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Refresh Group Limited Discounted Cash Flow (DCF) Analysis
Posted by Matthew Harvey on Aug012022
1. Introduction
Discounted Cash Flow (DCF) valuation remains a fundamental value investing model. Using a DCF continues to be one of the best ways to calculate a company's intrinsic value. Using a DCF remains the main method analysts use throughout finance, and some think using this type of valuation remains far too complicated for them.
There are several ways to estimate FCF, but it is typically calculated over five years (Partnoy, 2022). Sector, stage of growth, and financial predictability all factor into how long a corporation may expect a projection to be accurate(GasparsWieloch, 2019). The PV of free cash flows is calculated by discounting the cash flows at the WACC of the company. The terminal value and PV of cash flows are combined to calculate the company's total value. As a result, rather than looking at a single figure in a DCF report, we analyze the whole range of values. To understand how these assumptions impact the value, sensitivity analysis is utilized.
The application of the model is explained by taking Refresh Group Limited as an example. The historical financial data of Refresh Group Limited is used to project the cash flows for the next five years, and then the cash flows are discounted to calculate the company's intrinsic value.
2. Steps involved in DCF Analysis
Stepbystep instructions on how to design a DCF are provided in this section. DCF mastery is also provided, in the form of a collection of tools that allow one to build an indepth examination of the objective and its main performance factors, as well as a rational set of assumptions.
2.1 Step 1: Understanding the Business Model:
A DCF begins with extensive study and data collection about the firm in question and the industry in which it operates. To construct a framework for valuation, one must have a firm grasp of the company profile, which can be done by performing the SWOT, PESTEL, and Porter's Five Forces analysis(Viswanadham, 2018). WACC and terminal value assumptions and realistic financial estimates must be developed (or supported) by the banker for the goal.
To understand the business model of Refresh Group Limited, we start with an overall macroeconomic analysis and then conduct the industry analysis to which the company belongs. Next, we conduct the individual company analysis and compare it with its competitors.
2.1.1 Key Drivers:
Identifying the most important aspects influencing the company's performance is the next step in creating a realistic set of FCF estimates. Some of these influences are internal (such as the expansion of the company's facilities or the development of its goods), while others are external(Matar & Eneizan, 2018).
Depending on its organizational structure and management team, a company's development profile may be quite different from its industry competitors. A broad variety of factors, such as management style, brand recognition, customer base, and operational focus, as well as product mix, sales/marketing strategy, size, and technological advancements, affect profitability for enterprises in a certain sector(Malagueno, LopezValeiras, & GomezConde, 2018).
2.1.2 The Free Cash Flows are calculated using the following formula:
Free Cash Flow Calculation
Earnings before Interest and Taxes
Less: Taxes (at the Marginal Tax Rate)
2.1.3 Earnings before Interest after Taxes
Plus: Depreciation & Amortization
Less: Capital Expenditures
2.1.4 Less: Increase/ Decrease in Net Working Capital
Free Cash Flow
(Borad, 2022)
2.1.5 Historical Data:
Understanding previous performance allows for a more accurate estimation of FCF. For established firms operating in noncyclical industries, a firm's previous financial success is a solid predictor of future financial performance(Jesus & Mira da Silva, 2014). When estimating future financials, it is usually considered good if the past financial data of at least 10 years is used; however, the past data of 3 years can also be used(Beach, 2019). The historical unlevered cash flows for Refresh Group Limited are as follows:
(in million)  Actual  
2018  2019  2020  2021  
Sales  2,955  3,568  4,102  4,663 
Total costs  2,511  3,047  3,524  4,031 
EBITDA  444  521  578  631 
Depreciation & Amortization:  49  63  75  84 
EBIT  396  459  503  548 
Taxes (30%)  119  138  151  164 
Capex  79  41  169  
Increase/Decrease in NWC 

145  77  18 
Unlevered Free Cash Flow  159  309  281 
2.1.6 Projection Period:
In most cases, the analyst can anticipate the company's FCF for a period of five years. Established businesses in mature industries may be able to attain a steady condition within five years. At least one business cycle should be included in a fiveyear projection period, which allows adequate time for current or planned actions to be realized (N.Kaplan & S.Ruback, 1995).
In the case of Refresh Group Limited, the financial data is projected for the next five years, i.e., 2022 to 2026, using the historical data of the past four years, i.e., 2018 to 2021.
