Cash Flow Generating Capacity
Wecan categorize assets intothree groups based on their
capacity to generate cash flows—assets that are either
generatingcashflowscurrentlyorareexpectedtodosointhe
nearfuture,assetsthatarenotgeneratingcashflowscurrently
but couldin thefuturein theevent ofa contingency,and
assets that will never generate cash flows.
- The first group includes most publicly traded
companies, and these firms can be valued using
discountedcash flow models.Note thatwe donot
drawadistinctionbetweennegativeandpositivecash
flows,and young,start-up companiesthat generate
negative cash flows can still be valued using
discounted cash flow models. - The second group includes assets such as drug
patents, promising (but not viable) technology,
undevelopedoilorminingreserves,andundeveloped
land. These assets may generate no cash flows
currentlyandcouldgeneratelargecashflowsinthe
futurebutonlyundercertainconditions—iftheFood
and DrugAdministration(FDA) approvesthe drug
patent, if the technology becomes commercially
viable,ifoilpricesandcommercialpropertyvalues
goup.Althoughwecouldestimateexpectedvalues
using discounted cash flow models by assigning
probabilitiestotheseevents,wewillunderstatethe
valueoftheassetsifwedoso.Weshouldvaluethese
assets using option pricing models. - Assetsthatareneverexpectedtogeneratecashflows
include your primary residence, a baseball card