Today we are Mercury Systems, Inc. (NASDAQ:MRCY) by projecting its future cash flows and then discounting them to today’s value. This will be done using the Discounted Cash Flow (DCF) model. Such models may seem beyond the comprehension of a layman, but they are quite easy to follow.
Companies can be valued in a number of ways, so we will point out that one DCF is not right for every situation. If you want to know more about discounted cash flow, the logic behind this calculation can be read in detail in Simply Wall Cent Analysis Model.
See our latest analysis for Mercury Systems
Maths
We are using a 2stage growth model, which simply means that we take into account two stages of company growth. The company may have a high growth rate in the initial period and the second phase is generally considered to have a steady growth rate. In the first step we need to estimate the cash flow in the business over the next ten years. Where possible we use analyst estimates, but when these are not available we extrapolate past free cash flow (FCF) from previous estimates or reported value. We believe that companies with shrinking free cash flows will slow their rate of shrinkage, and companies with growing free cash flows will see their growth slow over this period. We do this to show that the growth trend tends to be slower in the early years than in the later years.
A DCF is about the idea that one dollar in the future is worth less than one dollar today, and so the sum of these future cash flows is discounted to today’s value:
10 Year Free Cash Flow (FCF) Forecast
2023 
2024 
2025 
2026 
2027 
2028 
2029 
2030 
2031 
2032 

Leveraged FCF ($, million) 
US$70.9m 
US$118.0m 
US$136.0m 
US$149.2m 
US$160.2m 
US$169.5m 
US$177.3m 
US$184.0m 
US$190.0m 
US$195.4m 
Growth Rate Estimation Source 
analyzer x6 
analyzer x4 
analyzer x1 
Estimated @ 9.72% 
Estimated @ 7.39% 
Estimated @ 5.75% 
Est @ 4.61% 
Est @ 3.81% 
Estimated @ 3.25% 
Estimated @ 2.86% 
Present Value ($, million) discount @ 5.7% 
US$67.0 
US$106 
US$115 
US$120 
US$121 
US$122 
US$120 
US$118 
US$115 
US$112 
(“Est” = FCF Growth Rate Estimated by Simple Wall St.)
Present Value of 10 Years Cash Flows (PVCF) = US$1.1b
The second stage, also known as the terminal value, is the cash flow of the business after the first stage. The Gordon Growth Formula is used to calculate the terminal value equivalent to a 5year average of 1.9% of a 10year government bond yield at a future annual growth rate. We discount terminal cash flow at today’s price at cost of equity of 5.7%.
Terminal Value (TV)= FCF2032 × (1 + g) (r – g) = US$195m × (1 + 1.9%) (5.7% – 1.9%) = US$5.3b
Present Value of Terminal Value (PVTV)= TV / (1 + R)10= US$5.3b÷ ( 1 + 5.7%)10= US$3.0b
Net worth is the sum of cash flows and discounted terminal value for the next ten years, resulting in a total equity value, which in this case is US$4.2b. The final step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of US$59.4, the company appears to be at about an 18% discount to fair value where the stock price currently trades. Assumptions have a large impact on valuation in any calculation, so it is better to view it as a rough estimate, not an accurate one down to the final percentile.
DCF
Estimate
The calculation above is heavily dependent on two assumptions. First discount rate and second cash flow. If you don’t agree with these results, calculate yourself and play with the guesses. The DCF also doesn’t consider an industry’s potential cyclicality or a company’s future capital needs, so it doesn’t give a complete picture of a company’s potential performance. Given that we’re looking at Mercury Systems as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC), for debt. Is responsible. In this calculation we have used 5.7%, which is based on a leveraged beta of 0.887. Beta is a measure of a stock’s volatility compared to the market as a whole. We derive our beta from the industry average beta of globally comparable companies, with a set range between 0.8 and 2.0, a reasonable range for a stable business.
looking ahead:
While important, the DCF calculation is only one of many factors you need to evaluate for a company. The DCF model is not the exhaustive and endall of investment appraisal. Rather, it should be viewed as a guide to “What assumptions need to be true for this stock to be undervalued/overvalued?” For example, if the terminal price growth rate is adjusted slightly, it can dramatically change the overall result. For the Mercury system, there are three important factors that you should research further:

risk: take a risk, for example – Mercury Systems 3 warning signs We think you should know about it.

future earnings: How does MRCY’s growth rate compare to its competitors and the broader market? Dig deeper into analyst consensus numbers for years to come by chatting with our free analyst growth expectancy chart.

Other high quality options: Do you like a good allrounder? Explore our interactive list of high quality stocks to find out what else you have in store!
ps. Simply Wall St updates its DCF calculation every day for every US stock, so if you want to find the intrinsic value of another stock just search here.
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This article by Simple Wall St. is general in nature. We only provide commentary based on historical data and analyst forecasts using an unbiased methodology and our articles are not intended to be financial advice. It does not recommend buying or selling any stock, and does not take into account your objectives, or your financial situation. We aim to bring you longterm focused analytics powered by fundamental data. Note that our analysis may not factor in the latest pricesensitive company announcements or qualitative content. Simple Wall St does not have a position in any of the stocks mentioned.
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