2.2 Step 2: Projections of Free Cash Flows:
The unlevered FCF of a target is used to calculate the DCF. A company's "unlevered FCF" refers to the cash that has been generated after covering all the operating expenses incurred throughout the year and all the applicable taxes but before any interest expenses have been paid out by that company(Schueler, 2017).
Sales trend, margin ratios, and NWC all play a part in determining how much FCF the goal is projected to produce. The development of these assumptions is aided by past performance and direction from third parties and/or management. The most important factor in DCF valuation is the adoption of accurate FCF predictions(Januszewski, 2011).
FCF projections aim to forecast the target's financial performance to a point in the future when it may be used as the foundation for calculating the target's terminal value. The actual and forecasted sales, costs, CAPEX, NWC, and free cash flows for Refresh Group Limited are indicated in the below figure.
(in million)  Actual  CAGR  
2018  2019  2020  2021  (18 21)  2022  2023  2024  2025  2026  
Sales  2,955  3,568  4,102  4,663  16%  5,036  5,438  5,874  6,343  6,851 
Total costs  2,511  3,047  3,524  4,031  17%  4,316  4,661  5,034  5,436  5,871 
EBITDA  444  521  578  631  12%  720  778  840  907  980 
Depreciation & Amortization:  49  63  75  84  91  98  106  114  123  
EBIT  396  459  503  548  11%  629  680  734  793  856 
Taxes (30%)  119  138  151  164  189  204  220  238  257  
Capex  79  41  169  116  125  135  146  158  
Increase/Decrease in NWC 

145  77  18  14  33  35  38  41  
Unlevered Free Cash Flow  159  309  281  402  416  449  485  524 
2.3 Step 3: Calculation of Discount Rate:
The WACC is the discount rate used to find the PV of an organization's projected future cash flow (FCF) and terminal value (Visconti, 2022). It demonstrates the usual return on investment needed for a certain company. The "WACC" of an organization is calculated based on the projected capital structure of that organization. This is owing to the fact that debt and equity both come with their own unique sets of risks and repercussions for taxes.
To put it another way, the WACC might be regarded as the opportunity cost of capital for an investor, which is the return anticipated from an alternative investment with risk characteristics equivalent to those of the first investment.
The cost of capital for a corporation could change based on its many different business lines. Therefore, it is possible that carrying out a Discounted Cash Flow analysis using the "sum of the parts" method, where each distinct corporate sector has its own WACC, would prove advantageous in several different contexts(Khudoykulov, 2021).
In the case of Refresh Group Limited, we use the data for debt, equity, past returns, tax rates and other economic variables like riskfree rate of returns and market returns to calculate the WACC for the company. WACC can be calculated as:
WACC = Re(E/V)+Rd (1t) (D/V)
(Dikov, 2020)
Where:
Re = Cost of Equity
E = Total Market Value of Equity
V = Total value of Company i.e., Equity + Debt
Rd = Cost of Debt
T = Tax Rate
D = Market/ Book Value of Debt
2.3.1 Capital Structure:
The company's target capital structure comprises the weightage of debt and equity. The valuation of a company increases with the introduction of debt in the capital structure but only up to a specific level. The reason for the increase is due to the tax savings that are resulted from the interest payments of the debt (Harris, 2019). The capital structure is used in the calculation of the WACC. The target capital structure for Refresh Group Limited is indicated in the below figure.
Target Capital Structure  
Debt to Total Capitalization  29.10% 
Equity to Total Capitalization  71% 
Debt to Equity Ratio  41.80% 
2.3.2 Equity:
The preferred method to determine the cost of equity is CAPM, which is universally recognized and frequently utilized. Based on an ERP and an alpha component that compares the volatility of stock returns to the general market's return, riskfree interest rates and beta factors are all included in this formula(Situm, 2020). A simple way to represent the CAPM model is:
Cost of Equity = Rf + beta x ERP
The cost of equity for Refresh Group Limited is indicated in the below table:
Cost of Equity  
Riskfree rate  3.4% 
Market risk Premium  4.6% 
Levered Beta  1.22 
Cost of Equity  9.0% 
2.3.2.1 RFR:
The return that is unaffected by default risk is known as the riskfree rate. It is most usual to utilize longterm US treasury bonds as an alternative to riskfree investments such as stocks and bonds. Longterm bonds offer greater yields than shortterm ones because the holders of longterm bonds assume more risk.
