Question

1. Imagine that you are the CEO of Moet Hennessy Louis Vuitton SE (LVMH). You have just received share price valuation estimates for a potential buyout target, Rimowa, from two of your top financial analysts. You have confidence in their estimates because they have taken FIN 305 from the Shidler College of Business. Both analysts used the discounted cash flow (DCF) model to estimate the share price resulting in a valuation of $50, by the first analyst and $60, by the second analyst.

Part I: Identify two possible causes for the significant difference in valuation and briefly explain how each possible cause affected the DCF model’s share price estimate.

Answer 1

Solution:-

The two primary reasons which could result in a variation of share value arrived at by the two analysts and their impact on DCF model's share price estimates are as follows:

• Assumed growth rates for future earnings is one of the most common reasons for differences in DCF valuations among various analysts. DCF is nothing but the present value of futrue cash flows which is very much derived by the future earnings of the company. The analysts have to forecast the future earnings which are used to calculate the future cash flows and hence the present values. The two analysts could have used different projected growth rates (including the terminal growth rate) for earnings due to which their present values of shares are different from one another
• The discount rate used for discounting cash flows is another primary factor that results in different DCF values for different analysts. The analysts use a business's WACC as discount rate, however their WACC could differ due to various factors such as different methods used for calculating cost of equity, or different betas used in CAPM cost of equity calculation, etc. When the discount rates differ, the present values of cash flows also change accordingly