Discounted Cash Flow Valuation: The Inputs

1 Discounted cash flow Valuation: Discounted cash flow Valuation: The InputsThe InputsAswath Damodaran2 The Key Inputs in DCF ValuationThe Key Inputs in DCF ValuationlDiscount Rate Cost of Equity, in valuing equity Cost of Capital, in valuing the firmlCash flows Cash flows to Equity Cash flows to FirmlGrowth (to get future cash flows ) Growth in Equity Earnings Growth in Firm Earnings (Operating Income)3I. Estimating Discount RatesI. Estimating Discount RatesDCF Valuation4 Estimating Inputs : Discount RatesEstimating Inputs : Discount RateslCritical ingredient in Discounted cashflow valuation. Errors in estimating the discount rate or mismatching cashflows and discount rates can lead to serious errors in valuation. lAt an intuitive level, the discount rate used should be consistent with both the riskiness and the type of cashflow being Discounted . Equity versus Firm: If the cash flows being Discounted are cash flows to equity, the appropriate discount rate is a cost of equity.

What about historical premiums for other markets? l Historical data for markets outside the United States tends to be sketch and unreliable. l Ibbotson, for instance, estimates the following premiums for major markets from 1970-1990 Country Period Stocks Bonds Risk Premium Australia 1970-90 9.60% 7.35% 2.25% Canada 1970-90 10.50% 7.41% 3.09%

Tags:

  Flows, Sachs, Historical, Cash flow

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