2.3.2.2 Beta:
The asset's sensitivity to nondiversifiable risk is measured by its beta. It is calculated by comparing a public company's returns over time to the returns of a certain market. When the stock price moves in tandem with the market (e.g., a rise of 1% in the market corresponds to an increase of 1% in the price of the stock), it is known as having a beta of 1.0.
2.3.2.3 Equity Risk Premium:
The anticipated return on equity (ERP) is the difference between an asset's return on riskfree assets and an equity market's expected return on risky assets. Analyzing past performance is the most widely acknowledged approach to evaluating ERP.
2.3.3 Cost of Debt:
Leverage is a term used to describe a company's degree of debt. When individuals refer to their debt, they often imply both longterm interestbearing debt and shortterm interestbearing debt, as well as other debt equivalents, such as term debt, bonds due, and mortgage payments.
When a firm has debt, it is considered to be levered; however, when a company has no debt, it is said to be unlevered. The cash flow estimate may be impacted by a firm's status as a debtor, depending on how the DCF model was developed.
The cost of debt is calculated as:
COD = Rf + debt risk premium.
Rf, often known as the riskfree rate, has previously been discussed. For the relatively low risk of debt default, a premium of 40 to 120 basis points is levied(Teker, 2020). For big, highquality enterprises with considerable interest cover, a debt risk premium that falls toward the lower end of this range is preferable, and vice versa. Divide the yearly interest expenditure by the total amount of the company's current debt to get the cost of debt using this technique. You can calculate the cost of debt using this. The cost of debt for Refresh Group Limited is indicated in the below figure.
Cost of Debt  
Cost of Debt  6.0% 
Taxes  30.0% 
AfterTax Cost of Debt  4.2% 
One particular component of the cost of debt is the potential financial benefit of being able to deduct interest payments from taxable income to lessen the total tax burden that the taxpayer faces. This gives a tax advantage. The tax rate for Refresh Group Limited is 30% which is used in calculating the WACC.
Since the unlevered method only indirectly accounts for interest payments, this tax advantage is reflected in the discount rate as a decrease in the cost of debt and, as a result, the discount rate. Because interest may be written off for tax reasons to balance the income of each marginal dollar reported for tax purposes, the marginal tax rate is frequently the most relevant statistic to analyze the cost of debt after taxes have been considered.
The final WACC calculation for Refresh Group Limited is indicated in the figure below:
Wacc Calculation  
Target Capital Structure  
Debt to Total Capitalization  29.1% 
Equity to Total Capitalization  71% 
Debt to Equity Ratio  41.8% 
Cost of Equity  
Riskfree rate  3.4% 
Market risk Premium  4.6% 
Levered Beta  1.22 
Cost of Equity  9.0% 
Cost of Debt  
Cost of Debt  6.0% 
Taxes  30.0% 
After Tax Cost of Debt  4.2% 
WACC  7.6% 
2.4 Step 4: Calculation of Terminal Value:
Analysts calculate the company's longterm value using the terminal value, which estimates the value of a business after its forecasting period has ended since FCF cannot be forecasted indefinitely. The designation "terminal value" refers to an estimate of a company's last year's free cash flows based on the projection period.
Its terminal value determines more than threequarters of the value of a corporation in a DCF. The last year of a company's operations should reflect a consistent financial performance level rather than an extreme peak or low. In addition, the underlying assumptions that were utilized to generate the terminal value must be extensively evaluated and made more sensitive. The terminal value may be computed using the perpetual growth method.
The perpetual growth technique is used to find the company's terminal value after the projection period, which assumes that its terminal year FCF will continue to expand at an anticipated rate throughout time(Behr, Mielcarz, & Osiichuk, 2018). Based on the predicted WACC from Step III, the lender must expect the firm to expand at a sustainable longterm rate.
For Refresh Group Limited, the terminal cash flow in the year 2026 is $524 million. The perpetual growth rate for Refresh Group Limited is assumed to be 3.0%. The terminal value is calculated using the following formula: FCF is the free cash flow for the year 2026, g is the perpetual growth rate, and d is the WACC.
Terminal Value (TV) = ((FCF * ( 1 + g )))/(( d  g ))
In the case of Refresh Group Limited, the terminal value is calculated to be $11,742 million.
Terminal Value  
Terminal Year Free Cash Flow  524 
Perpetuity Growth Rate 
3.0% 
Terminal Value  11,742 
2.5 Step 5: Discounting Cash Flows and Calculating Intrinsic Value:
Because a dollar is worth more now than it will be tomorrow, the temporal value of money is a crucial concept in presentvalue calculations. Because of the time value of money, a corporation's expected free cash flow and terminal value must be discounted to their present value using the company's WACC(Fernandez, 2020).
