DCF

When using mid-year convention, how would you discount the terminal year if you were using perpetuity growth method vs. the multiples method?

Assume the terminal year in a DCF is year 5 When using perpetuity growth method, you would discount the terminal year at t=4.5 When using the multiples method, you would discount the terminal year at t=5 This is to account for the fact that you don't know when in the year the company would be bought out, so assume that the valuation is based on the inclusion of year 5 cash flows

If Company A has 11% NWC/Sales and Company B has 12% NWC/Sales and if everything else is the same, which company is valued higher?

IF SALES ARE INCREASING, company A will have higher cash flow due to changes in NWC and, thus, will have a higher valuation IF SALES ARE DECREASING, company B will have have higher cash flow due to changes in NWC and, thus, will have a higher valuation

In an inflationary environment, how would a firm's cash flow change if we switch from FIFO to LIFO? How would the DCF value change?

Ignoring the effect of taxes: In an inflationary environment (cost of inventory increases), LIFO would be more expensive than FIFO This would cause COGS to increase But, NWC would decrease by a proportionate amount due to larger decreases in inventory Cash flow wouldn't change, so there is no change in value BUT if we include the effect of taxes: Higher expenses with LIFO will allow the company to save on taxes, so cash flow will be slightly higher for the LIFO company (note: FIFO/LIFO is simply an accounting tool, the only thing that actually changes in hard cash flow is taxes you are paying) Thus, a LIFO company would have higher cash flow and a higher valuation

Suppose you are doing a DCF on a coal mine. Would you use the perpetuity growth method or the multiple method to find its terminal value?

Multiple method - for any depleting assets, you cannot use a perpetuity growth method since the asset will cease to exist at some point in the future

What is the mid-year convention and how is it used?

The mid year convention is an adjustment used to account for the fact that not all cash flows are generated at year-end, as is assumed in a DCF For example, instead of discounting year 1 cash flows with t=1, they are discounted with t=0.5 - the same is done for all remaining years It is essentially a way to "smooth out" cash flows

In an unlevered DCF, why don't you subtract interest expense to include the tax shield from interest?

The tax shield from interest is actually implicitly included in an unlevered DCF without having to include actual interest expense in any calculations It is implicitly included when discounting by WACC, since cost of debt is multiplied by (1 - tax rate) to create a tax shield in WACC

Why do you have to un-lever and re-lever beta?

Use of comparables to get the systematic and pure risk of the industry Unlever to make the beta capital structure neutral (get inherent risk of the company) Find median, shows systematic risk of the assets of the industry Re-lever to apply the capital structure of the target company