November 2012
Intermediate to advanced
608 pages
22h 17m
English
book
Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options
by David T. Larrabee, Jason A. Voss
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CHAPTER 5
DISCOUNTED-CASH-FLOW APPROACH TO VALUATIONa
Financial theory states that the fair market value of an ongoing business is the present value of its expected cash flows. This conceptual framework is known as the discounted-cash-flow (DCF) valuation approach. Although the DCF approach is deceptively simple in theoretical execution, in practice it is quite complex and very subjective. It requires that the analyst use great care in the estimation of cash flows, discount rates, and terminal values. Fortunately, there are ways to overcome the subjectivity and make the valuation process more rational and objective.
According to finance texts, the fair market value of an ongoing business is the present worth of its expected cash flows. This simple conceptual framework is known as the discounted-cash-flow (DCF) valuation approach. The calculations necessary in a DCF approach are equally simple: Add the present values of the individual cash-flow estimates for each year from one to infinity. Although the DCF approach is the technically correct way to value a company, and although it is deceptively simple in theoretical execution, in practice it is quite complex and very subjective. In this chapter, I will discuss ways to try to overcome that subjectivity and make the valuation process more rational and objective.
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