Training course provider: I just want you to be aware that there is another main way of valuing businesses. Does anybody know what that one is called?
Delegate: Cash flow discount.
Training course provider: It is. It is, so it’s something to do with discounting cash flows, and the way we normally describe it is: discounted cash flows. So if you’re taking notes in your packs, there is a major valuation camp if you like which is multiples. The other one is this one called discounted cash flows. Just so you are aware: discounted cash flows, and I’ll send this one through, don’t worry about copying this one in, but it’s just a chart to illustrate what’s involved here, it’s a different way of valuing businesses.
What they would do, what the bankers do is project the cash flows of the business year by year. They project the cash flows, they project the cash flows. Then they do something which is called “discounting”. Again the clue is in the title, they discount those cash flows.
[Aside] Again, another 50:50. Has that great export: “”Who wants to be a millionaire” made it to Portugal and Spain? I am sure it has, because we’ve been flooded in Europe with these shows. Do you have “Who wants to be a millionaire”? Yes? Because on the show you have the 50:50 don’t you – you’re in the 50:50 situation. Alright, now a 50:50 situation.
The time value of money
Another question for you guys at Linklaters: “a bird in the hand is worth two in the bush”. Have you heard that phrase before?
Delegate: Yes.
Training course provider: You’ve heard that? Is there a Spanish or a Portugese equivalent?
Delegate: Yes.
Training course provider: What is it? What’s the translation? I don’t speak… what does it translate as?
Delegate: It is better to have a bird in your hand than two flying.
Training course provider: A bird in your hand and two flying, so it’s not in the bush, it’s in the air?
Delegate: Yes.
Training course provider: So a bird in the hand is worth two in the air. So you know what you mean.
Delgate: 100… in Spain.
Training course provider: In Spain it’s 100 in the air… it’s 100. So you guys are more conservative, is that right? You’re more worried, you’re more worried. Forget about those 100 up there I want this one.
Cash flows further out are discounted more
A bird in the hand is worth two in the bush. A bird in the hand is worth two in the bush. Here’s my question guys, and it could be in the exam paper, but it’s not. A bird in the hand is worth two in the bush. A 50:50 chance – which of those cash flows is going to be discounted more? Which one of those cash flows is going to be discounted more?
Delegate. The year four, year four.
Training course provider: The furthest out the heavier we’re going to discount: a bird in the hand is worth two in the bush. That’s right. So what happens is we discount these cash flows more the further out we are.
That’s kind of all you need to know I think. It’s a valuation methodology, I do a whole separate course on this, so you’re really getting the condensed version. We project the cash flows, we discount those ones the most [points to far out cash flows], we total them up and that tells us what our valuation is.
DCF valuation: from enterprise value to shares value
Just like we were with our multiples, our discounted cash flow valuation gets us here [points to LHS] and we’ve got a route to get to shares value. So that’s the other main camp for bankers of valuing businesses. The other main way, as well as the multiples… projecting forward the cash flows and discounting them, the further out they are the more they are going to discount them. That’s DCF valuation. That’s the quickest lecture you’ll ever get on DCF valuation.
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What they would do, what the bankers do is project the cash flows of the business year by year. They project the cash flows, they project the cash flows. Then they do something which is called “discounting”. Again the clue is in the title, they discount those cash flows.
[Aside] Again, another 50:50. Has that great export: “”Who wants to be a millionaire” made it to Portugal and Spain? I am sure it has, because we’ve been flooded in Europe with these shows. Do you have “Who wants to be a millionaire”? Yes? Because on the show you have the 50:50 don’t you – you’re in the 50:50 situation. Alright, now a 50:50 situation.
