) = 7% + 1.2 × 7% = 7% + 8.4% = 15.4%

2Step 2: After-tax Cost of Debt
Kd × (1-T) = 8% × 0.75 = 6%

3Step 3: Calculate WACC
WACC = Ke × (E/V) + Kd(1-T) × (D/V)
WACC = 15.4% × 0.60 + 6% × 0.40 = 9.24% + 2.4% = 11.64%

WACC = 11.64%

Exercise 3: Terminal Value

Problem: Calculate Terminal Value using both methods.

?Given: Year 5 FCFF = ₹10,000 Cr | Terminal Growth = 3% | WACC = 12%
Year 5 EBITDA = ₹15,000 Cr | Industry EV/EBITDA = 8x

1Method 1: Gordon Growth
FCFF₆ = 10,000 × 1.03 = ₹10,300 Cr
TV = 10,300 / (0.12 - 0.03) = 10,300 / 0.09 = ₹1,14,444 Cr

2Method 2: Exit Multiple
TV = EBITDA × Multiple = 15,000 × 8 = ₹1,20,000 Cr

Gordon Growth TV = ₹1,14,444 Cr | Exit Multiple TV = ₹1,20,000 Cr
Difference: ~5% - Both methods should ideally converge

Exercise 4: FCFE vs FCFF

Problem: Calculate both FCFF and FCFE, then explain the difference.

1FCFF Calculation:
FCFF = EBIT(1-T) + Dep - CapEx - ΔWC
FCFF = 8,000 × 0.75 + 2,000 - 3,000 - 1,000 = 6,000 + 2,000 - 4,000 = ₹4,000 Cr

2FCFE Calculation:
FCFE = FCFF - Interest(1-T) + Net Borrowing
FCFE = 4,000 - 500 × 0.75 + 2,000 = 4,000 - 375 + 2,000 = ₹5,625 Cr

FCFF = ₹4,000 Cr | FCFE = ₹5,625 Cr
FCFE > FCFF because Net Borrowing (2,000) > After-tax Interest (375)

Exercise 5: Complete DCF Valuation

Problem: Perform a complete DCF valuation for Wipro.

?Given: Current FCFF = ₹12,000 Cr | Growth = 6% (5Y) | Terminal g = 3.5%
WACC = 11% | Net Debt = -₹15,000 Cr | Shares = 520 Cr

1PV of FCFFs (5 Years at 11%):
Year 1-5 FCFF: 12,720, 13,483, 14,292, 15,150, 16,059
PV Factors: 0.901, 0.812, 0.731, 0.659, 0.593
Sum of PV = ₹51,234 Cr

2Terminal Value:
FCFF₆ = 16,059 × 1.035 = ₹16,621 Cr
TV = 16,621 / (0.11 - 0.035) = ₹2,21,613 Cr
PV of TV = 2,21,613 × 0.593 = ₹1,31,416 Cr

3Equity Value:
EV = 51,234 + 1,31,416 = ₹1,82,650 Cr
Equity = 1,82,650 - (-15,000) = ₹1,97,650 Cr
Fair Value = 1,97,650 / 520 = ₹380 per share

Wipro Intrinsic Value = ₹380 per share

Key Takeaways

Model Selection: Use FCFF for most companies, FCFE for stable leverage, Residual Income for banks and negative FCF firms.

Terminal Value: Often 60-70% of total value. Use FCFₙ₊₁ (not FCFₙ) in Gordon Growth. Cross-check with Exit Multiple.

WACC Sensitivity: 1% change in WACC can change value by 15-20%. Always do sensitivity analysis.

Garbage In, Garbage Out: DCF is only as good as assumptions. Use conservative, realistic inputs.

Range Not Point: Always present a range of fair values (bull/base/bear cases) rather than single number.

Cross-Check: Validate DCF with relative valuation (P/E, EV/EBITDA) and other methods.

