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Unformatted text preview: Aswath Damodaran Discounted Cash Flow Valuation: Many a slip between the cup and the lip… Aswath Damodaran www.damodaran.com Aswath Damodaran Some Initial Thoughts " One hundred thousand lemmings cannot be wrong" Graffiti Aswath Damodaran Misconceptions about Valuation ■ Myth 1: A valuation is an objective search for “true” value • Truth 1.1: All valuations are biased. The only questions are how much and in which direction. • Truth 1.2: The direction and magnitude of the bias in your valuation is directly proportional to who pays you and how much you are paid. ■ Myth 2.: A good valuation provides a precise estimate of value • Truth 2.1: There are no precise valuations • Truth 2.2: The payoff to valuation is greatest when valuation is least precise. ■ Myth 3: . The more quantitative a model, the better the valuation • Truth 3.1: One’s understanding of a valuation model is inversely proportional to the number of inputs required for the model. • Truth 3.2: Simpler valuation models do much better than complex ones. Aswath Damodaran Approaches to Valuation ■ Discounted cashflow valuation , relates the value of an asset to the present value of expected future cashflows on that asset. ■ Relative valuation , estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common variable like earnings, cashflows, book value or sales. ■ Contingent claim valuation , uses option pricing models to measure the value of assets that share option characteristics. Aswath Damodaran Discounted Cash Flow Valuation ■ What is it : In discounted cash flow valuation, the value of an asset is the present value of the expected cash flows on the asset. ■ Philosophical Basis : Every asset has an intrinsic value that can be estimated, based upon its characteristics in terms of cash flows, growth and risk. ■ Information Needed : To use discounted cash flow valuation, you need • to estimate the life of the asset • to estimate the cash flows during the life of the asset • to estimate the discount rate to apply to these cash flows to get present value ■ Market Inefficiency : Markets are assumed to make mistakes in pricing assets across time , and are assumed to correct themselves over time, as new information comes out about assets. Aswath Damodaran DCF Choices: Equity Valuation versus Firm Valuation Assets Liabilities Assets in Place Debt Equity Fixed Claim on cash flows Little or No role in management Fixed Maturity Tax Deductible Residual Claim on cash flows Significant Role in management Perpetual Lives Growth Assets Existing Investments Generate cashflows today Includes long lived (fixed) and shortlived(working capital) assets Expected Value that will be created by future investments Equity valuation : Value just the equity claim in the business Firm Valuation : Value the entire business Aswath Damodaran Valuation with Infinite Life Cash flows Firm: Predebt cash flow Equity: After debt cash flows Expected Growth...
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This note was uploaded on 12/01/2011 for the course FINANCE 350 taught by Professor Aswath during the Summer '10 term at NYU.
 Summer '10
 Aswath
 Valuation

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