Cash flow valuation method

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					Cash flow valuation method
To understand and use a little financial knowledge that it must be based on
     No one can accurately calculate the true intrinsic value of a business (even Warren
Buffett), almost on the line
     Recently, Buffett has been reading and thinking text. Have Accounting colleges to
sit, read 4 times
     "Buffett's letter to shareholders," the time and
feel very different from the previous. Buffett had always been to stay longer to
understand some of the views of the level, but in the end how calculate the value of a
company, how to get to a specific judge whether there is a huge investment in the
stock value of the issues I was dumb. I have been pondering is how Buffett is
calculated. Buffett used to calculate the intrinsic value method of business, the
specific use of the discounted cash flow method.

    I think the key to Buffett's philosophy is to ensure the relative accuracy
of the intrinsic value, and then compare the intrinsic value and market value, to see if
there are enough safe space to decide whether to buy! Need to ensure the accuracy of
the intrinsic value of the two conditions.
    1. Outstanding enterprises, to ensure the stability and increase cash flow, which is
to calculate the intrinsic value of the key!
    2. Ability to circle: to understand the scope of their own, insist on only his own
understanding of the business! Calculation of cash flow is the key!

    By the way what is good corporate Buffett eyes! Should meet the following
    1 It is the customer needs; 2 are customers that can not find alternatives; 3 from
the price restrictions
    I think the Chinese to meet such a condition Maotai count! Buffy selected
including Gillette Wells Fargo and other Coca-Cola.
    Let us ask themselves these questions, give you 100 million and the best
management, you can beat the top wine in Coke and Coca-Cola and Maotai it? This
proved a good way!

    Buffett liked to buy a suitable quality management into the management of the
stability of business excellence. There are two key, the right price, and excellent
enterprise, these two issues are interrelated! Buffett's all about the
company's requirements are expected to be a reliable company can
generate future cash flows, without the prerequisite to calculate the enterprise value
would be extremely unreliable. If it is not good business, not to mention what the
price is right! Because you can not determine the future of business!
Buffett's philosophy is to win all the more reliable valuation, which is
Buffett continued emphasis on capacity-ring because only he can understand the
business and enterprise can calculate the exact cash flow!
    Buffett used a discounted cash flow, Buffett think this is a company which can
estimate the intrinsic value method. But this is the prerequisite for good corporate
    This approach has two key issues, one is the company's cash flow, a is
the discount rate, discount rate is risk-free interest rate. Buffett that the discount rate
for the 30-year U.S. Treasury interest rates. Now to solve cash flow problems, using
the indirect method of cash flow data prepared by the general calculation is used
    (1) net profit + (2) depreciation, depletion costs, amortization expense and certain
other cash costs. But Buffett that the fashionable thing Wall Street does not truly
reflect the company's cash flow, it also could not be evaluated The value of
the company, Buffett that the company's cash flow should be
    (1) net profit + (2) depreciation, depletion costs, amortization expense and certain
other cash charges - (3) business to safeguard its long-term competitive position and
unit production plant and equipment used for annual capitalization expenditure.

    The third point of comparison to judge the importance of design to a key word
here, "capacity ring," Buffett insisted only do they know the
business. Why? Said before, to improve the accuracy of calculation of intrinsic value!
Only they know the business, we have the ability to accurately judge (3) business to
maintain its competitive position and long-term yields used for plant and equipment
of the average annual capital expenditure. This is based on our understanding of social
cognitive ability and ability! Ability to continuously improve their knowledge and
analysis of water products is very important, but must have self-knowledge!

    Buffett, the following example to estimate the calculation procedure of the process
to be more thought and research. Because the business of (3) business to safeguard its
long-term competitive position and unit production and for plant and equipment of the
average annual capital expenditure. I can not specifically determine, so, instead of
corporate profit! Is the assumption that the true incidence of depreciation costs and
expenses equal to that front costs (2) and cost (3) fairly. Buffett's
investment in Coca-Cola in 1988.

