The tendency of passing from the internalization to the globalization of the economic life was an outstanding feature of the business background evolution on worldwide scale- during 20th century. This tendency was to be noticed in the field of the commercial transactions (the spreading out of the world commerce), of the foreign investments (output internationalization), of the organizational business structures (firm internationalization).settling up; commercial transaction; international economical globalization; internalization; GATT/OMC;

Dan Florentin Sichigea

Nicolae Sichigea

English

Research Papers in Economics

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  61 
COMPANY EVALUATION USING THE DISCOUNTED NET CASH 
FLOW METHOD 
 
Nicolae Sichigea 
University of Craiova, Romania 
Faculty of Economics and Business Administration 
 
Dan Florentin Sichigea 
University of Craiova, Romania 
Faculty of Economics and Business Administration 
 
Abstract:  
This paper treats one of the most important methods of evaluation of company, namely discounted cash 
flow method. So, after short theoretical considerations about this method we presented a practical study of 
valuation for a leasing firm. 
 
Key words: discounted cash flow method; company evaluation  
 
1. Introduction 
This method is appreciated as being the most modern and complex one. In the Anglo-Saxon 
formulation, this method is known as discounted cash-flow (DCF), and in the French formulation is 
used the expression discounting method of future cash flow. 
Concerning  the  cash-flow,  there  are  several  definitions  of  this  notion,  depending  on  the 
coverage sphere. In special papers there are met expressions like: cash flow, financial flow, flow of net 
liquid assets, treasury flow, liquidities flow etc. 
As in the economic theory, by the term “cash” it is understood only the “actual currency”, 
namely the bank notes and divisional currency, we consider that this expression is not quite correct, as 
in  the  structure  of  money  supply  besides  the  actual  currency  there  is  also  the  money  of  account 
(deposits in current accounts), time deposits and other assets with a higher or smaller rank of liquidity. 
Consequently, the terms of liquidities flow and treasury flow seem to be the most appropriate ones. 
 
2. Theoretical and methodological background 
The theoretical, methodological base and of mathematic calculation of company values using 
this  method,  is,  basically,  the  theory  and  practice  for  the  determination  of  investment  economic 
efficiency,  and,  particularly,  the  economic-financial  calculations  afferent  to  the  estimation  of 
feasibility for a investment project.  
Virtually, it is taken into account the forecasting of cash flows during the exploitation and at the 
end of exploitation (determination of terminal value).    
Actually, the company evaluation using the discounted cash flow method comes back to the 
direct  application  of  the  discounted  value  method  (VAN)  to  select  the  investments  projects.  The 
method is used both by the buyer, and by the company seller having a positive VAN, in order to 
establish the price offer. So, the buyer uses to determine the maximal purchase price he is ready to pay 
and, analogously, the seller can use it to determine the company value to the minimal price he is 
willing to accept. 
An important role, in VAN criterion, is played by the cash flow forecasting period. 
From the evaluation point of view, the company life can be divided in two distinct periods: 
■ Explicitly forecasting period, where the cash flow can be calculated with credibility for each 
year. The number of years for this period is established by the evaluator, taking into account: the life 
period remained for the basic plant assets; the products cycle for their economic life; credibility of 
forecasting; period of time when the business (production) becomes stable, respectively as an annual 
rate for the growth of production volume, net profits attractive for the investor and rising etc. 
Generally, for industrial companies, with a normal technical endowment and a rising field, the 
cash flow prediction is done for a period of 5-10 years. It is accepted that, after this period, the 
credibility of forecasting become smaller and smaller due to higher incertitudes, according as rising Journal of Applied Economic Sciences Journal of Applied Economic Sciences Journal of Applied Economic Sciences Journal of Applied Economic Sciences            
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the time horizon for predictions. Usually, a 10 years time period is chosen when the company has a 
long exploitation history, while for younger companies, the optimum time period is considered to be 5 
years. For the situation present now in our country, we consider that a horizon of financial prediction 
for 5 tears is the most appropriate for making pertinent estimations for cash flows. 
■  non-explicit forecasting period, when cash flow can not be credible calculated for each 
year.  As  a  global  expression  of  whole  cash  flow,  realizable  in  this  period  (of  which  duration  is 
included between the end of the explicitly forecasting period and the infinite), it is calculated the 
company residual value (terminal or continuous) (Vrez). 
The  determination  as  correct  as  possible  of  the  size  of  the  residual  value  (terminal  or 
continuous – continuing value) has a great importance in the evaluation assembly using the DCF 
method.  
The residual value represents the company value after the explicit forecasting period. 
For calculating this value there are used two methods: 
■ accounting proceeding, according to which the residual value is equal with the net asset at 
the end of the period reduced with the costs of liquidation, namely the net liquidating value. Therefore, 
this liquidation method supposes that the most conservative calculation method for the residual value 
is based on the idea that the company will be liquidated at the end of the forecasting horizon.  
Also, another calculation method for the residual value is by correcting the net profit in the last 
year with a residual multiplier (Z).  
Frequently, the residual value is determined by correcting the cash flow in the last year of 
prognosis using the residual multiplier.  
The residual multiplier depends on the sector of activity the company is part of. For developed 
countries, this is between 3 and 6. Another method to determine the Z is the Gordon model, namely: 
Z
CMPC g
=
−
1
 
