Describe the advantages and disadvantages of these 3 valuation methods: 1) the Discounted Cash Flow method (fundamental method) 2) the Venture Capital Method and 3) the First Chicago Method. In answering the question, assume that you plan to value a startup.
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According to McClure (2010) in simple terms, discounted cash flow tries to work out the value of a company today, based on projections of how much money it's going to make in the future. According to this same author, DCF analysis says that a company is worth all of the cash that it could make available to investors in the future; it is described as 'discounted' cash flow because cash in the future is worth less than cash today. According to this site one of the first things one needs to think carefully about is what the industry and company could look like as they evolve in the future; when forecasting revenue growth, we need to consider such factors as whether the company's market is expanding or contracting, and how its market share is performing; we also need to consider whether there are any new products driving sales or whether pricing changes are imminent; but because that future can never be certain, it is valuable to consider more than one possible outcome for the company. According to this author, in order to work out free cash flow we need to look at what's left over from revenues after deducting operating costs, taxes, net investment and the working capital requirements (which is the cash a business requires for day-to-day operations).
According to McClure (2010) in terms of the advantages and disadvantages of DCF: Advantages include:
1) it produces the closest thing to an intrinsic stock value; the alternatives to DCF are relative valuation measures which use multiples to compare stocks within a sector; while relative valuation metrics such as price-earnings and price-to-sales ratiois are over or undervalued, by contrast a carefully designed DCF should help investors steer clear of companies that look inexpensive against expensive peers;
2) Unlike standard valuation tools such as the P/E ratio, DCF relies on free cash flows; for the most part, free cash flow is a trustworthy measure that cuts through much of the arbitrariness ...
The advantages and disadvantages of various valuation methods are examined.