Companies valuation with discounted cash-flows technique: a case study

Companies valuation with discounted cash-flows technique: a case study

Abstract:

The valuation process of any asset is always complicated; and it becomes even more complex when trying to assess the value of a Company because of the multiplicity of variables to be taken into account. Although there are other techniques that provide interesting and relevant information about the value of the firm (such as multiples and ratios), from a theoretical point of view it is generally accepted that valuation on the basis of discounted cash-flows technique appears as the most accurate one. Such a technique requires, on the one hand, the estimation of the expected cash-flows of the firm; and, on the other hand, the required rate of return for those free cash-flows. When talking about the last item, Financial Theory provides different tools which make it possible to measure the risk involved in the investment, and consequently, to estimate the risk premium that can be gained for the same risk in the market. And in relation to the expected cash-flows, practitioners usually use forecasting techniques in order to work out the forecasted financial statements from which the dividends that the company will pay can be obtained. The problem relies on the fact that it is not easy to do long term projections, and this is why it is very common to do the aforementioned process for a short term horizon (most accurate estimation period) and summarize what is expected to happen after that moment in the commonly known as “continuing value” (which often involves some complex calculations based on different growth hypothesis). In this paper we present a simple case study in which different scenarios are proposed in relation to the expected growth for the future cash-flows of the firm, which allows us to do a sensitivity analysis of its market value related to variables that are difficult to forecast properly.

Keywords: Valuation, discounted cashflow technique, continuing value, sensitivity analysis, risk, scenarios.