Question

In your view, what are the major differences between Operating Income methods of valuation and DCF methods?

What would inspire you to choose one method over another?

What are the limitations of Operating Income methods?

Answer 1

In accounting the valuation plays a significant role in the investing, financing, and operating decisions of the firms and several methods are used to approximate the true value of an organisation. Most of the techniques are based on similar theory, however may provide different results in the application. When the business used the income approach, the theory of valuation of business determines the value of a business with an assessment of the present value of its net cash flows in future. On the other hand when business is applying the discounted cash flow methodology determines the value of business as the present value of expected future net cash flows however at the discounted rate depicting the time value for money and the attributable risks to these cash flows

I will choose the discounted cash flow method over the income valuation approach. It is favourite of academics and practitioners because it solely relies on the flow of cash in and out of an organisation instead of the accounting-based earnings. Also are less prone to manipulation with the usage of the accounting policies. It can avoid divergent results with usage of different accounting principles such as US-Generally Accepted Accounting Principles, and International Financial Reporting Standards.

The limitations of operating income method is an estimation on the streams of future benefit and determination of a capitalization It requires a high degree of judgment from professionals