The purpose of this paper is to give a clear understanding of discounted cash flow valuation. The paper will explain what a discounted cash flow valuation is and its importance in financial business decisions regarding investment strategies. This paper will give a detailed discussion about discounted valuations for both present and future multiple cash flows with respect to even and uneven schedules using clear step-by-step examples. Also included will be some advantages and disadvantages in using the discounted cash flow valuation method for corporate business. Finally, the paper will give a summary of important highlights discussed in the body of the paper.
Discounted Cash Flow Valuation
Today financial corporate managers are continually asking, “What will today’s investment look like for the future health of the company? Should financial decisions be put on hold until the markets become stronger? Is it more profitable to act now to better position the company’s market share?” These are all questions that could be clearly answered if the managers had a magical financial crystal ball. In lieu of the crystal ball, managers have a way of calculating the financial risks with some certainty to better predict positive financial investment outcomes through the discounted cash flow valuation (DCF). DCF valuation is a realistic approach, a tool used, to “determine the future and present value of investments with multiple cash flows” over a particular period of time which is incurred at the end of each period (Ross, Westerfield, & Jordan, 2011). Solutions Matrix defines DCF as a “cash flow summary adjusted so as to reflect the time value of money (The Meaning of Discounted Cash Flow, 2014).” The valuation of money paid or rec...
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...ow valuation has been correctly calculated to show the projected future cash inflow will greater than the present value of the company asset.
Works Cited
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Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2011). Essentials of Coporate Finance (7th ed.). New York, New York, US: McGraw-Hill/Irwin. Retrieved January 19, 2014
In order to determine the value of operations, and using proforma income statement and balance sheet statement, Cash flow statement was formulated for the next 5 years. The Account Receivables plus the Inventory minus the Account Payable was determined as Net Operating Working Assets. An organization cost of 0,000 was amortized over the 5-year period.
Discounted cash flow is a valuation technique that discounts projected cash inflows and outflows to evaluate the potential value of an investment. There are three discounted cash flow methods: Net Present Value (NPV), Profitability Index (PI) and Internal Rate of Return (IRR). The net present value discounts all cash inflows and outflows at a minimum rate of return, which is usually the cost of capital. The profitability index refers to the ratio of the present value of cash inflow to the present value of cash outflows. The internal rate of return refers to the interest rate that discounts cash inflow projections to the present to ensure that the present value of cash inflows is equivalent to the present value of cash outflows (Brown, 1992).
Earlier 2002, the stock price of Agnico-Eagle Mines sharply decreased by $1 finally closed at $13.89. This price has reached one of the lowest level, from the company's historical perspective. As a professional equity portfolio manager, who has a large number of AEM stocks on hand. Acker and his team are necessary to find a proper way to estimated the fair value of AEM as well as its equity. Discounted Cash Flow (DCF) has been chosen to do this job. The theory behind DCF valuation approach is that the firm's value can be estimated by using the expected future free cash flow discounted by an appropriate discounted rate (Koller etc 2005). However several assumptions need to be clearly examined within this approach. The following sections are showing the process of DCF step by step.
This object is one of the financial goals to invest properly. Marriott used discounted cash flow techniques to evaluate potential investment. It is beneficial because it is considered present time value. Projects which increase shareholder value could be formed with benchmark hurdle rates, the company can ensure a return on projects which results in profitable and competitive advantage.
This statement is used to report cash payments and cash receipts of an organization’s during a certain period. During 2015, the Group had operating free cash flow amounting to 606 million euros, versus a negative 164 million euros a year earlier (Air france-klm group, 2016). The statement displays the relationship of the net income to the changes in the cash balances. It is important to understand that cash balances can wane despite and increase in net revenue or vice versa Horngren, 2014, p. 674). The statement also aids in the evaluating management’s use of cash and management’s generation, defining a company’s capability to pay dividends and interest to pay debts when the time comes to pay them, and forecasting upcoming cash flows (Horngren, 2014, p. 674).
The fifth section, concerning the discounted cash flow analysis, is the central part of this thesis. The DCF analysis aims to figure out the intrinsic value of Chipotle.
There are many valuation methods that could be used to evaluate this company. Finding a method that valuates the stand-alone value is difficult. The stand-alone value should be dependent upon the firm’s own assets and projected future income. We decided to evaluate this company based upon two methods: The Discounted Cash Flow Method and the Comparable Companies Method.
A real option analysis always starts from the standard NPV analysis. In fact, the standard discounted cash flow (DCF) approach is a special case of the real option analysis, evaluating the project as if no flexibility is present. It is therefore vital to start real option analysis to correct standard NPV valuation. The total value of a project is expressed by the following formula. (Luehrman, 1998)
In order to make a proper investment decision for her mutual fund, Miss Ford made her own discounted-cash-flow forecast. This forecast proved that Nike shares were overvalued by $5.95 per share when maintaining a discount rate of 10%. A sensitivity analysis showed that stock was undervalued at discount rates less than 9.4%. To be certain...
The inputs for DCF valuation are the discount rate, the cash flows and the growth rate. DCF valuation can be used both for valuing equities and firms
Parrino, R., Kidwell, D. S., & Bates, T. W. (2011). Fundamentals of Corporate Finance. Hoboken, NJ: John Wiley & Sons. (Original work published 2009)
To calculate the valuation of Ryanair, the firm's future revenues and costs, as well as the firm's current accounting value must be calculated. To account for a range of possibilities, three different valuations have been calculated through 2012. These are called Annual Report, Valuation 1, and Valuation 2. Descriptions of each of these valuations will develop as the revenue and cost modeling are discussed. A description of the valuations will conclude the Analysis portion of this document.
In other words, financial risk plays a significant role in determining an investor’s required rate of return. Therefore, any changes to the financial risk will impact the required rate of return in a similar fashion. If Home Depot increases its rate from 8% to 10%, the investor’s required rate of return increases. In addition, the company’s present value will decrease due to the increase in risk. “This happens beause the higher the discount rate, the lower the investment needs to be in order to achieve the target yield” (Schmidt 2013). For example, Home Depot has a 2015 free cash flows future value of $113 million. By increasing the risk discount rate from 8% to 10%, Home Depot’s present value decreases by $1.9 million from ($104.63) million to ($102.73) million. The higher discount rate enables Home Depot to invest its available $1.9 million in free cash flows into other capital leases or other growth-related opportunities. If Home Depot decreases its discounting rate to 6%, the present value for 2015 increases to ($106.60). In addition, the required rate of return decreases and the net present value increases by $88.59 million. Home Depot needs to increase its free cash flows to meet desired future value (Schmidt 2013) (The Home Depot, Inc. Form 10-K 2015) (Financial Risk
Star Appliance is looking to expand their product line and is considering three different projects: dishwashers, garbage disposals, and trash compactors. We want to determine which project would be worth doing by determining if they will add value to Star. Thus, the project(s) that will add the most value to Star Appliance will be worth pursuing. The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.
Organizations that have high free cash flow, creditors are willing to invest in these companies since these companies have powerful tools for debt repayment and they clearly have greater financial flexibility. On the other hand, cash enables managers to develop growth opportunities and development programs that will lead to an increase in company 's value. The free cash flow theory was first introduced by Jensen (1986), he stated that “Free cash flow as cash flow left after the firm has invested in all available positive NPV projects”.