Last time we learned that DCF calculates intrinsic business value by discounting future cash flows to present value.

Now comes the challenging part: how do we actually project those future cash flows? This unit teaches you to build realistic financial projections without complex modeling tools.

Engagement Message

Name one factor that makes projecting future cash flows difficult.

The foundation of any cash flow projection is revenue forecasting. We start by analyzing historical revenue trends to understand the business's growth patterns.

Look for consistency, seasonality, and any major changes in growth rates over the past 3-5 years.

Engagement Message

Given revenue growth of 20%, 15%, 25%, and 10% over four years, about what growth rate would you forecast for next year?

Beyond historical trends, consider the business drivers behind revenue growth. Is it more customers, higher prices, new products, or market expansion?

A restaurant chain grows through new locations. A software company grows through more users and higher subscription prices. Understanding drivers improves forecasting accuracy.

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What's the primary revenue driver for your favorite streaming service?

For expense projections, start with the concept of fixed versus variable costs. Variable costs change with sales volume (like materials), while fixed costs stay relatively constant (like rent).

This distinction helps predict how expenses will change as revenue grows or declines.

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Is marketing expense typically fixed or variable for most companies?

A useful approach is expressing expenses as percentages of revenue. If a company consistently spends 60% of revenue on cost of goods sold, project that relationship forward.

But watch for economies of scale - some expenses grow slower than revenue as companies get larger.

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Why might administrative costs grow slower than revenue as a company expands?

Working capital represents the cash tied up in day-to-day operations - mainly inventory, accounts receivable, and accounts payable.

Growing businesses typically need more working capital. If sales grow 20%, working capital usually increases too, requiring additional cash investment.

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Why would a rapidly growing retail company need more cash for inventory?

When building projections, think in terms of "free cash flow" - the cash available to all investors after necessary business investments.

This equals operating cash flow minus capital expenditures needed to maintain and grow the business. This is what DCF values.

Engagement Message

Which is more valuable for DCF: accounting profit or actual cash generation?

Type

Fill In The Blanks

Markdown With Blanks

Let's practice building a simple revenue projection. TechCo had these annual revenues:

Year 1: $100M
Year 2: $120M
Year 3: $144M

The growth rates were [[blank:20%]] and 20% respectively.

If this trend continues, Year 4 revenue would be approximately [[blank:$173M]].

Suggested Answers

• 20%
• $173M
• 25%
• $150M