Discounted Cash Flow Valuation: Basics
Aswath Damodaran

Aswath Damodaran

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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

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Equity Valuation versus Firm Valuation

n n

Value just the equity stake in the business Value the entire business, which includes, besides equity, the other claimholders in the firm

Aswath Damodaran

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I.Equity Valuation

n

The value of equity is obtained by discounting expected cashflows to equity, i.e., the residual cashflows after meeting all expenses, tax obligations and interest and principal payments, at the cost of equity, i.e., the rate of return required by equity investors in the firm. t=n Value of Equity =

CF to Equity t ∑ (1+ k )t t=1 e

where, CF to Equityt = Expected Cashflow to Equity in period t ke = Cost of Equity n The dividend discount model is a specialized case of equity valuation, and the value of a stock is the present value of expected future dividends.

Aswath Damodaran

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II. Firm Valuation

n

The value of the firm is obtained by discounting expected cashflows to the firm, i.e., the residual cashflows after meeting all operating expenses and taxes, but prior to debt payments, at the weighted average cost of capital, which is the cost of the different components of financing used by the firm, weighted by their market value