The Practical Application of Discounted Cash-Flow Based Valuation Methods

Valuation is the estimation of an asset’s value, whether real or financial, based on variables perceived to be related to future investment returns, on comparison with similar assets, or, when relevant, on estimates of immediate liquidation proceeds (Pinto, Henry, Robinson, Stowe; 2010). Correct valuation of real assets can present challenges to financial analysts. Different models can be used to arrive at the closest estimate of value and yet certain issues will always arise. This case attempts to tackle two approaches in real asset valuation: Discounted Cash Flow (DCF) analysis and the issues surrounding such, as well as the Black-Scholes Model for Real Options. Questions to be addressed in the study are:

It is focused on cash flow rather than accounting practices and allows for different components of a company to be valued separately. Conversely, the biggest challenge of the DCF method is that the determined value is only as accurate as the information it is given, that being the FCF, TV and discount rates. In other words, if the information given to determine the DCF isn’t accurate then the fair value for the investment won’t be accurate and the model won’t be helpful when assessing stock prices due to the inaccuracies. Furthermore, DCF is only good for long term values not short term investing. “The bottom line is that DCF is a rigorous valuation approach that can focus your mind on the right issues, help you see the risk and help you separate winning stocks from losers and help reduce uncertainty.” (McClure, 2011) So, now that we’ve looked at CAPM and DCF, what can we conclude?

This case attempts to tackle two approaches in real asset valuation: Discounted Cash Flow (DCF) analysis and the issues surrounding such, as well as the Black-Scholes

An equity investment is a number of shares owned by a corporation that are purchased by investors who are then entitled to shares of the firm’s assets in the case of liquidation. These shares are then bought and sold among stockholders. Before buying any shares, the stockholders and investors value the stock to determine if it is worth buying. There are different methods stockholders and investors use to value a stock price. The common ones are the discounted cash flow model and the dividend discount model. The purpose of the discounted model is to determine the value of the firm and its stock. It uses future cash flow projections discounted back to the present values to estimate the potential for the investment. (Discounted Cash Flow (DCF), n.d.) Another valuation method is the dividend discount model. This method uses predicted dividends and discounting them back to the present value to obtain a value price. Both models were used to evaluate each company’s stock price to help us determine which one is the best option to purchase.

This valuation of NABR was based on equity and debt resulting in the financial value of the firm, and connects with the value of the firm's asset. By using the DCF method, the total fair market value of the business entity is calculated by discounting future projected cash flows back to the date of valuation. At the end of the projection period, a residual or terminal value is calculated and discounted to its present value at the date of the valuation. The theory behind the discounted cash flow method is that an entity's value is equal to its present value of its expected future cash flow. This method is considered the most detailed analysis because it is thorough in nature and aids the owner to get a true picture of the firm value. This consists of certain steps which involve developing a method to be used to project future earnings of cash flow, a risk adjusted discount rate, discounting the projected cash flow to the date of the valuation, and capitalizing the terminal year's projection into a residual value using the discount rate less the growth rate. In this case, we estimated the growth rate of 2.3%, and the summation of the present values of the discounted cash flows and terminal value.

In finance, the discounted cash flow (DCF) analysis is a method of valuing a project, company or asset using the concepts of time value of money (Wikipedia, 2004). Three inputs are required to use the DCF, also called dividend-yield-plus-growth-rate approach, include: the current stock price, the current dividend, and the marginal investor’s expected dividend growth rate. The stock price and the dividend are east to obtain, but the expected growth rate is difficult to estimate (Ehrhardt & Brigham, 2011). The advantages and disadvantages of using DCF approach will be explained along with the further clarification on the cost of capital using DCF approach.

An investment offers $8,500 per year for 15 years, with the first payment occurring 1 year from now. If the required return is 9 per cent, what is

This process is complicated by the fact that while some of the assets of a firm have already been made, and are thus assets-in-place, a significant component of firm value reflects expectations about future investments. Thus, to value a firm we need to measure not just the cash flows from investments already made, but also estimate the expected value from future growth. In the following section, we will consider some of the basic principles that should guide our estimates of cash flows, growth and discount rates. 1 . Cash Flow to the Firm The cash flow to the firm that we would like to estimate should be both after taxes and after all reinvestment needs have been met. Since a firm includes both debt and equity investors, the cash flow to the firm should be before interest and principal payments on debt. The cash flow to the firm can be measured in two ways. One is to add up the cash flows to all of the different claim holders in the firm. Thus, the cash flows to equity investors (which take the form of dividends or stock buybacks) are added to the cash flows to debt holders (interest and net debt payments) to arrive at the cash flow. The other

In this paper, we describe the four main groups comprising the most widely used company valuation methods: balance sheet-based methods, income statement-based methods, mixed methods, and cash flow discounting-based methods. The methods that are conceptually “correct” are those based on cash flow discounting. We will briefly comment on other methods since -even though they

Corporate valuation is channeled alongside the corporate valuation model. It is a substitute to stock valuation. The model points out company's main operational and non-operational assets as well as the total worth of firm value and growth (Ehrhardt and Brigham, 2008, pg 659). It is usually an alternative to discounted dividend models in determining firm value of companies with no history in dividend and its

There is possibility to use, with respect to the object of valuation, several methods for valuation of a company in practice. One of the most important and highly used group of methods are yield methods. They are usually called Discounted Cash Flows (DCF) methods. Value of a company is derived from present value of future incomes connected with the ownership of a company. The core of these models is working with time value of future incomes investor gets in case of realization of an investment. There are several possibilities to work with future incomes in DCF

Companies spend a great deal of time and money on new investments. Executives need measures of productivity of capital, which can be applied to distinguish good ones from bad ones. There are broadly two types of measures – some based on accounting income and some based on cash flows. The cash flow based measures can be further categorized as those that consider time value of money and those that don’t. Cash flow based measures that consider time value of money are called Discounted Cash Flow (DCF) techniques.

Les modèles d’évaluation basés sur les flux monétaires actualisées (DCF model) considèrent la valeur intrinsèque d’une action comme étant la valeur actualisée des flux monétaires espérés. Dans ce chapitre les flux monétaires utilisés par les modèles d’évaluation sont : le free cash flow to the firm (FCFF) et le free cash flow to equity (FCFE). Les dividendes représentent les flux monétaires distribués aux actionnaires tandis que les free cash flow

This section reflects the underlying health of the business thus making it the most important section of the cash-flow statement. The ability of a firm to fund its operating capability, repay loans, pay dividends etc are indicated by the cah flows arising from operating activities.

FCFF= Net Income + Depreciation + Interest Expense – Change in net working capital – CapEx