A Tutorial on Discounted Cash Flow, Fall 2015
Notes prepared by John Tsagarelis, jtsagare@uwo.ca
DRAFT: Comments, Suggestions Welcome
9/20/2015

Preamble
As we walk through life we develop mental maps of situational settings. These are not sight patterns, but rather decision patterns among choices available to us in any given circumstance. For example, we take familiar roads to our summer cottage or accept return-on-equity is an unbiased stock return predictor. Once we form a map, it is hard for us to realize it may be incorrect and/or to imagine alternative scenarios. This lack of flexibility in decision making is as dangerous as following maps on our satellite-based navigation devices that fails to account for new roads. We could call this a blind spot, but it is more sinister—it is a false picture of reality. It is for this reason, during creative problem solving and brainstorming sessions groups often strive to suspend judgement until they have entertained ranges of plausible scenarios and responses to them. The initial scenario we envision may be woefully inadequate and our initial responses significantly inferior to others we can imagine. As part of our inherent capacity to memorize, we should always strive to challenge our beliefs through a feedback mechanism. To test our existing constructs with new potentially better ones. It is with this in mind that we explore the classic or naive discounted cash flow modelling techniques.

1

Introduction

The essential steps for a DCF are:
1. Gather information: Use historic Income, Balance Sheet & Cash Flow Statements to calculate
‘earnings’, ‘cash flows’ or any other variable you’re trying to obtain data for,
2. Generate Forecast Assumptions: based on our historical observations generate a starting cash flow range, growth rate and discount rate assumptions . . .
3. Actually forecast