Deducing the value of a company is a complex task. In this Valuation Series edition, we look at the four variables that are key to determining the firm value.
The value of a firm is a function of four variables:
1. The Cash Flows from assets in place (existing investment)
The cash flow on an asset can be measured prior to debt payments (This is categorised as a cash flow to the firm) OR after debt payments (This is categorised as a cash flow to equity).
Cash Flow to the firm should be discounted at the cost of capital. Cash Flow to the equity should be discounted at the cost of equity.
2. The expected growth in these Cash Flows
Does the company plan to evolve its business model? Does it plan to take on more capital?
3. The length of the period over which the firm can sustain high growth
Each startup needs to have a revenue projection for 5-10 years to show how sustainable their business is in the long-term.
4. The Cost of Capital
What is the return rate promised on the company debt? What is the current interest rate, which determines the ultimate price of money?
The value of the firm is different from individual assets, and as such one also needs to measure the value at the end of the forecast period. This value is called the Terminal Value and can account for a large portion of the value of the asset.
By Dulal Das
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