where: 
CMPC – balanced average cost of capital; g – constant rate for the annual growth of cash flow 
for long time period; if the predictions are made on current prices, g must be mentioned in current 
prices, and if the predictions are made in constant prices, also g must be mentioned in the same type of 
prices (so, deflated). 
   
Therefore the calculation formula for the residual value, in this case, is the following: 
 
Vrez Z CFn = ⋅  
■  financial proceeding, according to which the company residual value equals the amount of 
discounted cash flows which the company will be capable to educe beyond the prognosis period. 
Concretely, this supposes an extrapolation of cash flow in the last designing year.  
  In this proceeding we meet the following methods: 
￿ perpetuities method; 
￿ PER method. 
Perpetuities method supposes that the company future cash flows shall be continuous. This 
method encloses two sub-methods: 
￿ method of constant perpetuities; 
￿ method of rising perpetuities. 
Method  of  constant  perpetuities  supposes  that  the  company  will  generate  cash  flows 
continuously. The calculation formula is: 
K
CF
Vrez
n =  
where:  
k – discounting rate. 
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Method of rising perpetuities supposes a continuous rise of companies cash flows with s g rate. 
The calculation formula is: 
g K
) g ( CF
Vrez
n
−
+
=
1
 
where: 
k = rate of own capital cost.  
 
PER method supposes that the best way to determine the residual value is to use the market 
price to establish a relevant PER. The calculation formula is: 
 
Vrez PN PER n comparativ = ⋅  
where: 
PNn    = net profit in year n; 
PERcomparativ  = a company PER similarly quoted or a average PER per economy. 
 
Referring to the residual value, we can notice the following rules: 
￿  residual value is the company value at the end of the last “n” year of explicit forecasting; 
￿  as much as n is bigger, the discounting rate is bigger, as much the residual value is reduced 
getting close to zero – and it is even zero if we exceed 15-20 years of prognosis; 
￿  as much as n is smaller, the discounting rate is reduced too, as mush the residual value is 
higher. 
The method is based on the evaluation of actions by forecasting on a horizon of 5-10 years of 
the cash flows available for shareholders, cash flows taking into account: net current profit (after 
taxation), adding the redemption and the provisions and minus the capital expenses (investments), 
minus the raise of operating capital, plus the raise of debts bearing interests, after taking out of these 
the repayment of credits.  
The calculation formula:  
∑
= +
+
+
=
n
p
n
n
p
p
) k (
ala min Vter
) k (
CFNA
V
1
0 1 1
 
where:   
Vo  = company value 
CFNAp   = net cash flow available for shareholders in p year; 
Vterminalăn = terminal value (residual) at the end of n year;   
n = prognosis horizon; 
k  = discounting rate (usually the balanced average cost of capital - CMPC of WACC - weight 
average cost of capital). 
   
