This website uses cookies to ensure you have the best experience. Learn more

Dcf Discounted Cash Flow Valuation: Basics Aswath Damodaran

1546 words - 7 pages

Discounted Cash Flow Valuation: Basics
Aswath Damodaran

Aswath Damodaran

1

Discounted Cashflow Valuation: Basis for Approach
t = n CF t Value = ∑ t t = 1( 1 +r)

where CFt is the cash flow in period t, r is the discount rate appropriate given the riskiness of the cash flow and t is the life of the asset. Proposition 1: For an asset to have value, the expected cash flows have to be positive some time over the life of the asset. Proposition 2: Assets that generate cash flows early in their life will be worth more than assets that generate cash flows later; the latter may however have greater growth and higher cash flows to compensate.

Aswath Damodaran

2

Equity Valuation ...view middle of the document...

Value of Firm = CF to Firm t ∑1 ( 1 +WACC) t t=
t=n

where, CF to Firmt = Expected Cashflow to Firm in period t WACC = Weighted Average Cost of Capital

Aswath Damodaran

5

Firm Value and Equity Value

n

o o o

o n o o o

To get from firm value to equity value, which of the following would you need to do? Subtract out the value of long term debt Subtract out the value of all debt Subtract the value of all non-equity claims in the firm, that are included in the cost of capital calculation Subtract out the value of all non-equity claims in the firm Doing so, will give you a value for the equity which is greater than the value you would have got in an equity valuation lesser than the value you would have got in an equity valuation equal to the value you would have got in an equity valuation

Aswath Damodaran

6

Cash Flows and Discount Rates

Assume that you are analyzing a company with the following cashflows for the next five years. Year CF to Equity Int Exp (1-t) CF to Firm 1 $ 50 $ 40 $ 90 2 $ 60 $ 40 $ 100 3 $ 68 $ 40 $ 108 4 $ 76.2 $ 40 $ 116.2 5 $ 83.49 $ 40 $ 123.49 Terminal Value $ 1603.0 $ 2363.008 n Assume also that the cost of equity is 13.625% and the firm can borrow long term at 10%. (The tax rate for the firm is 50%.) n The current market value of equity is $1,073 and the value of debt outstanding is $800.
n

Aswath Damodaran

7

Equity versus Firm Valuation

Method 1: Discount CF to Equity at Cost of Equity to get value of equity n Cost of Equity = 13.625% n PV of Equity = 50/1.13625 + 60/1.136252 + 68/1.136253 + 76.2/1.136254 + (83.49+1603)/1.136255 = $1073 Method 2: Discount CF to Firm at Cost of Capital to get value of firm Cost of Debt = Pre-tax rate (1- tax rate) = 10% (1-.5) = 5% WACC = 13.625% (1073/1873) + 5% (800/1873) = 9.94% PV of Firm = 90/1.0994 + 100/1.09942 + 108/1.09943 + 116.2/1.09944 + (123.49+2363)/1.09945 = $1873 n PV of Equity = PV of Firm - Market Value of Debt = $ 1873 - $ 800 = $1073

Aswath Damodaran

8

First Principle of Valuation

n n

Never mix and match cash flows and discount rates. The key error to avoid is mismatching cashflows and discount rates, since discounting cashflows to equity at the weighted average cost of capital will lead to an upwardly biased estimate of the value of equity, while discounting cashflows to the firm at the cost of equity will yield a downward biased estimate of the value of the firm.

Aswath Damodaran

9

The Effects of Mismatching Cash Flows and Discount Rates
Error 1: Discount CF to Equity at Cost of Capital to get equity value
PV of Equity = 50/1.0994 + 60/1.09942 + 68/1.09943 + 76.2/1.09944 + (83.49+1603)/1.09945 = $1248 Value of equity is overstated by $175.

Error 2: Discount CF to Firm at Cost of Equity to get firm value
PV of Firm = 90/1.13625 + 100/1.136252 + 108/1.136253 + 116.2/1.136254 + (123.49+2363)/1.136255 = $1613 PV of Equity = $1612.86 - $800 = $813 Value of Equity is understated by $ 260.

...

Other Papers Like Dcf Discounted Cash Flow Valuation: Basics Aswath Damodaran

Capital Budgeting Process Essay

942 words - 4 pages discounted to reflect the present value of the firm. The last remaining requirement is to estimate what the value of the acquired firm will be at the end of year 5, or whenever annual cash flows are no longer estimated. (Cleverley, chapter 20) Free Cash Flows. Cash flow is usually defined more broadly than net income plus depreciation for valuation purposes. Often, the term “free cash flow” is used. Free cash flow is typically used in the DCF

Stock Valuation on Pepsi Essay

2508 words - 11 pages investment, discounted cash flow model plays a prominent role in finding the equity valuation. The reason of using DCF is that the price of an asset to a shareholder must be associated to the returns that investors must be look forward to obtain from holding the asset. In its easiest form, DCF model can be represented as; DCF= CF1(1+d)1+ CF2(1+d)2+… + CFn(1+d)n Where: CFn = Cash flows in period n. d = Discount rate, Weighted Average Cost of Capital

Financial Detective

639 words - 3 pages for Company H, which is indicative of a vast retail store presence Exhibit 1 Additional Sources Damodaran, Aswath. "Merger and Acquisition Valuation Case Study." Valuation for M&A Building Value in Private Companies (2015): 329-57. Stern School of Business. NYU. Web. 1 Feb. 2016.

