capitaldeclinedtomoresustainablelevels(say 12 percent)
andthebetamovedtoward1.Bythesametoken,youcan
haveanextraordinarygrowthperiod,wherethegrowthrateis
less thanthestablegrowth rate andthen movesup to the
stablegrowthrate.Forinstance,youcouldhaveafirmthatis
expectedtoseeitsearningsgrowat 2 percentayearforthe
next fiveyears (which would be the extraordinary growth
period) and 4 percent thereafter.
ESTIMATION APPROACHES
There are threeapproaches that are used to estimate cash
flowsinvaluation.Thesimplestandmostwidelyusedisthe
expectedvalueapproach,whereanalystsestimateanexpected
cash flow for each time period, allowing implicitly or
explicitlyforgoodandbadscenarios.Thesecondisavariant,
where cash flows are estimated under different scenarios,
rangingfrombestcasetoworstcase,withvaluesestimated
undereachscenario.Thelastandmostinformation-intensive
istoestimateprobabilitydistributionsforeachinputandto
run simulations, where outcomes are drawn from each
distribution and values estimated with each simulation.
Expected Value
Inmostvaluations,analystsestimateexpectedcashflowsin
eachtimeperiodfrominvestinginabusinessoranasset.The
expectedcashflowrepresentsthesinglebestestimateofthe
cash flow in a period and, computed correctly, should
encapsulatethelikelihoodofbothgood andbad outcomes.
This should therefore require a consideration of the
probabilities of eachscenario occurring and thecash flow
under each scenario. In practice, however, such detailed