3. The application in practice the method of discounted cash flow 
We will point out the application in practice the method of discounted cash flow using the 
example  of S.C.  RO LEASING  S.A. Craiova, company  having as object of activity the  financial 
leasing for movables and fixed property for clients in almost entire country. 
Although the company was set up 5 years ago, it acquired a registered capital of 13 billions lei, 
contract which generated incomes of almost 300 billions lei. The company is set out only by capital 
accounts, and its development perspective needs high financial sources, a fact that determined the 
Supervisory Board to propose the General Meeting of Shareholders a growth of registered capital with 
6-9 billions lei, a fact that imposes the evaluation of shares. 
Discounting rate, k, is the minimum rate of profitableness an investment must acquire in order 
to  satisfy  the  shareholders  requirements  of  profitability.  In  case  of  S.C.  RO  LEASING  S.A.,  the 
discounting rate is the cost of capital accounts, as the company is not set out from other sources.  
The determination of shares value supposes to follow the next steps:  
1.  CFNA forecasting of 2004-2008 horizon. 
This is performed s follows:  Journal of Applied Economic Sciences Journal of Applied Economic Sciences Journal of Applied Economic Sciences Journal of Applied Economic Sciences            
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  64
- thousands lei - 
Performances  Forecasting 
C
r
t
n  
2003  2004 BVC  2005  2006  2007  2008 
1  Total incomes*  29.442,8  26.200  29.820  26.700  24.735  24.760 
2  Expenses at 1000 lei 
Total incomes - lei 
 
823,6 
 
883 
 
880 
 
870 
 
860 
 
850 
3  Total expenses  24.247,9  23.150  26.250  23.230  21.300  21.060 
4  Gross profit   5.194,9  3.050  3.570  3.470  3.435  3.700 
5  Net profit   3.861,1  2.250  2.600  2.600  2.580  2.775 
6  Redemption  330  350  350  350  350  350 
7  Investments  620  150  200  200  200  200 
8  Growth for the need 
of working capital 
( NFR )** 
 
4.254,4 
 
-1.453 
 
217 
 
-187 
 
-118 
 
+2 
  CFNA ( 5+6-7-8 )  -683,3  3.903  2.613  2.937  2.848  2.923 
*Prognosis of real incomes 
 
  2005  2006  2007  2008 
From contracts at 31.12.2003 ($) 
From contracts at 31.12.2004 ($) 
From contracts at 31.12.2005 ($) 
378.000 
331.200 
189.000 
75.790 
224.000 
252.000 
24.380 
- 
189.000 
 
TOTAL                             ($)  
rate leu/$  
Incomes   millions lei 
From contracts 2006 
898.200 
33.200 
29.820 
 
 
 
189.000 
 
 
 
252.000 
 
 
 
189.000 
TOTAL                             ($)  
rate leu/$  
Incomes   millions lei 
From contracts 2007 
  740.590 
36.000 
26.700 
 
 
 
189.000 
 
 
 
252.000 
TOTAL                             ($)  
rate leu/$  
Incomes   millions lei 
    654.380 
37.800 
24.735 
 
From contracts 2006 
TOTAL                             ($)  
Incomes   millions lei 
      189.000 
630.000 
24.760 
 
 
Contracts 2004 = 562.500 $ inclusive VAT 
        2004 = 472.700 $ without VAT 
 
Incomes for 2 years (472.700x168=795.200) 
 
Encashment  - 30% in 2004 
    - 40% in 2005 
    - 30% in 2006 
 
Contracts 2005 = 500.000 $ inclusive VAT 
        2005 = 420.000 $ without VAT 
 
Incomes for 2 years (420.000 x 1,5 = 630.000 $  
5.1.1   
5.1.2  Encashment  2005       189.000 
     2006       252.000 
     2007       189.000 
 
** Prognosis for the growth of NFR Journal of Applied Economic Sciences Journal of Applied Economic Sciences Journal of Applied Economic Sciences Journal of Applied Economic Sciences            
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  65 
 
NFR  = Stocks + Book debts + Regulating assets – Current debts – Regulating liabilities 
 
NFR 2003  = 4.368,8 - 1.343,9 = 3.024,9 mil. lei  
 
NFR 2002 = 3.415,2 - 4.644,7 = -1.229,5 mil. lei  
Ratio NFR2003 in total incomes % 3 , 10 100
8 , 442 . 29
9 , 024 . 3
= =  
NFRmedium 2002-2003  lei mil. 7 , 897
2
5 , 229 . 1 9 , 024 . 3
=
−
=  
Ratio NFRmedium in total incomes 2003 %
, .
,
3 100
8 442 29
7 897
= =  
 
Taking into consideration the high track between the two ratios, we considered as relevant to 
choose a value placed in this interval, respectively 6%. 
 