  The following information comes from the "Warren Buffett
Way," Robert's book, a revised

    Future cash flow projections: the 1988 cash flow was 8.28 billion U.S. dollars, in
1988 after 10 years, growing at a rate of 15% (7 years prior to the actual 17.8%), it is
the nature of good business to ensure the stability of cash flow , to 10 years, the cash
flow for the 3.349 billion U.S. dollars. 1988 after 11 years, the net cash flow increased
to 5%.
    Discount rate: in 1988 the 30-year U.S. bond yields of 9% as the standard.
Discount rate is the data will change.
    Valuation Results:
    1988 Coca-Cola stock intrinsic value of 48.377 billion U.S. dollars.
    Assuming a 5% cash flow growth rate, the intrinsic value still has 207 billion U.S.
dollars (8.28 billion U.S. dollars divided by 9% -5%)
    Than in 1998 when Buffett bought Coca-Cola stock market value of 14.8 billion
U.S. dollars would also be much higher! The formula used here and in front of the
company after 10 years using the same as the present value of cash flow = cash held
by the end of the present value / kg, k as the discount rate, g the growth rate, the
formula used in the k less than g time.
    On k is greater than g, the following calculation shows, that is, 15% of the first 10
years of computation. After 11 years, is calculated using the formula mentioned
    Expected Year 12,345,678,910
    Stable cash flows estimated 9.52 10.95 12.59 14.48 16.65 19.15 22.02 25.33 29.13
    The present value of compound interest factor 0.917 0.842 0.772 0.708 0.650
0.596 0.547 0.502 0.46 0.422
    In the present value of cash flow 9.22 8.74 9.72 10.26 10.82 11.42 12.05 12.71
13.41 14.15
    Total of 11.25 billion of cash flow

     10 years later, the total cash flow for the first 11 years of cash flow for the 3.517
     35.17 / 9% -5% = 87.93 billion for the discount to 10 by the end of the present
value. Converted into present value 879.30/0.4224 = 37143000000
     Come the intrinsic value of 48.39 billion, interval between 20.7 to 48.39 billion!

    The present value of compound interest factor can be calculated look-up table can
also be their own, in this case the first year 1/1.09, 1/1.09 * 2 1.09 this year in
    Instance ============================ =================
    GEM model of IPO pricing: discounted cash flow method
    GEM will soon set up, how to determine reasonable GEM listed
company's issue price will directly affect the issuer's financing
results and the future of the secondary stock market trend.
    This article describes the general international value of the four compute the
internal pricing model: the discounted cash flow model, relative valuation, economic
value added (EVA) pricing model, option pricing method. Pricing advantages and
disadvantages of each. Published today is a discounted cash flow model.
       ?- Editor

    Cash flow method is the appropriate discount rate selected, the
company's future earnings discounted to present value and is the
company's current real value, to determine the price of new shares, which
is a prediction based solely on future data. The basic principle of this method is the
value of an asset equal to the asset is expected in the future cash flows generated by
the whole of the present value of the sum, it is the international assess Qiyejiazhi,
basic methodology.
       ?Basic model
       ?For GEM listed companies, because of their shares tradable, so: the
company's overall stock price = value / total equity. Namely:
    ?V P = ─ ─ Z
   ?Where: P said the stock's issue price; V said the estimated value of the
real value of the company; Z
     IPO after the company said the total share capital. Easier to determine the Z
values because, for V can be solved through the following three models:
       ?Zero growth model
       ?This model assumes to be listed in the next year's cash flow remains
unchanged, the model is as follows:
      ?n 1 V = X0Σ ─ ─ ─ t = 1 (1 + R)
   ?Where: V, said the estimated value of the real value of the company; X0 said it
issued the previous fiscal year's income before tax income, that cash flow;
R, said the company's average cost of capital (WACC).
       ?Stable growth model
       ?This model assumes that the listed company to be cash flow in future years to
a stable growth rate G, the model is as follows:
    ?X0 V = ─ ─ ─ (R-G)
   ?Where: V, said the estimated value of the real value of the company
       ?X0 said the company issued the previous fiscal year's income
before tax income, that is cash flow.
       ?R said that the company's average cost of capital, that the discount
       ?G said the company's steady growth
       ?Two-stage growth model

