Company Valuation 1st Valuation Method Discounted Cash Flow Valuation5844.doc

Company Valuation 1st Valuation Method Discounted Cash Flow Valuation5844
Part I: Discount Rates
Risk Free Rates (Ch 7)
Risk Premiums (Ch 7)
Risk Parameters (Ch 8)
Cost of Financing () (Ch 8)
Kalaitzoglou

Iordanis
Company Valuation:
1
st
Valuation Method
Discounted Cash Flow
Valuation
Recap: Last Week
DCF Choices: Equity Valuation versus Firm Valuation
Equity valuation
: Value just the equity claim in the business
Firm Valuation
: Value the entire business
A business and the equity in the business can be very different numbers…
A firm like GE in 2005 had a value of $ 500 billion for its business but its equity is worth only $ 300 billion - the difference is due to the substantial debt that GE has used to fund its expansion1>.
You can have valuable businesses, where the equity is worth nothing because the firm has borrowed too much
….
In general, you should maintain consistency in your definition of debt. If you choose to call something debt in your cost of capital calculation - operating leases, for instance - you should subtract the item out to get to the value of equity.
If you do it right (and it is tough to do- see spreadsheet on my web site), you should get the same value for equity using both approaches. (The requirement is that the debt ratio assumptions should be the same in both approaches)
Generic DCF Valuation Model
The four pillars of value:
Cashflows
Potential for high growth
Length of the high growth period (before the firm starts growing at the same rate as the economy)
Discount rate
Note the variations and the need for consistency:
With equity ->
Cashflows
to equity - > Growth rate e -> Discount at the cost of equity
With firm ->
Cashflows
to firm - > Growth rate in operating e -> Discount at the cost of capital
Discounted Cash Flow Valuation: The Steps
The process is not always sequential. It may seem irrational to pick the DCF model after you have estimated the inputs