Union Investment Endowed Chair of Asset Management

Prof. Dr. Roland Fss

Topic: The Validity of Company Valuation Using Discounted Cash Flow Methods
Tutor: Zeno Adams (zeno.adams@ebs.edu) You may either write in English or German

Discounted Cash Flow (DCF) methods are an important part in fundamental company valuation. In the typical two phase formula the companys future expected Free Cash Flows are discounted individually for the first few periods, and aggregated to a terminal value for the more distant future periods:

FVt %

!1 # r "

FCFt #1

# 1

!1 # r "

FCFt #2
2

# ... #

!1 # r "

FCFt # n
n

FCFt # n $ !1 # g "

!r & g "

!1 # r "

It turns out that in most practical situations the terminal value contributes the largest part to the firm value (FV). However, this term is an approximation that incorporates mainly uncertainty of future free cash flows. Small changes in the FCF forecast for time t+n, changes in the expected growth rate of future free cash flows g, as well as the discount rate r allow for a wide range of possible firm values. The aim of this seminar topic is to show how the firm value reacts to changes in one of these fundamental factors and to discuss possibly reasonable ranges for the firm value as well as for the determining factors of the model.
Literature: !

Brealey, R.A., Myers, S.C., and Allen, F. (2006), Corporate Finance, 8th ed

Bodie, Z., Kane, A., and Marcus, A.J. (2005), Investments, 6th ed, Ch. 18. Stephen, H.P., and Sougiannis, T. (1996), A Comparison of Dividend, Cash Flow, and Earnings Approaches to Equity Valuation, SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=15043