Damodaran on Valuation

Part I: Discounted Cash Flow Valuation

In discounted cash flow valuation, we begin with the premise that the value of an asset is the present value of the expected cash flows on the asset. Since it lies at the heart of all valuation approaches, the next five chapters will be dedicated to examining the estimation issues and the application challenges in using discounted cash flow models.

In Chapter 2, we begin by looking at how best to estimate the cost of equity, the cost of debt, and the overall cost of capital for a firm. In the process, we take a quick look at the different risk and return models in finance and their underlying assumptions and at the best estimation practices in estimating parameters for these models.

In Chapter 3, we turn our attention to the estimation of cash flows. We start by considering the adjustments that we have to make invariably to the reported accounting earnings for a firm to update and normalize them and to make them consistent. We then look at the tax rate that we should use in estimating cash flows and what items should and should not be considered when estimating reinvestment.

In Chapter 4, we examine different ways of estimating growth. After pointing out the limitations of historical and management (or analyst) estimates of growth, we link the expected growth of a company to its reinvestment policy—how much it reinvests and how well it reinvests. We also consider how best to estimate the terminal value at the end of the estimation phase. ...