Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

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classroomsandcomeswiththebesttheoreticalcredentials.In
thissection,wewilllookatthefoundationsoftheapproach
andsomeofthepreliminarydetailsonhowweestimateits
inputs.


Basis for Approach


Webuymostassetsbecauseweexpectthemtogeneratecash
flowsforusinthefuture.InDCFvaluation,webeginwitha
simpleproposition.Thevalueofanassetisnotwhatsomeone
perceives itto be worth, but rather itis a functionof the
expectedcashflowsonthatasset.Putsimply,assetswithhigh
and predictable cash flowsshouldhavehigher valuesthan
assetswithlowandvolatilecashflows.InDCFvaluation,we
estimate thevalue of an asset as the presentvalue of the
expected cash flows on it.


where


E(CFt) = Expected cash flow in periodt


r= Discount rate reflecting riskiness of estimated cash flows


n= Life of asset


Thecashflowswillvaryfromassettoasset—dividendsfor
stocks,coupons(interest)andthefacevalueforbonds,and
after-taxcashflowsforabusiness.Thediscountratewillbea
function oftheriskiness ofthe estimatedcash flows,with
higher rates for riskier assets and lower rates for safer ones.

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