4.1 - Business Valuation Fundamentals

This section describes the essential methodology used to value investments in a business. There are always two essential questions --

• What future returns is the business investment expected to generate, whether fixed or variable?
• What is the present value of those returns, assuming an appropriate discount rate to reflect their risk?

4.1.1 - Cash flows (returns)

An investment's value depends on the cash flow (or cash flows) that you anticipate it will provide over the period of ownership. To have value, the investment need not provide constant returns. Intermittent cash flows, a single cash payment and even declining cash flows have value. (More 4.1.1>>)

4.1.2 - Required return (discount rate)

An asset's riskiness affects its value. The greater the uncertainty of cash flows, the lower their value. Risk can be factored into the valuation process by either increasing the discount rate or formalizing it in a model (such as the Capital Asset Pricing Model) that relates risk (ß) and returns. (More 4.1.2>>)

4.1.3 - Discounted cash flow (DCF) model

The value of an asset is the present value of all expected future cash flows -- that is, cash flows discounted to present value. (More 4.1.3>>)