9

Excel Lab Guide

Step-by-step instructions to build your own DCF model

Building a DCF Model in Excel

Step 1: Setup Assumptions Tab

Revenue growth rate
Operating margin (EBIT %)
Tax rate
Depreciation % of revenue
CapEx % of revenue
Working capital % of revenue
WACC, Terminal growth

Step 2: Build FCFF Projection

Create columns for Years 1-10 with:

Revenue = Prior × (1 + growth)
EBIT = Revenue × Margin
NOPAT = EBIT × (1-Tax)
+ Depreciation
- CapEx
- Change in WC
= FCFF

Step 3: Calculate Present Values

Key Excel formulas:

Discount Factor: =1/(1+WACC)^year
PV of FCFF: =FCFF*DiscountFactor
Terminal Value: =FCFF_n1/(WACC-g)
PV of TV: =TV/(1+WACC)^n

Step 4: Sensitivity Table

Use Data Table (What-If Analysis):

Row input: Terminal growth
Column input: WACC
Output: Fair value per share
Shows impact of assumptions

Pro Tips

Name your cells (Ctrl+F3) for formula clarity
Use conditional formatting to highlight key outputs
Build scenario manager for bull/base/bear cases
Always audit: Sum of PVs + PV of TV should equal EV

10

Knowledge Assessment

Test your DCF valuation understanding

DCF Valuation Quiz

Discounted Cash Flow Valuation

Introduction to DCF Valuation

What is DCF Valuation?

When DCF Works Best

DCF Limitations

Three DCF Approaches Compared

Free Cash Flow Fundamentals

FCFF: Free Cash Flow to Firm

Key Components Explained

Exercise: FCFF Calculation Using Both Methods

Practice Exercise: Calculate FCFF Using Both Methods

Why Use EBIT Method Over Net Income Method?

FCFE: Free Cash Flow to Equity

When FCFE = FCFF

Net Borrowing

Comprehensive Exercise: FCFF and FCFE for Reliance Industries (Both Methods)

PART A: FCFF Calculation (Two Methods)

PART B: FCFE Calculation (Two Methods)

Quick Reference: FCFF vs FCFE Formulas

DCF Model: FCFF Approach

FCFF DCF Framework

Step 1: Forecast FCFF

Step 2: Calculate WACC

Step 3: Terminal Value

Step-by-Step: Building WACC

Step 1

Step 2

Step 3

Exercise 1: Calculating Cost of Equity (Ke) using CAPM

Exercise 2: Calculating After-Tax Cost of Debt (Kd)

Exercise 3: Calculating WACC (Combining Ke and Kd)

Exercise 4: Calculating Terminal Value (Both Methods)

Exercise 5: Calculating Enterprise Value (Complete DCF)

Exercise 6: From Enterprise Value to Equity Value per Share

Complete DCF Valuation Flow: Summary

Terminal Value: Two Methods

Gordon Growth (Perpetuity)

Exit Multiple Method

Critical Pitfall: FCFₙ vs FCFₙ₊₁

Illustration: TCS FCFF DCF Valuation

FCFE Model: Direct Equity Valuation

When to Use FCFE Model

FCFE is Preferred When

Avoid FCFE When

Key Difference: Discount Rate

Exercise 1: FCFE from FCFF (Formula 1)

Exercise 2: FCFE Direct from Net Income (Formula 2)

Exercise 3: Cost of Equity (Ke) for FCFE Model

Exercise 4: FCFE Terminal Value (Both Methods)

Exercise 5: Complete FCFE DCF Valuation

Illustration: Infosys FCFE Valuation

FCFE Formulas Summary: All Methods

Residual Income Model

Understanding Residual Income

When RI Model Works Best

Key Insight

Exercise 1: Basic Residual Income Calculation

Exercise 2: Multi-Year Residual Income Projection

Exercise 3: Residual Income Valuation with Growth

Exercise 4: Bank Valuation using Residual Income

Exercise 5: Complete Residual Income Model (Two-Stage)

Residual Income Formulas Summary: All Methods

Illustration: HDFC Bank Residual Income Valuation

Interactive DCF Calculator

Sensitivity Analysis: WACC vs Terminal Growth

Case Studies

Case 1: HUL - Stable FMCG (DDM + DCF Hybrid)

Key Assumptions

Valuation Summary

Key Learning

Case 2: Infosys - 2-Stage DCF

Stage 1: High Growth (5 Years)

Stage 2: Mature Growth

2-Stage DCF Approach

Case 3: Tata Motors - Sensitivity Focus

DCF Challenges

Key Learning

Hands-On Exercises

Exercise 1: FCFF Calculation

Exercise 2: WACC Calculation