The predicted FCF and terminal value for each year by the appropriate discount factor are determined by multiplying the FCF and terminal value. Separate reductions are given to the FCF and terminal value for each year. The discount factor, which is a fractional number, represents the present value of a dollar that will be received later. This fractional value is calculated by applying a preset discount rate.
For instance, if a corporation had a WACC of 10%, its predicted FCF would be worth $91 million today rather than the original $100 million. The present value of the free cash flows of Refresh Group Limited is shown below, where the free cash flows are discounted at the weighted average cost of capital of 7.6%. The total present value of free cash flows is $1,887 million.
DCF model  
(in million)  Actual  CAGR  Forecast period  
2018  2019  2020  2021  (18 21)  2022  2023  2024  2025  2026  
Sales  2,955  3,568  4,102  4,663  16%  5,036  5,438  5,874  6,343  6,851 
Total costs  2,511  3,047  3,524  4,031  17%  4,316  4,661  5,034  5,436  5,871 
EBITDA  444  521  578  631  12%  720  778  840  907  980 
Depreciation & Amortization:  49  63  75  84  91  98  106  114  123  
EBIT  396  459  503  548  11%  629  680  734  793  856 
Taxes (30%)  119  138  151  164  189  204  220  238  257  
Capex  79  41  169  116  125  135  146  158  
Increase/Decrease in NWC  145  77  18  14  33  35  38  41  
Unlevered Free Cash Flow  159  309  281  402  416  449  485  524  
WACC  7.6%  
Discount Period  0.5  1.5  2.5  3.5  4.5  
Discount Factor  0.96  0.90  0.83  0.77  0.72  
Present value of free cash flow  387  373  374  376  377 
The present value of terminal value for Refresh Group Limitedis also calculated using the WACC of 7.6%. The PV of terminal value for Refresh Group Limitedis calculated to be $8,142 million.
Terminal Value  
Terminal Year Free Cash Flow  524 
Perpetuity Growth Rate 
3.0% 
Terminal Value  11,742 
Discount Period  5.0 
Discount Factor  0.7 
Present Value of Terminal Value  8,142 
Finally, the enterprise value for Refresh Group Limited is calculated by adding the present value of cash flows and the present value of terminal value. The total enterprise value for Refresh Group Limited came out to be $10,029 million.
The equity value of the Refresh Group Limited is calculated by subtracting the total debt and adding the cash and cash equivalents. The total equity value came out to be $10,229 million.
Suppose we assume that the total outstanding shares of Refresh Group Limited are 1000 million. In that case, the share price of Refresh Group Limited can be calculated by dividing the total equity value by the total outstanding shares. The share price, in this case, is calculated to be $10.23 per share.
This intrinsic value of Refresh Group Limited is then compared with the current share price of the company to determine if the company's share is undervalued or overvalued.
Enterprise value  
Present value of Free Cash Flow  1,887 
Terminal Value  11,742 
Discount Factor  0.69 
Present Value of Terminal Value  8,142 
Enterprise value  10,029 
Less: Total debt  100 
Plus: Cash and Cash Equi.  300 
Net Debt  200 
Implied Equity Value  10,229 
Outstanding shares  1,000 
Implied share price  10.23 
3. Sensitivity Analysis
Assumptions in the DCF have a substantial impact on a company's worth. Due to the various input assumptions, the DCF result is believed to be in a range instead of a single figure. Sensitivity analysis may determine a company's monetary worth range by adjusting crucial inputs. It is shown via sensitivity analysis, which shows that valuation is an art as much as it is a science. A DCF's most often sensitive inputs include important valuation metrics, including WACC, exit multiple, and perpetuity growth rate(Marchiono & Magni, 2018).
Similar businesses and past deals might provide useful comparisons when evaluating a DCF value range. If the outcome differs significantly from the assumptions, it's best to examine them and finetune them if required. WACC, terminal value assumptions, and inaccurate financial predictions are some of the most common DCF errors that may bias the DCF valuation. This does not imply, however, that the analysis is erroneous only because the DCF implies a significantly different value than the other methods.
The sensitivity analysis is performed to check the impact of perpetual growth rate and WACC on the enterprise value of the Refresh Group Limited. The following table shows the different enterprise values for different values of perpetual growth rate and WACC.
