IB Interview Questions: Valuation : Discounted Cash Flow Analysis Fundamentals

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1. What are Stage 1 and Stage 2 within a DCF analysis?

Stage 1 reflects the Explicit Projection Period in which we construction detailed cash flow projections.

Stage 2 (also called ‘Terminal Value’) reflects all value beyond Stage 1. During this phase, we make simplifying assumptions around the long-term performance of the business to value all Cash Flows beyond Stage 1.

2. For how many years do you project into the future in your Stage 1?

Typically, you project out 5-10 years or until the business reaches maturity…or a ‘steady-state’.

Most candidates memorize the ‘5-10 years’ answer. Interviewers ask this to see if you understand that the real goal is to project until the business hits a ‘steady-state’, from which you can make simplifying assumptions about long-term growth.

3. What is Terminal Value?

Reflects the discounted value of all Cash Flow beyond the explicit projection project period (Stage 1) for a DCF analysis.

4. How do we calculate Free Cash Flow in a DCF?

Unless you’re explicitly asked to calculate ‘Levered Free Cash Flow‘, you should assume that you need to calculate ‘Unlevered’ Free Cash Flow (i.e. excluding the impact of debt).

The formula for Unlevered Free Cash flow is: EBIT – Tax + D&A – CapEx +/- Changes in Net Working Capital. This calculation gets us to the underlying cash generated by the business irrespective of its capital structure (i.e. Debt/Equity mix)





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