An Integrated, Consistent Market-Based Framework for Valuing Finite Cash Flows
Management Research News, Vol. 28, No. 10, pp. 65-92
23 Pages Posted: 2 Feb 2005 Last revised: 1 Apr 2009
Date Written: January 1, 2005
In this teaching note, we present an integrated, consistent market-based framework for valuing finite cash flows. We derive the relevant cash flows from integrated financial statements, and based on Modigliani and Miller's (M & M) theories, we estimate the appropriate cost of capital and value the cash flows in seven different ways. The first five methods are variations of the Discounted Cash Flow (DCF) method.
The last two methods, the RIM and EVA, are interesting because they differ from the DCF methods. In particular, they apply a charge for equity (based on the book value of equity) to the net income or a charge for invested capital (based on the book value of invested capital) to the Net Operating Profit after tax (NOPLAT), roughly speaking. Happily, the results from the DCF methods are fully consistent with the RIM and EVA.
Since the results from the seven methods must always match, calculating the (present) values with the seven methods is a powerful check on the consistency of the valuation exercise. With the availability of computing resources, it is easy to implement the seven methods on a routine basis.
In Principles of Cash Flow Valuation, 2004, Academic Press we present and explain the valuation methods in detail.
Keywords: Multiperiod WACC, firm valuation, levered equity, valuation with EVA, cost of equity
JEL Classification: D61, G31, H43
Suggested Citation: Suggested Citation