Financial Modeling 2: Estimation of Investment Attractiveness through Discounted Cash Flow Method

This article discusses the estimation of investment attractiveness through the discounted cash flow method in Financial Modeling 2. It explains the Gordon Growth Model and its application to Walgreens. The article also covers the calculation of terminal value using the Gordon Growth Model.

Running head: FINANCIAL MODELING 2
Financial Modelling 2
Name of the Student:
Name of the University:
Author Note:

1FINANCIAL MODELING 2
1. Estimation of the attractiveness of an investment is valued through discounted cash
flow method. Analysis of using ideal cash flow for future, discounting and projecting
them this is done through required annual rate so that estimation of present value can
be identified. Present value is used to identify the probable for investment. Decision
of investing is taken if the analysed value obtained through DCF model is greater than
the present cost. This is considered to be a good chance.
The purpose of the model is to estimate the present value of the business. To
full fill the purpose a business that is run on a going concern basis a terminal value shall be
calculated at every end of a convinced estimate period. At the time, where cash flow of the
business becomes constant at that time a fair value of the business can be expected which are
earned after that point in time.( Nolan,2015).
2. I chose the discounted cash flow model to analyze Walgreen’s finances due to its
market value relying heavily on sales. It has revenues based on both pharmacy and
retail sales and has a consistent history of paying dividends, which allows me to
utilize the Gordon Growth Model variation of the DCF model. The Gordon method is
based on the cost of equity and based on expected future cash flows paid to the
shareholders of Walgreens. It is also based on the assumption of a constant distributed
dividend rate in the following years. It is a simple formula based on the firm being
stable and with a history of paying dividends and of future growth.
3. There are different methods for estimating the terminal value but Gordon Growth
Model is the well known model to value the company’s time without end. The model
calculates the terminal value on the basis of :
Terminal Value = Final Projected Year Cash Flow X (1+Long-Term Cash Flow Growth
Rate) / (WACC – Long-Term Cash Flow Growth Rate)

2FINANCIAL MODELING 2
The principle simplifies the sensible difficulty of prognostic cash flows far into the
outlook. The principle is based on the assumption that the cash flow of the previous year
that was been projected would become stable and the rate would continue till ages. This
one is not expected to take place every year into time eternity. There will be fluctuations
but there is a hope of growth in future. (Krüger et al., 2015).
Walgreens full fills these criteria. This model is dependent on accurate assumptions of
discount rate and long term cash flow rate. Under this method Walgreen’s “stock becomes
more valuable as its dividend increases, the investor’s required rate of return decreases, or the
expected growth rate increases.” The Gordon’s model is best approach because even if the
distributions are less profitable than retiming, there is acceptability of high dividends from
low dividends time to time. At a lower rate near dividends and payouts that are higher are
discounted.

3FINANCIAL MODELING 2
Reference:
Krüger, P., Landier, A., & Thesmar, D. (2015). The WACC fallacy: The real effects of using
a unique discount rate. The Journal of Finance, 70(3), 1253-1285.
Nolan, J. P. (2014). Financial modeling with heavy‐tailed stable distributions. Wiley
Interdisciplinary Reviews: Computational Statistics, 6(1), 45-55.
Wu, Jiang, et al. "Inventory models for deteriorating items with maximum lifetime under
downstream partial trade credits to credit-risk customers by discounted cash-flow
analysis." International Journal of Production Economics 171 (2016): 105-115.
Wüthrich, M. V., & Merz, M. (2013). Financial modeling, actuarial valuation and solvency
in insurance. New York: Springer.