Sensitivity Analysis  
Perpetuity growth %  
##  10,029  2.0%  2.5%  3.0%  3.5%  4.0% 
WACC  6.1%  11,670  13,077  14,938  17,516  21,326 
7.1%  9,360  10,211  11,271  12,625  14,417  
8.1%  7,810  8,374  9,047  9,868  10,889  
9.1%  6,700  7,096  7,556  8,099  8,749  
10.1%  5,867  6,157  6,488  6,870  7,314 
4. Conclusion
Using DCF, it is possible to arrive at values that are completely unbiased by market forces. It is said to be a more objective way of valuation than others since it does not rely on market emotion to determine worth.
The DCF model is applied to Refresh Group Limited to calculate the intrinsic share price, which helps in determining if Refresh Group Limited is undervalued or overvalued.
The DCF is unaffected by transient market distortions, although the market may frequently misprice firms. Consider the longterm worth of a possible investment when calculating DCF. A longterm return on investment is calculated by considering the time value of money and giving investors an idea of when they may expect to receive a specific amount of profit.
There are certain advantages to using DCF over other valuation techniques, but there are also some drawbacks to be aware of. DCF analysis relies on the accuracy of the estimations used. Many assumptions go into DCF models, and if they're wrong, it may have a big effect on the investor. For example, an investor's overestimation of future cash flows may lead to an investment that does not pay off in the long run, resulting in lost revenue. Cash flow assumptions that are excessively high might lead to lost opportunities. This model demands a lot of information. It is difficult and timeconsuming to gather and evaluate the financial data needed to build a DCF model.
5. References
Beach, R. (2019). Critical Assumptions for Financial Projections. Credit Analysis.
Behr, A., Mielcarz, P., & Osiichuk, D. (2018). Terminal value calculation in dcf valuation models: An empirical verification. eFinanse: Financial Internet Quarterly, 2738.
Borad, S. B. (2022). Free Cash Flow. Retrieved from Finance Management: https://efinancemanagement.com/workingcapitalfinancing/freecashflow
Dikov, D. (2020, 02 21). Understanding the Weighted Average Cost of Capital (WACC). Retrieved from Medium: https://medium.com/magnimetrics/understandingtheweightedaveragecostofcapitalwacc948182d97e6
Fernandez, P. (2020). Three Residual Income Valuation methods and Discounted Cash Flow Valuation.
GasparsWieloch, H. (2019). Project Net Present Value estimation under uncertainty. Central European Journal of Operations Research, 179197.
Harris, C. (2019). Cash flow risk and capital structure decisions. Finance Research Letters, 393397.
Januszewski, S. (2011). HOW TO PERFORM DISCOUNTED CASH FLOW VALUATION? Foundations of Management, 8195.
Jesus, D., & Mira da Silva, M. (2014). Financial Projections based on Business Model Canvas.
Khudoykulov, K. (2021). THE VALUATION OF THE COST OF CAPITAL THROUGH THE DCF MODEL.
Malagueno, R., LopezValeiras, E., & GomezConde, J. (2018). Balanced scorecard in SMEs: effects on innovation and financial performance. Small Business Economics, 221244.
Marchiono, A., & Magni, C. A. (2018). Investment decisions and sensitivity analysis: NPVconsistency of rates of return. European Journal of Operational Research, 361372.
Matar, A., & Eneizan, B. (2018). Determinants of Financial Performance in the Industrial Firms: Evidence from Jordan. Asian Journal of Agricultural Extension, Economics & Sociology , 110.
N.Kaplan, S., & S.Ruback, R. (1995). The Valuation of Cash Flow Forecasts: An Empirical Analysis. Journal of Finance, 50(4), 10591093.
Partnoy, F. (2022). Market Prices vs. Fundamental Value: The Case for Using Discounted Cash Flow Analysis in Securities Class Actions.
Schueler, A. (2017). A Tool Kit for Discounted Cash Flow Valuation: Consistent and Inconsistent Ways to Value Risky Cash Flows. Journal of Business Valuation and Economic Loss Analysis.
Situm, M. (2020). Determination of expected cost of equity with the CAPM. Managerial and Decision Economics, 7784.
Teker, S. (2020). REVISITING DISCOUNTED CASH FLOWS MODEL AS A CAPITAL BUDGETING DECISION TOOL. PressAcademia Procedia, 6063.
Visconti, R. M. (2022). DCF Metrics and the Cost of Capital: ESG Drivers and Sustainability Patterns. 18.
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