Module 6: DCF Capstone: From Valuation to a Bid Range
Worked teaching capstone. The graded student packet withholds the complete solution.
Learning objectives and prerequisites
By the end of this lesson, you should be able to defend a bid range from linked base and downside models. Prerequisite knowledge: Modules 1–5. Work from assumptions to equations, explain the acquisition consequence, and record the evidence needed to rely on the answer.
Units: $000 unless a section explicitly states otherwise.
Learning objectives: Integrate the DCF, reconcile value methods, and defend a conditional acquisition recommendation. Study time: 3 hours.
Case packet
Use Harbor's normalized Year 0 revenue of 5,000, EBITDA 800, D&A 100, maintenance CapEx 120, and operating NWC 450. For this capstone, forecast revenue growth of 4% annually for five years. Set EBITDA margin at 16%, D&A at 2% of revenue, CapEx at 2.4%, operating NWC at 9%, and the illustrative unlevered tax rate at 25%. Use year-end cash flows, a 20% discount rate, and 2% terminal growth. Keep EBITDA, D&A, CapEx, and ending NWC as the same percentages of revenue in the terminal year, while reducing revenue growth to 2%. The seller asks for operating EV of 3,200. Excess cash is 50 and financial debt is 500; ignore other equity adjustments for the base exercise.
These inputs supersede the standalone examples in earlier lessons. They are a simplified case, not observations about a real target. Keep a column for evidence required before each assumption can support an actual offer.
Build sequence
- Forecast revenue using prior-year revenue multiplied by 1.04. Calculate EBITDA and D&A from their revenue ratios.
- Calculate EBIT, NOPAT, ending NWC, and the annual change in NWC. Use 450 as opening NWC rather than expensing the entire Year 1 balance.
- Calculate UFCF and discount it. Forecast Year 6 revenue at 2% growth and rebuild UFCF from its components. NWC investment must reflect 2% revenue growth rather than the explicit forecast's 4%. Then use Year 6 UFCF divided by (20% - 2%) for terminal value.
- Bridge EV to equity using the specified excess cash and debt. Keep the asking-price comparison on an EV basis.
- Write a recommendation that separates estimated operating value, buyer affordability, and outstanding diligence.
Base-case solution checkpoints
| Item | Year 1 | Year 5 |
|---|---|---|
| Revenue | 5,200.0 | 6,083.3 |
| EBITDA | 832.0 | 973.3 |
| EBIT | 728.0 | 851.7 |
| Ending operating NWC | 468.0 | 547.5 |
| UFCF | 507.2 | 593.4 |
Annual UFCF grows 4% in the explicit forecast. Year 6 revenue is 6,204.9, and terminal UFCF is 615.7 after NWC investment of 10.95. The PV of explicit cash flows is about 1,620.0, and terminal-value PV is about 1,374.8. EV is approximately 2,994.8 and equity value 2,544.8. The seller's 3,200 EV ask exceeds the modeled value by about 205.2. These figures do not yet include buyer transaction costs, financing fees, or a required minimum cash reserve.
Downside and interpretation
Run a separate scenario with flat revenue at 5,000, EBITDA margin 14%, D&A 2%, CapEx 3%, and NWC at 10%. Keep the same discount rate and terminal growth for comparability. Year 1 NWC rises from 450 to 500, so Year 1 UFCF is 350. Years 2–5 UFCF are 400. Year 6 revenue is 5,100; NOPAT is 459, D&A 102, CapEx 153, and NWC investment 10. Terminal UFCF is therefore 398, giving approximate EV of 2,043.2. Explain why the first-year working-capital investment creates a sharper cash decline than the EBITDA change alone suggests.
Do not present the base and downside average as the correct price. Decide which uncertainties can be resolved before signing, which can be allocated through terms, and which require a lower bid or rejection. Course 3 will test debt capacity; a positive DCF result is not proof that a loan can be serviced.
Submission and grading
Submit the linked model, assumption register, sensitivity table, EV-to-equity bridge, and a two-page acquisition memorandum. Allocate 30 points to correct cash flow, 25 to terminal value and discount timing, 20 to scenario logic, 15 to evidence and limitations, and 10 to recommendation clarity. Pass at 80/100, with no unresolved double-counted debt or negative-denominator terminal calculation.
