The problem in valuation is not that there are not enough models to value an asset, it is that there are too many. Choosing the right model to use in valuation is as critical to arriving at a reasonable value as understanding how to use the model. This chapter attempts to provide an overview of the valuation models introduced in this book, and a general framework that can be used to pick the right model for any task.
In the broadest possible terms, firms or assets can be valued in one of four ways: asset-based valuation approaches where you estimate what the assets owned by a firm are worth currently, discounted cash flow valuation approaches that discount cash flows to arrive at a value of equity or the firm, relative valuation approaches that base value on how comparable assets are priced, and option pricing approaches that use contingent claim valuation. Within each of these approaches, there are further choices that help determine the final value.
There are at least two ways in which you can value a firm using asset-based valuation techniques. One is liquidation value, where you consider what the market will be willing to pay for assets if the assets were liquidated today. The other is replacement cost, where you evaluate how much it would cost you to replicate or replace the assets that a firm has in place today.
In the context of discounted cash flow valuation, cash flows to equity can be discounted at the cost ...