Page 1

What do we know for sure about ďŹ nancial valuation

?


1


Future Cash Flows


The financial value of any venture can only come from the cash generated in the future—no accrued values, no actual or historical performance.

✘ Now


12


TimeofValue Money


The longer we have to wait for an amount of money the less it is worth right now— that's why future cash flows are discounted.

Now


3

12


Risk-Free

Rate of Return


For every major currency there is an interest rate at which we can invest our money, for any horizon, with practically zero risk—the government bond yield curve. Every investment must be compared to this risk-free rate.

Now

%


34

12


Importance of

Risk


The more uncertain a cash flow is the less it is worth. If we buy a bunch of uncertain cash flows which provide us—on average—the same return as a risk-free government bond, we would probably go for the bond—or pay less for those cash flows.

Now


45

23


Valuation of

Uncertainty


What Black and Scholes or Cox, Ross, and Rubinstein developed for special cases in the financial world, we can now—with Monte Carlo simulation—ulitize for the valuation of every kind of uncertainty.

Probability of Under-Performance

Expected Value

Value of Uncertainty


OK, let‘s see again what we have ...


Future Cash Flows


Future Cash Flows

⌛

Time Value of Money


Future Cash Flows

⌛ %

Time Value of Money Risk-Free Rate of Return


Future Cash Flows

⌛ %

!

Time Value of Money Risk-Free Rate of Return Importance of Risk


Future Cash Flows

⌛ %

!

Time Value of Money Risk-Free Rate of Return Importance of Risk Valuation of Uncertainty


5

So, these are the

Five truths

we know about ďŹ nancial valuation


Future Cash Flows

⌛ %

!

Time Value of Money Risk-Free Rate of Return Importance of Risk Valuation of Uncertainty


And what don‘t we know? Or what are the

? Lies


And what don‘t we know? Or what are the

? Lies

(Even if we pretent they were true?)


Rock-Solid Future Cash Flows


Although everybody knows that future cash flows are highly uncertain, almost all financial projections, planning, budgets, etc. treat them exactly like this—rocksolid figures.

Now

✘


Lie!

So, it's a

Now


Equity Cost of

Capital 9.

95 %


The cost of capital is a fiction: A crucial part of capital—equity—has no price tag. Although the WACC* is critical to valuation, there is little practical guidance on how to determin it. The cost of capital is no ingredient to the valuation rather than one of its possible results.

WACC = Cost of Debt +

Cost of Equity

?

? ? ?

Market Risk Premium

CAPM

5% .7 7

*) Weighted Average Cost of Capital

MCPMTM

Beta

Stock Price Volatility


Lie!

Capital Cost is a

WACC = Cost of Debt +

Cost of Equity

?

? ? ?

Market Risk Premium

CAPM

5% .7 7

*) Weighted Average Cost of Capital

MCPMTM

Beta

Stock Price Volatility

What We Know About Valuation  

This presentation is about what we really know about financial valuation--and what's just myth.

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