Annual growth of NFR  
- thousands lei -  
  2003  2004  2005  2006  2007  2008 
Total incomes  29.442,8  26.200  29.820  26.700  24.735  24.760 
NFR/VT  0,103  0,06  0,06  0,06  0,06  0,06 
NFR  3.024,9  1.572  1.789  1.602  1.484  1.486 
Growth NFR    -1.453  +217  -187  -118  +2 
 
2. The determination of the discounting rate (K)  
According to Gordon and Shapiro formula, the cost rate of capital account is given by the: 
g
P
D
K + =
0
1 ; 
f R b g ⋅ = ; 
where: 
D1 = dividend per action for next year (2004); 
P0  = share current price (book value2003); 
g  = rate of constant annual growth of dividend; 
b = capitalization rate for net profit; 
Rf = financial profitability (net profit /capital account).    
 
% , % , % , % ,
.
, .
K 8 19 24 8 56 11 24 8 100
568 233
135 983 26
2003 = + = + =  ; 
f R b g ⋅ = = 40% x 20,6% = 8,24%; 
b = capitalization rate in 2003 = 40%; 
Rf 2003  = 20,6% 
 
3. Forecasting the terminal value at the end of year 2008 
Vterminal 2008
1155 , 0
923 . 2
0824 , 0 198 , 0
923 . 2 2008
=
−
=
−
=
g K
CF
= 25.300 mil. lei 
 
4. Value determination per share  
a. Determination of discounted cash flow available for shareholders: 
 
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  2004  2005  2006  2007  2008  Total 
1.CFNA  3.903  2.613  2.937  2.848  2.923   
2. Discounting factor 
corresponded to the rate of 19,8% 
0,83  0,70  0,58  0,49  0,41   
3. CFNAdiscounted  3.240  1.829  1.703  1.396  1.185  9.353 
 
b. Determination of discounted terminal value 
Vterminal 2008 = 25.300x0,41 = 10.373 mil. lei 
c. Company value 
Vo = 9.353+10.373   = 19.726 mil. lei 
No of shares    = 80.050 
Value per share    = 246.420 lei 
   
4. Conclusions 
Although  it  seems  quite  simple,  the  discounted  cash  flow  method  is,  as  we  stated  at  the 
beginning of this article, very complex due to the fact that it is based several elements which must be 
evaluated,  so  the  subjectivism  plays  a  very  important  role.  The  predictions  of  some  cash  flows, 
residual value, rated average cost (and, implicitly, of the discounting rate) is very difficult to perform 
for companies which are not quoted in the stock market. According as more and more companies shall 
be quoted at the Stock Market in Bucharest, this method will be used more often also in our country, 
given the fact that it also has the main advantage as it is more complete and satisfying from the 
conceptual point of view. 
 
Bibliography: 
[1]  Berceanu,  D.;  Ciurezu,  T.,  (2003),  Company  evaluation  –  academic  manual,  Universitaria 
Publishing House, Craiova. 
[2] Sichigea, N., (2003), Company financial administration, Universitaria Publishing House, Craiova.  
[3]  Stan,  S.  et  al.,  (2003),  Company  evaluation,  IROVAL  Publishing  House,  Bucharest.Journal of Applied Economic Sciences Journal of Applied Economic Sciences Journal of Applied Economic Sciences Journal of Applied Economic Sciences            
VolumeI_Issue1 (1)_2006 VolumeI_Issue1 (1)_2006 VolumeI_Issue1 (1)_2006 VolumeI_Issue1 (1)_2006      
 
  67 
 

Company evaluation, IROVAL Publishing House,

Company financial administration,

COMPANY EVALUATION USING THE DISCOUNTED NET CASH FLOW METHOD

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COMPANY EVALUATION USING THE DISCOUNTED NET CASH FLOW METHOD

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