Question

QUESTION:

A) The term "value" means different things to different people.DISCUSS

B)In each of the four cases (Type of Firm) below, explain why the use of the Discounted Cash Flow approachmight be difficult.

i) Cyclical firm during recession

ii)A private firm that the owner is planning to sale

iii) Kenfront Ltd , which owns a lot of land that is valuable but not currently being utilized

Answer 1

Note: "Value" is very common term, can be used in various streams , like in ethics , finance, social sciences etc.

Here , i am assumed the question has been asked about Value for investment or in finance domain.

Answer A)

Value is the economical assessed worth of an product , asset,security , goods and/or services. The Term "Value" is associated with a many concepts includs value of a firm,fair value, enterprise value, shareholder value, book value, net asset value (NAV), market value,value investing, Fundamental value, value stock, intrinsic value, value-added, monetory value added and many others.Many of these terms are frequently used as jargon, few of them are consider as formal terms of reporting in accounting and auditing standards.

The common mis-conception in the value of a firm and valuation of a firm,for a general investors the concept of value of a firm is an absolute number, while valuation is generally shown as a multiple to EBIT, earnings, flow of cash or any other operating metric.The method of discounting cash flow is one of the most used method for firmvalue analysis.

The other approaches like multiple of EPS, Book value by net asset approach , price in market as per demand and economical factors and many more can be used as well.

Answer B)  

The concept of Discounted Cash flow (DCF) is a valuation approach used to find the attractiveness of an investment option, based on the uses of future free cash flow generation and discounts them (using rate of cost of capital , opportunity cost , risk free rate or WACC) to get a present value,as potential value. The method is considered as one of the most used method for valuation in finance world, but not suitable for all types of business or firms. like

i) Cyclical firm during recession : As DCF(discounted cash flow) valuation approach uses positive cash flows for valuation . The revenue of cyclical firms changes according to cycle of business , in general case current earning and cash flow depressed due to effect of recession . So, the DCF will provide misleading informations.

ii) A private firm that the owner is planning to sale : In case of private firm the revenue or cash flow diretly depend on the owner's special skills , good will and contacts in the merket . it is hard to find the success( cash flow and revenues) of the private firm if existing owners sell the firm. So, there will be lack of correct information about flow of future cash in the business.

(iii) Kenfront Ltd , which owns a lot of land that is valuable but not currently being utilized :  The land resources opposed by the company are having a huge economical value , but not generating any cash for the business due to non-utilization .In such case DCF approach has no use for valuation .