TRUE COLOR DCF FORMULA
Subject : TRUE COLOR DCF FORMULA
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FCF at year 0 is 10.
FCF Growth is 12%.
Discount Rate is 6.5%.
What is the Discounted FCF at Year 25?
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(A)
Academic Discounted FCF
(FCF discounted every year for 1 year length each and accrued together)
= 10×1.12÷1.065×(1-(1.12÷1.065)^25)÷(1-1.12÷1.065)
= 513.440492193
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(B)
True color Discounted FCF
(Lumpsum all FCF first, then one shot discount for 25 years length)
= 10×1.12×(1-1.12^25)÷(1-1.12)÷1.065^25
= 309.3273443872
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The conventional DCF is using method A and it is bloated.
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(C)
You have $10 in the bank saving account.
Interest rate is 12%.
Inflation is 6.5 %.
After 25 years, what is the total amount show in account book?
10×1.12×(1-1.12^25)÷(1-1.12)
= $1,493.33934462
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What is the buying power of total amount at year 0?
10×1.12×(1-1.12^25)÷(1-1.12)÷1.065^25
= 1,493.33934462÷1.065^25
= $309.3273443872
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(D)
Conclusion:
A company is like a bank account, the FCF generated is kept by the companies (like bank account), the FCF does not go to your pocket at all.
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For True Color Discounted FCF, investor should use method B.