Case 058Company analysis and valuationCore
Value a consumer company with a simple two-stage DCF: free cash flow of Rs 50 crore next year growing 12% for five years, then 5% for ever, at a 12% discount rate. Compare the value per share with a Rs 120 share price.
1The situation
Sonpari Water Purifiers sells household water purifiers and service contracts. Its free cash flow next year is expected to be Rs 50 crore, growing 12% a year through year five, then 5% a year for ever as the market matures. The discount rate is 12%.
Sonpari has Rs 100 crore of net cash and 10 crore shares, which trade at Rs 120. You have two days to build the model and present it to a panel.
2Your task
What is Sonpari worth per share, how much of that is terminal value, and what does today's price assume?
Quick check
Roughly what share of Sonpari's enterprise value comes from the terminal value?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
About Rs 99 a share against a price of Rs 120, with 75% of the value in the terminal value. Five years of cash flow are worth Rs 223.2 crore today, the terminal value Rs 669.6 crore and net cash Rs 100 crore, Rs 993 crore in all. The price implies growth for ever of about 6.6% rather than 5%, or a discount rate near 10.7%, so the gap turns on the terminal assumptions.
Step 1How do you lay out the five explicit years?
Write the cash flows first, then discount. Year one is Rs 50 crore and each later year is 12% more: 50.0, 56.0, 62.7, 70.2, 78.7. Because the growth rate equals the discount rate, each year's present value is the same Rs 44.64 crore, and five of them sum to Rs 223.2 crore. Spotting that shortcut in an interview saves a minute and shows you understand what discounting does: growth and discounting cancel exactly when they are equal.
| Rs crore | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
|---|---|---|---|---|---|
| Free cash flow | 50.00 | 56.00 | 62.72 | 70.25 | 78.68 |
| Discount factor at 12% | 0.8929 | 0.7972 | 0.7118 | 0.6355 | 0.5674 |
| Present value | 44.64 | 44.64 | 44.64 | 44.64 | 44.64 |
Step 2How is the terminal value built, and why does it dominate?
Take year six's cash flow, Rs 78.68 crore times 1.05, Rs 82.61 crore, and divide by the discount rate less growth, 7%: a terminal valueThe value at the end of the forecast of all cash flows beyond it, usually a growing perpetuity or an exit multiple. of Rs 1180 crore at the end of year five. Discount it five years and it is worth Rs 669.6 crore today. That is 75% of enterprise value, so the answer is mostly a view on what Sonpari looks like after year five. It is like valuing a young orchard: the first five harvests matter less than how long the trees keep bearing fruit.
Step 3What does the Rs 120 price assume, and how sensitive is the answer?
Run the model backwards. Holding the discount rate at 12%, the market price needs growth for ever of about 6.6%; holding growth at 5%, it needs a discount rate of about 10.7%. Neither is absurd, which is the point: a one-point change in either terminal input moves the value by Rs 9 to Rs 15 a share, a large part of the Rs 21 gap to the price. The grid below shows value per share across discount rates of 11% to 13% and terminal growth of 4% to 6%.
| Rs a share | Growth 4% | Growth 5% | Growth 6% |
|---|---|---|---|
| Discount 11% | 102 | 115 | 132 |
| Discount 12% | 90 | 99 | 111 |
| Discount 13% | 81 | 88 | 96 |
Step 4What view would you present to the panel?
State the number, then the reason it could be wrong. On these inputs Sonpari is worth about Rs 99, some 17% below the price. The market is paying for either longer high growth or a higher terminal growth than 5%, and your case should test which is more plausible: household penetration, service revenue that grows with the installed base, and competition from cheaper brands. A panel will be more impressed by a clear statement that three quarters of the value rests on the terminal assumptions than by a fourth decimal place.
Where candidates lose it
The first slip is discounting the terminal value by six years instead of five, or forgetting to discount it at all. The perpetuity formula values cash flows from year six onwards as at the end of year five, so it is discounted five years.
The second is presenting Rs 99 as the answer without the sensitivity. With 75% of value in the terminal value, a DCF without a grid is an opinion dressed as a number.
What the interviewer asks next
- Use an exit multiple of 20 times year-five free cash flow instead. What changes?
- Where would you get a defensible discount rate for Sonpari?
- Free cash flow is after capex of 3% of sales. What if growth needs 6%?
- How would you model the service contract revenue separately?
Asked at HPS Investment Partners, Asset Management, New York, 2025 (Wall Street Oasis): Then got sent the case study, very simple DCF for a fake business.
Company names and figures are illustrative.