Financial Forecasting, Analysis and Modelling: A Framework for Long-Term Forecasting

CHAPTER 5

Business Valuation

Chapter 5 describes the valuation of a company based on the Discounted Cash Flow (DCF) technique. DCF modelling is pretty much the gold standard for valuation and the free cash flow (operating cash flow minus capital expenditures, at its simplest level) is the best proxy for corporate financial performance. The step-by-step building of a free cash flow model is presented in a comprehensive way. The discount rate is calculated using the Capital Asset Pricing Model (CAPM) and the cash flow estimates are discounted into an estimated New Present Value (NPV). One row serves to hold the year-by-year cash flow estimates, while the rows which follow hold the discount factors and the cash balances.

Estimating the terminal value is the next step. The terminal value is then discounted and its present value is added to the NPV. As part of this process, the terminal value is applied after the calculation of explicit cash flows for 5 years. Finally the net cash/debt is added/subtracted from the total NPV and the result is divided by the number of the company's shares outstanding to calculate its intrinsic value.

5.1 VALUATION APPROACHES

There are many valuation approaches and methods that one could use to value a company. Amongst the most common approaches are the following:

1. the net asset approach,
2. the market approach, and
3. the income approach.

The net asset approach treats the business as a set of assets and liabilities where their net difference represents its ...