Aswath Damodaran
Valuation: Basics!
Aswath Damodaran
Aswath Damodaran!
1!
Approaches to Valuation!
Intrinsic valuation, relates the value of an asset to the present value of expected future cashflows on that asset. In its most common form, this takes the form of a discounted cash flow valuation.
Relative valuation, estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common variable like earnings, cashflows, book value or sales.
Contingent claim valuation, uses option pricing models to measure the value of assets that share option characteristics.
Aswath Damodaran!
2!
I. Discounted Cash Flow Valuation!
What is it: In discounted cash flow valuation, the value of an asset is the present value of the expected cash flows on the asset.
Philosophical Basis: Every asset has an intrinsic value that can be estimated, based upon its characteristics in terms of cash flows, growth and risk.
Information Needed: To use discounted cash flow valuation, you need
• to estimate the life of the asset
• to estimate the cash flows during the life of the asset
• to estimate the discount rate to apply to these cash flows to get present value
Market Inefficiency: Markets are assumed to make mistakes in pricing assets across time, and are assumed to correct themselves over time, as new information comes out about assets.
3!
Aswath Damodaran!
Risk Adjusted Value: Three Basic Propositions
The value of an asset is the present value of the expected cash flows on that asset, over its expected life:
Proposition 1: If “it” does not affect the cash flows or alter risk (thus changing discount rates), “it” cannot affect value.
Proposition 2: For an asset to have value, the expected cash flows have to be positive some time over the life of the asset.
Proposition 3: Assets that generate cash flows early in their life will be worth
Aswath Damodaran
Aswath Damodaran!
1!
Approaches to Valuation!
Intrinsic valuation, relates the value of an asset to the present value of expected future cashflows on that asset. In its most common form, this takes the form of a discounted cash flow valuation.
Relative valuation, estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common variable like earnings, cashflows, book value or sales.
Contingent claim valuation, uses option pricing models to measure the value of assets that share option characteristics.
Aswath Damodaran!
2!
I. Discounted Cash Flow Valuation!
What is it: In discounted cash flow valuation, the value of an asset is the present value of the expected cash flows on the asset.
Philosophical Basis: Every asset has an intrinsic value that can be estimated, based upon its characteristics in terms of cash flows, growth and risk.
Information Needed: To use discounted cash flow valuation, you need
• to estimate the life of the asset
• to estimate the cash flows during the life of the asset
• to estimate the discount rate to apply to these cash flows to get present value
Market Inefficiency: Markets are assumed to make mistakes in pricing assets across time, and are assumed to correct themselves over time, as new information comes out about assets.
3!
Aswath Damodaran!
Risk Adjusted Value: Three Basic Propositions
The value of an asset is the present value of the expected cash flows on that asset, over its expected life:
Proposition 1: If “it” does not affect the cash flows or alter risk (thus changing discount rates), “it” cannot affect value.
Proposition 2: For an asset to have value, the expected cash flows have to be positive some time over the life of the asset.
Proposition 3: Assets that generate cash flows early in their life will be worth