PART ONE
Discounted Cash Flow Valuation
Indiscountedcashflowvaluation,webeginwiththepremise
thatthevalueofanassetisthepresentvalueoftheexpected
cash flows on the asset. Since it lies at the heart of all
valuationapproaches,thenextfivechapterswillbededicated
to examining the estimation issues and the application
challenges in using discounted cash flow models.
InChapter2,webeginbylookingathowbesttoestimatethe
costofequity,thecostofdebt,andtheoverallcostofcapital
forafirm.Intheprocess,wetakeaquicklookatthedifferent
risk and return models in finance and their underlying
assumptionsandatthebestestimationpracticesinestimating
parameters for these models.
InChapter3,weturnourattentiontotheestimationofcash
flows.Westartbyconsideringtheadjustmentsthatwehave
tomakeinvariablytothereportedaccountingearningsfora
firm to update and normalize them and to make them
consistent.Wethenlookatthetaxratethatweshouldusein
estimatingcashflowsandwhatitemsshouldandshouldnot
be considered when estimating reinvestment.
In Chapter 4, we examine different ways of estimating
growth.After pointing out thelimitations ofhistoricaland
management (or analyst) estimates ofgrowth, we link the
expected growth of a company to its reinvestment
policy—howmuchitreinvestsandhowwellitreinvests.We