    In general, the fund raised for investment projects not completed and fully
operational before the company's cash flow is unstable. Only after a period
of time, the company's cash flow will become stable; Therefore, the
proposed issue of new shares to raise capital cash flow forecast can also take a
two-stage model. Namely:
    t = n X1 Xn +1 V = Σ ─ ─ ─ ─ + ─ ─ ─ ─ ─ ─ ─ t = 1 (1 + R)
2 (1 + R) n + (RG)
   ?Where: V, X0, R, etc. that the meaning of the preceding model
       ?Xi said that the instability of the former n-year growth in net cash flow during
the period, G said that after years of steady growth rate n
       ?Company calculated the average cost of capital
       ?Company average cost of capital (discount rate) R reflects the risk
characteristics of cash flow,
    By the debt financing costs and equity financing costs two weighted income, that
is: R = P1R1 + P2R2, of which P1, P2 are the debt financing and equity financing
ratio, R1 is a debt refinancing costs, can the company's bonds or bank
loans to calculation; R2 is the cost of equity financing, more complex calculation
methods, you can use the capital asset pricing model (
     CAPM), the debt equity rate of return plus a risk premium and the dividend
growth model obtained by other methods.
       ?Growth forecast
       ?Use the model in the pricing of new shares, the estimated growth rate of G is
critical. Forecast growth rates are generally three basic methods:
       ?A simple model using historical data or time series model. This approach has
been applied to establish a stable history of growth patterns, and its industry
fundamentals have not changed the company.
       ?2 use of the professional analysts average forecast derived. This method is
suitable for the basic factors stabilize the industry, there are a large number of
professional analysts concerned about the company.
       ?3, starting from the company to estimate the growth rate of the basic factors.
Basic factors include the company's product line, profit margins, leverage
and dividend policy. This method is particularly suitable for companies with their own
unique products.
       ?Calculation of expected cash flows

    In the above series of models to start, always will be the future cash flow available
to deal with as a known variable. In fact, corporate dividends are affected by many
factors, each company has its own different dividend policy. Even so, for a normal
profit and to maintain normal growth of the enterprise, can be obtained through the
method of accounting can be used to pay dividends of its maximum value, discounted
cash flow model is the X,
    Often referred to as free cash flow FCFE (Free cash Flow to equity).
       ?According to the accounting statements of enterprises, enterprises can use the
cash payment to shareholders is the net profit net of the reinvestment of surplus:
    ?Free cash flow sales (FCFE) accounting method - cost of sales - sales tax and
additional operating profit - profit operating costs - Interest expense - net profit after
tax of tax payable (NI) + depreciation (DEP) - working capital Delta (D1) -
investment in fixed assets (I) free cash flow FCFE

    As the table shows, free cash flow (FCFE) is: after-tax net income (NI) deductions
for business development and growth in net working capital increment (D1) and the
incremental net fixed assets (investment in fixed assets depreciation I-DEP ), you can
allocate to the shareholders. Namely:
      ?FCFE = net income + depreciation - investment in fixed assets - incremental
working capital

    Using the above formula, FCFE can be the current period net income, depreciation,
fixed asset investment, incremental working capital calculated. As can be seen from
the formula, although the FCFE is not equivalent to EPS, and EPS are linear positive
correlation, because both the investment in fixed assets or working capital of the
increment, are based on the year how much profit to be decided is the after-tax a
certain percentage of net profit. Therefore, we can assume that the ratio Q
    The net profit for the maintenance of the required proportion of future growth,
may be used for part payment of cash dividends:
  X = EPS (1 - Q) will be on the type of substitution in the two-stage growth model
can be obtained: V = VT1 + VT2 = T EPST (1-Q) EPST +1 (1-Q) Σ ─ ─ ─ ─
─ ─ + ─ ─ ─ ─ ─ ─ ─ t = 1 (1 + R) t (1 + R) T (RG)
  ?V values calculated according to the model after, in the case of the known Z
values can model 2.1.1 to request the issue price of new shares.
       ?Model Evaluation

