# In Depth: How DCF Tool Works: Part 2

## Breaking down DCF Tool using a real example by hand calculating a DCF model

Jun 18, 2021

Welcome back! After breaking down the historical financials, calculating EBIT, and finding the unlevered free cash flows from Part 1, we can finish the DCF model to find the intrinsic value of our example (WMT).
If you haven’t read Part 1, check it out here.

### Calculating WACC

Weighted Average Cost of Capital (WACC) is commonly used as the Discount Rate. The Discount Rate is the required return (%) you would need to justify the investment, and the rate at which we will discount the future cash flows of the company. Another common rate used is the average stock market return of 9%, which can be used in lieu of the WACC.

To find a company specific WACC, the following are all required for the current date only:

• Market Cap
• Total Debt
• Current 10yr Treasury Rate
• Company Beta

Finding this information again on any financial news site, WMT gives the following:

• Market Cap: 378.559
• Total Debt: 48.871
• Current 10yr Treasury Rate: 0.0154
• Company Beta: 0.47

Note that these numbers vary somewhat daily, so depending on how they change what you see may be slightly different. DCF Tool updates these values daily.

WACC = [Market Cap / (Market Cap + Total Debt) ] x [ Treasury Rate + Beta x (9% - Treasury Rate] + [ Total Debt / (Market Cap + Total Debt) ] x [ (Interest Income / Total Debt) x (1 – Tax Rate) ]

Simplifying this to what each expression relates to:

WACC = Equity Rate + Debt Rate

Plugging in all of the values, including those found during the UFCF calculation such as Tax Rate, the outputs give you:

• Tax Rate: 0.333495
• Equity Rate: 0.0446923
• Debt Rate: 0.003421
• WACC: 0.048113

DCF Tool currently gives 4.8% which matches our hand calculations.

### Growth Rate

DCF Tool uses exponential fit to find the historical growth rate for each ticker. When using our site, you can input your expected growth rate as you desire.
When using DCF Tool, you can input your expected growth rate as you desire.

DCF Tool WMT Growth Rate: 5%.

### Growth Phase

DCF Tool uses a 2 phase DCF model projection, with the first phase being the growth phase.
By default, this is set to a 5 year projection outlook.
To calculate the growth phase, the equation is as follows:

2022 (the next year) UFCF Flow = 2021 UFCF x (1 + Growth Rate) / [ (1 + Discount Rate or WACC) ^ n ]
Where n is the number of years in the future you are projecting.

For 2022, UFCF = 18.4 x 1.05 / (1.048)^1 = 18.42

Plugging these in, both our hand calculations and DCF Tool give the following results:

Future Flow Discounted Flow
2022 19.3 18.42
2023 20.27 18.45
2024 21.28 18.49
2025 22.34 18.52
2026 23.46 18.56

To find the total value of the Growth Phase, we add all of the discounted flows together.
Combined, WMT’s Growth Phase represents a total present value of 93 Billion.

### Terminal Phase

The second phase involves estimating the value at the end of the company’s life or model period. There are several methods to finding this value, however DCF Tool by default uses a perpetual growth method.

#### Terminal Value

The calculation to find the terminal value is:

Terminal Value = UFCF (last year of growth phase) x (1 + Terminal Rate) / (Discount Rate or WACC – Terminal Rate)

Terminal Rate by default is set to 2% and more can be found here on the importance of terminal value.

For WMT this looks like:
Terminal Value = 23.56 x 1.02 / (.048 - .02) = 858 Billion

However, DCF Tool automatically cuts this result off if it exceeds 30 times the final year cash flow, in this case of 23.56. As a result, we show the Terminal Value at just 704 Billion.

#### Discounting Terminal Value

The 704 Billion terminal value we just found is the future value of the company. In order to get the present value, we must discount this back to the present:

Terminal Value (Present) = Terminal Value (Future) / (1 + Discount Rate)^ (n +1)

Where again, n is the number of years in the growth phase.

For our example this works out to:

Terminal Value (Present) = 704 / (1.048^(6)) = 531 Billion

### Finding Intrinsic Value

Finally, after performing all of these calculations, one more step is required to finish the DCF model and get a single intrinsic value number. You’ll want to look one last time at the financial news site for data on the total number of outstanding shares the company has issued. The equation is simply:

Intrinsic Value = (Growth Phase Value + Terminal Value) / (Total number of outstanding shares)

For Walmart (WMT) we get:

Intrinsic Value = (93 + 531) / 2.81 = 221.59

WMT Intrinsic Value = \$221.59

### Implications of Results

Simply put, the “Intrinsic Value” we have just found is what our DCF model says the company is truly worth, based solely on the financial performance of the company. This is important, it does not take into account the current stock price, chart movements, etc. It is purely based on the company and tries to apply a value to that performance.

If the Intrinsic Value found is less than the current stock price, we refer to this as the company being “undervalued”. This represents potentially a good value opportunity as one could expect the stock price to approach the intrinsic value.

If the Intrinsic Value found is more than the current stock price, we refer to this as the company being “overvalued”. This represents potentially a bad value opportunity as one could expect the stock price to approach the intrinsic value.

### Summary

If you have made it this far, it’s probably evident to you that DCF models are extensive, time consuming calculations. Depending on how many years of data you want to analyze, it quickly becomes a task involving hundreds of values. Those values however provide massive insight into whether a particular company is trading above or below it’s true intrinsic value.

DCF Tool was specifically created for beginners to understand DCF modeling and to simplify this process drastically. At its core, 3 major inputs fundamentally drive all DCF models. DCF Tool puts these at the forefront of your focus, while in the background it handles the heavy lifting task of performing hundreds of calculations in milliseconds.
The next time you approach reviewing a company, you can use DCF Tool to automate the modeling process to assist your research needs.