Self-review: Can another learner reproduce every output from the stated inputs? Does the recommendation change when cash conversion deteriorates? If not, inspect formulas and explain why the business is unusually resilient before accepting that result.
Defend assumptions rather than defend a preferred price
The capstone's 4% growth, 16% EBITDA margin and 9% NWC ratio are supplied modeling assumptions. A real acquisition recommendation must connect them with retention, pricing, capacity, wages, maintenance and collections. An internally consistent model can still overpay if its inputs describe a business the seller cannot transfer.
Prepare an evidence register with each material assumption, its source, date, confidence, and consequence if wrong. Replacement-management cost should match the jobs the owner actually performs. Revenue concentration should be evaluated in contribution profit and receivables as well as sales. Capital spending should reflect condition rather than merely tax depreciation.
Translate value into a conditional bid
The base EV is approximately 2,994.8 and the seller asks 3,200. Those amounts are both operating values, making the 205.2 difference meaningful. Equity value of 2,544.8 is lower because debt exceeds excess cash. Comparing the asking EV directly with equity value would invent an additional disagreement caused only by inconsistent definitions.
The buyer's total capital requirement also includes fees, opening cash and any investment outside the agreed perimeter. A valuation that supports an EV does not establish that the buyer has sufficient equity or that a lender will advance the balance. Course 3 supplies that separate underwriting process.
Interpret the downside economically
The downside keeps revenue flat, reduces EBITDA margin and increases reinvestment intensity. Year 1 cash is lower partly because NWC moves from 450 to 500. The 50 investment occurs once; it is not a recurring annual loss when the balance remains constant. When terminal revenue resumes 2% growth, the model again needs incremental operating capital.
At downside EV about 2,043.2, the choice is not automatically to average base and downside values. Determine what uncertainty can be resolved through diligence, what can be assigned through permitted terms, and what risk the buyer must accept. A price concession cannot make a nontransferable license transfer or cause an unfunded borrower to become eligible.
Separate three different bid constraints
Intrinsic value asks what supported operating cash is worth. Market evidence asks what sufficiently comparable buyers pay. Affordability asks which project cost can be funded while meeting repayment and liquidity requirements. A specific buyer's reservation price incorporates alternatives and required return. These constraints may yield different numbers without any arithmetic contradiction.
Present a range and clear conditions rather than a falsely precise maximum. If the price depends on retention evidence not yet obtained, label it conditional. If the business only survives with a rate reduction or immediate customer growth, identify the execution requirement before recommending a bid.
Construct an auditable investment memorandum
Start with the recommendation and its conditions. Explain the earnings-to-cash bridge, terminal-year reinvestment, discount-rate reasoning, EV-to-equity bridge and downside. Attach the sensitivity table and evidence register. Do not make a reader search a workbook for the one assumption that drives the decision.
For the model defense, change revenue growth, DSO or the discount rate during review and explain the resulting direction before recalculating. Trace every changed statement to its driver. If a formula breaks or a check fails, investigate the cause instead of pasting the prior solution over it. The skill being assessed is independent construction and defense, not reproducing one memorized answer.
Spreadsheet construction and audit lab
Rebuild Harbor's six operating years, including the terminal cash-flow year. Calculate EV, bridge equity and compare the asking EV on the same perimeter. Use operating scenarios separately from discount-rate sensitivities.
Use named row labels and explicit units. Blue-font inputs should contain assumptions or source data; black-font formulas should calculate results from those inputs. Reproduce the worked example first, then change one economically important assumption and predict the direction of the result before recalculating. Save a base case and a dated challenge case rather than silently replacing assumptions. A zero arithmetic check does not establish an executable deal.
Learning summary and further reading
Defend a bid range from linked base and downside models. The acquisition decision depends on the bridge between source evidence, modeled cash and the claim being valued. Explain what the model includes, what it omits, and which outstanding evidence could reverse your conclusion. Consult the source and alignment references for attributed public reading; fictional case assumptions are not market observations or legal approvals.
Previous module · Course overview · Sources and CFI alignment
Independent assessment
Complete the student assignment before consulting the separate instructor key. The chapter's worked examples teach the method; the assignment uses independent inputs.