Damodaran on Valuation

Chapter 4. Forecasting Cash Flows

In the preceding chapter, we focused on the question of how best to measure cash flows. In this chapter, we turn to the more difficult question of how best to estimate expected future cash flows. We begin by looking at the practice of using historical growth rates to forecast future cash flows and then look at the equally common approach of using estimates of growth either supplied by management or from other analysts tracking the company. As a final variation, we describe a more consistent way of tying growth to a firm's investment and financing policies.

In the second part of the chapter, we examine different ways of bringing closure to valuation by estimating the terminal value and how to keep this number from becoming unbounded. In particular, we look at the connection between terminal growth and reinvestment assumptions. In the final section of the chapter, we consider three variations on cash flow forecasting: expected value estimates, scenario analysis, and simulations.