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1.
What is the basic idea behind discounted cash flow?
A stock's worth is equal to the present value of all its estimated future cash flows. Discounted cash flow is ultimately what analysts use to identify a stock's intrinsic value.
2.
For the purpose of discounting a company's future cash flows, the term "cost of capital" means _______.
The rate used to discount the company's future cash flows backward to the present. The math will explain how it figures into the cash flows.
3.
Chicago Flames Fire Retardant, Inc. is expected to generate $1 billion in cash flow one year from now. If that company has a 10% cost of capital, what is that future cash flow worth today?
$909 million. $1,000,000,000/1.10 = $909,090,909, or $909 million.
4.
Suppose Company A has a long history of profitability, and its outlook is stable, and Company B has yet to make a profit in its short history, and its outlook is much more uncertain. Company A's cost of equity should be _______.
Less than that of Company B. This is because estimated cash flow in the future from Company A is much more certain than it is from Company B. Risk and assumed cost of equity (the return equity investors require) should be concurrent. Lower risk should mean a lower cost of equity assumption, and vice versa.
5.
The concept of perpetuity value involves estimating a company's future cash flows for a certain period and then estimating the value of all cash flows after that in what form?
One lump sum. The perpetuity value will be expressed in one lump sum, then discounted for its present value.
