Question

Please discuss the two most common traditional valuation methods: Earnings Multiple, and Discounted Cash Flow Method. How can they be applied to various actual situations? How effective are these methods?

Answer 1

the two most common traditional valuation methods: Earning Multiple, and Discounted Cash Flow Method.

busines valuation three approaches are:-

*The Income Approach, - The Single Period Capitalization Method

The Multiple Period Capitalization Method

*The Market Approach, and

*The Cost Approach.

The Single Period Capitalization Method

(Discounted Cash Flow model)

• It  is an income valuation approach.
• It is also known as The Single Period Capitalization Method
• It is a “single period” model, we need a single sum of an amount as the cash flow for all future years.
• It is used to calculat the value of a stock/ firm/company/project .
• Then value of stock is discounting with an appropriate discount rate.
• Discovered on future cash flow.

• This method apply when The time value of money assumes that a dollar today is worth more than a dollar tomorrow.

Formula-

Value = Net Income / Discounting Rate.

The Multiple Period Capitalization Method

• It is also income valuation approach.
• It is a “multi period” model, we need a multiple sum of an amount as the cash flow for all future years.
• In different investment decisions ,if market price is lower then the value calcuated under this method then buy the stock because of trading undervalued Vice versa stock is trading higher then value calcuated under this method then sell the stock signals generate.

Formula -

Po = D1/ (1+r) + D2/ (1+r) ^2 + D3/ (1+r) ^3 + …… Dn/ (1+r) ^n

Where,

Po = Price of the equity share

D1 = expected dividend 1 year from now

D2 = expected dividend 2 years from now

Dn = expected dividend n years from now.

r = expected rate of return.