Intuit Case

2867 words - 12 pages Value 596,725,882 48,943,320 add long term investement 0 Subtract pension obligation 0 Total Enterprise Value 48,943,320 537,072,994 Current Debt 0 Long term debt 0 Total Debt 0 Equity Value 537,072,994 Valuation Using Economic Profit Invested Capital Total Value 0.892857 16496432 Valuation Using Core Free Cash Flow add excess cash 0.892857 67272002 Core Ecnomic Profit Present Value Factor 56053883 75344643 Discounted Cash

Guillermo Furniture Store Analysis

1617 words - 7 pages %+11.34%*15.7%=5.54% WACC 2008=7.5%*1-42%*82.4%+11.34%*17.5%=5.57% Discuss the use of multiple valuation techniques in reducing risks. There are a number of valuation techniques that help reduce risk. One is called the Discounted Cash Flow Valuation. it is a valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often

Whatsapp Valuation

1486 words - 6 pages Is Skype worth $8.5 billion? An exercise in valuing young, growth companies Posted by Aswath Damodaran Wednesday, May 18, 2011 Last week, Microsoft announced that it would buy Skype for $8.5 billion. The reaction was fast, furious and very predictable. First, there was the search for reasons for the deal and technology mavens listed a few. Second, there was the reaction from investors and analysts, which was generally not very positive. Third

Google Inc

1172 words - 5 pages Terms: capital budgeting Objective: 5 AACSB: Analytical skills 21) Deducting depreciation from operating cash flows would result in counting the initial investment twice in a discounted cash flow analysis. Answer: TRUE Diff: 2 Terms: discounted cash flow (DCF) methods Objective: 5 AACSB: Analytical skills 22) In determining whether to keep a machine or replace it, the original cost of the machine is a sunk cost and is NOT a relevant

Guillermo Furniture Store

2180 words - 9 pages large sum of cash is going out the door. Value arrives at DCF analysis in a higher flow cost of investment and possibility might be good. Calculated as: DCF= CF1 + CF2 + … + CFN (1 +r) ² (1 + r) ² (1 + r) ⁿ CF = Cash Flow r = discounted rate (WACC) The pertinent tool of this valuation is to value the asset to some disadvantages. First valuation technique, it might not

Palmex

2927 words - 12 pages . 18 Ad hoc Analysis Substantial Value SV = Σ Assets - Σ Liability MXN ('000) MXN Σ Assets Σ Liability Substantial Value USD ('000) (13.00 MXN) Guaranteed Minimum Value Scenario 1 Scenario 2 Average '10-'13 2013 (Last Period) $2,512,041 $2,826,930 $1,136,107 $1,219,976 $1,375,934 $1,606,954 $105,841 $123,612 19 Ad hoc Analysis DCF (Discounted Cash Flow) DCF = Σ perpetuity FCF * WACC Free Cash Flow -Historical Information

Rocky Mountain Advanced Genome

2087 words - 9 pages price of a share to its book value, which are the company's net assets minus its outstanding debt. Things to keep in mind when using P/B valuation are the P/B ratio is a measure of relative, not absolute, value since it depends on comparable firms. When accounting standards vary widely across firms, the price-book value ratios may not be comparable across firms. P/B for biotech companies is 6.71. Discounted Cash Flows (DCF):Discounted Cash Flows

Rocky Mountain Advanced Genome

2322 words - 10 pages Colorado of 38% (Tax Foundation 2011). This figure is corroborated by the average effective tax rate of 35%. Hence, these underlying assumptions and resulting NPAT, are apparent in the pro forma statement (Fig.2). FCF Projection: The discounted cash flow (DCF) valuation utilised a Weighted Average Cost of Capital (WACC) of 20%, as it was the consensus figure by RMAG and Big Sur as it was “low for a typical venture capital investment, but

Related Essays

A Review Of The Discounted Cash Flow Techniques On Investment Appraisal Of

2550 words - 11 pages cash flow (DCF) methods of investment appraisal available to management. 'Discounted cash flow techniques take account of the time value of money. This means that they take into account the fact that £1 now is worth more than £1 received in the future, because £1 received now can be invested and made to grow bigger as time passes' (Walker, 2009) Dayanada et al (2002) identify two discounted cash flow methods, namely the Net Present Value

Nothing Yet Essay

4983 words - 20 pages is the value of control? How can you estimate the value? Aswath Damodaran 2 Steps involved in an Acquisition Valuation I I I I I Step 1: Establish a motive for the acquisition Step 2: Choose a target Step 3: Value the target with the acquisition motive built in. Step 4: Decide on the mode of payment - cash or stock, and if cash, arrange for financing - debt or equity. Step 5: Choose the accounting method for the merger

Valuation With Multiples Essay

4017 words - 17 pages Operating free cash flow Capex Capital expenditures PE Price earnings EPS Earnings per share EV Enterprise value EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization IRR Internal return rate BV Book value PEG Price earnings to growth NOPLAT Noral operatting profit less adjusted tax FCF Free cash flow   Reference List Publications Aswath Damodaran (2002). INVESTMENT VALUATION: 2nd edition Cragg, J.G., and B.G. Malkiel

American Greetings Exec Summary Essay

529 words - 3 pages (millions) 2011 118 2012 83 2013 86 2014 88 2015 91 Operating Cash Flow (millions) 2011 118 2012 83 2013 86 2014 88 2015 91 We then determined a WACC of 5.37% based on a cost of equity of 8.85% (calculated with beta of 1.76, risk fee rate of 0.05%, and market risk premium of 5%) and estimated the cost of debt at 6%. Then, we calculated the discounted cash flows (DCF = OCF / (1 + WACC)^Period): Discounted