Using Discounted Cash Flow Valuation Method for Asset and Project Valuation

This article explains the discounted cash flow valuation method and how it can be used to estimate the value of assets and projects. It also discusses the concept of intrinsic value and how it is calculated. The article provides an example of how Amazon's intrinsic value is calculated using this method.

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Security Analysis

Amazon
The primary objective of using a discounted cash flow valuation method in the management
of a company is to find out the value of the Asset or project carried out by the organisation
with the help of time value of money concept. This method can also be used to estimate the
profit that can be earned on a specific investment to determine the costs, all the necessary
future cash flows, and outflows are estimated to find the appropriate discount rate on the
present value of the asset. The discount rate is being reflected with the help of the weighted
average cost of capital which helps to estimate the risk that may be present in the expected
cash flow and the time value of money (Berk et al., 2011). Therefore, all these cash flows are
very different from each other regarding their objectivity and also the face value of bonds, the
dividend for stock and after-tax cash flows for a particular project. With the increase of risk
in nature, the discounted are also increased.
The method of discounted cash flow can also be used to estimate the intrinsic value of the
assets owned by an organisation by its fundamentals. The term inherent value can be
understood as the value that can be attached or connected to an organization by an analyst
who carries out the task of estimation of the cash flows and also price to assign the right
discount rate to each of them so that the work can be carried out in the most lawful manner
(Bodie et al., 2014). In many cases that have been observed that the market prices deviate
from the intrinsic value because of which it is expected that the two will converge sooner by
the estimated fundamentals (Parrino et al., 2012).
Different types of discounted cash flows models can be used by an organisation to estimate
the value of the assets. Every model differs from another by various factors or dimensions. A
discounted cash flow valuation method and be used to determine the equity stake of a
particular company to provide a fundamental value of the firm (Needles & Powers, 2013).
This concept consists of long-term plans of investment rather than short-term because the
entire company is valued with the help of the equity stake. Generally, it is noticed that the
valuation of the organisation helps a lot to find the intrinsic value of a stock because of the
relevancy that it provides by dividing the number of shares to the total amount of the
organisation which can help to give a value to the equity (CNBC, 2017).
The methods that are used in the discounted cash flow model help to find stock prices in a
differentiated and skilful manner. Also, it helps to see the actual cost of the organisation as a
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Amazon
whole. After making of comparison over the estimate or intrinsic value to the current stock
price, the organisation can take more definitive decisions (Peirson et al., 2015).
The task of estimation of a pair value of the stock or intrinsic value is very complicated
because of the variables that are present in the day to day work of an organisation. Hence, the
use of a discounted cash flow model helps to cover all the variables and then estimate the
value of stocks. The discounted cash flow models use several ratios which can be helpful for
an investor to make assumptions and decisions based on them (Gowthrope, 2011). The
organisational growth can also be affected with the help of increment in the profit margin and
removing the risks from the company in general.
As all the intrinsic value calculations are being derived with the help of cash flow intrinsic
value or discounted earnings inherent value, it cannot be used by the organisation for
applying them in their managerial functions without proper earnings or revenue (Madura &
Fox, 2011). All the necessary details of calculating intrinsic value are clearly described below
in the paper.
Intrinsic value = (growth multiple x free cash flow pertaining to average of 6 years + Total
stockholder equity* 0.8)/ outstanding shares
(14.8625* 5698.3333 + 39125 *0.8)/487
=238.18
In the present scenario, the intrinsic value of Amazon stands at $238.18. The current stock
price of Amazon stands at $1665.53. Therefore, Amazon price to intrinsic value :
The projected FCF ratio is 7.0
Ratio in the present scenario 7.0
Calculation
As it is observed in the previous statement that the intrinsic value calculations which are
based on the discounted cash flow methods are not applicable by the companies until they are
earning consistent revenue, hence a new valuation model based on the normalized free cash
flow and book value of the company was taken into consideration (Deegan, 2011).
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Amazon
In this method, an organization needs to find out all the free cash flows for the past 6 to 7
years after which it multiplies the results to a growth multiple and adds the total portion of
equity to it.
Value = ((Growth Multiple)*Free Cash Flow (6 year average) + 0.8*Total Stockholders’
Equity (most recent))/Shares Outstanding (Diluted Average)
In the case of negative total equity, the following formula is used (see the Total Equity
section for the reason):
Value = ((Growth Multiple)*Free Cash Flow (6 year average) + Total Stockholders’ Equity
(most recent)/0.8)/Shares Outstanding (Diluted Average)
Here Amazon.com Inc's FCF (6-year average) is calculated as
Amazon.com Inc Quarterly Data
Add all the Free Cash Flow together and divide 6 will get Amazon.com Inc's FCF (6-year
average) = $5,698.33.
Amazon.com Inc's Intrinsic Value: Projected FCF for today is calculated as
The growth multiple is situated between 8.35 and 17.74
Amazon.com Inc Price to Intrinsic Value: Projected FCF Ratio for today is computed as
Price to Intrinsic value = Share price/ Intrinsic Value
=1665.53/238.177
=6.99
The growth multiple was observed to be between the values 8.5 and 17.4. Further, the total
equity weighing is found to be more art than science because of which it should be analysed
in a much more detailed manner by professionals (Merchant, 2012). It has been observed that
the waiting from 0% to 100% or more than hundred per cent can be made possible. However,
80% was chosen to be the equilibrium by which all the above ideas have been considered.
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Amazon
Amazon earned $4.02 per share and led to the generation of $121 billion in sales during the
past 12 months. The company is headed towards the growth of 50% rate during the past three
to five years with more acceleration during the next two years (CNBC, 2017). However, at
the present scenario, that is 193.6 times current EPS, and it appears to be overvalued.
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Amazon
References
Berk, J, DeMarzo, P & Stangeland, D. (2015). Corporate Finance. Canadian Toronto:
Pearson Canada.
Bodie, Z, Kane, A. & Marcus, A. J. (2014). Investments. McGraw Hill
CNBC. (2017). Amazon 'terrifies me as a company,' says a valuation professor. Retrieved
from: https://www.cnbc.com/2018/07/27/amazon-terrifies-me-as-a-company-says-dean-
of-valuation.html
Deegan, C. M. (2011). In Financial accounting theory. North Ryde, N.S.W: McGraw-Hill
Gowthrope, C. (2011). Business accounting and finance for non specialists (3rd ed.). South
Western
Madura, R., & Fox, J. (2011). International financial management (2nd ed.). South Western
Merchant, K. A. (2012). Making Management Accounting Research More Useful. Pacific
Accounting Review, 24(3), 1-34. doi: https://doi.org/10.1108/01140581211283904
Needles, B.E., & Powers, M. (2013). Principles of Financial Accounting. Financial
Accounting Series: Cengage Learning.
Parrino, R., Kidwell, D., & Bates, T. (2012). Fundamentals of corporate finance. Hoboken,
NJ: Wiley
Peirson, G., Brown, R., Easton, S., Howard, P & Pinder, S. (2015). Business Finance. North
Ryde: McGraw-Hill Australia.
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