    In theory, the pricing of new shares in the most scientific method should be the net
present value, may invest in value for the Panduan business Neizai provide a useful
basis, but in practical operation in the Reasonably Utilizing model can be difficult.
Because the GEM listing to raise funds for Gong Si, mostly in a start-up stage or
growth stage, the project investment involves high risk, Wei Lai uncertainty exists in
the development of 前景, Zhunque expected future cashflow 困难.
    Discounted cash flow method
    From mba think tank Wikipedia (
    Discounted cash flows (discounted cash flow method)
          A discounted cash flow method
          2 discounted cash flow method of the basic formula
          3 advantages and disadvantages of discounted cash flow method
          4 examples of discounted cash flow method
    [Edit] discounted cash flow method
    Discounted cash flow method is the business within a specific period of expected
future cash flows back into the current present value. As the essence of enterprise
value, or its future earnings capacity, and only when companies have this ability, its
value will only be accepted by the market, so theorists usually discounted cash flow
method as the preferred method of business valuation, assessment practice also
received a large number of applications, and has become perfect and mature.
    [Edit] discounted cash flows, the basic formula
    The formula: p assessment of the value of a business;
    n an asset (business) life;
    cft an asset (business) in the t time cash flow;
    r 1 reflect the expected cash flows discount rate
    From the above formula, we can see that the method has two basic input variables:
cash flow and discount rate. Therefore, before using this method should first make a
reasonable forecast of cash flow. In assessing the impact companies in the future to
fully consider the profitability of various factors, objective and fair manner on the
business to make a reasonable forecast of future cash flows. Second, choose a suitable
discount rate. The choice of discount rate is mainly based on the evaluation staff
assessment of the risks of the business future. As the business is an objective
uncertainty, so the enterprise is essential to judge the risk of future revenues, future
earnings when business risk is high, the discount rate should be higher when the risk
of lower future earnings , the discount rate should be lower.
     [Edit] discounted cash flow advantages and disadvantages
     Discounted cash flow method for assessing the intrinsic value of the scientific
enterprise is more suited to the characteristics of M & A assessment, a good
value reflects the nature of the enterprise; and the first two business valuation method,
discounted cash flow theory of value the most, can through a variety of assumptions,
reflecting the company's management and experience management.
Nevertheless, discounted cash flow method still has some shortcomings: First, the
discount rate from the point of view, this approach does not reflect the benefits of
enterprise mobility, this flaw has determined that it can not be applied to strategic
areas of business; Second, this approach does not take into account the
interdependence between business projects, business investment is also not taken into
account the time dependence between projects; third, using this method, the result
depends entirely on the accuracy of the assumptions used in the conditions accuracy,
the application is must not be divorced from reality. And if the future cash flows of
companies are experiencing instability, loss-making enterprises, etc., discounted cash
flow method can not do anything.
     [Edit] example of discounted cash flow method
     To all of the discounted cash flow method more specific understanding, we
assume an example for reference:
     The first part is to calculate the commuted present value of the company for the
next five years, cash flow, we first annual cash flow discounted to present value, that
is, the cash flow the first year of ¥ 11.6, compared with ¥ 10.4 commuted after
     (¥ 11.6 x 0.89), after the second year of discounted cash flow was ¥ 10.7
(¥ 13.5 x
     0.80), and the remaining three years of discounted cash flow up, however after the
then present value of these together, we arrive at ¥ 56
     ( ¥ 10.4 + ¥ 10.7 + ¥ 11.1 + ¥ 11.5 + ¥ 11.9), this is the
company's future after five years commuted value of the cash flow.
     The second part is to focus on calculating the commuted value of the
company's future cash residual value after five years. First, we assume that
up to 16% of the company after five years of rapid growth, the growth rate of cash
flow will be from 16% to 7% per year, so the company's future cash flow
was the sixth year
     ¥ 26.1 (¥ 24.4 x
     1.07), assuming the company was cash flow to maintain a steady increase of 7%
per year, and also assumes that we are asking for 12% annual return (discount rate),
the residual value can harbor has enabled the company is projected to be ¥ 521.4
     (¥ 26.1 / (12% -7%)), then we look at the company's future residual
value after five years, discounted to present value (present value), or ¥ 295
(¥ 521.4 x
     0.57), can be estimated by the discounted cash value of the company's
future residual value after five years. Finally, we will be the first and the second part
of the present value calculation to add up to get the company's intrinsic
value of ¥ 351
     (¥ 55.6 +
     ¥ 295.9), and investors can be based on this figure, divided by the number of
shares the company has to get the intrinsic value per share. If the intrinsic value per
share is higher than the market, then investors may consider purchasing, otherwise be
     Part I: the first 5 years of forecast cash flow (project 5 years cash flows)
     1. Last year's cash flow (prior year cash flow): the company with
annual cash flow figures
     2. Growth rate (growth rate): In contrast with the company's earnings
growth in previous years profit
     3. Cash flow (cash flow): the company will distribute all the profit situation, the
shareholders of cash flow = cash flow (n-1) x (1 +0.16), n =
     1,2, ..., 5
     4. Discounting parameters (discount factor): the present value of future value into
the value = 1 / (1 +0.12) ^ n, n = 1, 2, ..., 5
     5. The present value (present value): the discounted value of future value for the
first year will be multiplied by the discounted future cash flow derived parameter
values = (3) x (4)
     6. The sum of discounted cash flow
     Part II
     Residual value (terminal value / residual value):
     Residual value is calculated through the constant growth model, that is assuming
the company started from the first five years at an annual rate of 5% constant growth.
     7. The first five years of cash flow (cash flow in year 5): the company will
distribute all the profit situation, the shareholders in the first five years of cash flow
     8. Growth rate (growth rate): 5 years after the company's growth.
     9. The sixth year of cash flow (cash flow in year 6): all profits will be distributed
in the company where the shareholders in the sixth year of cash flow
     10. Required rate of return minus growth rate (required rate of return minus
growth rate):
     Required rate of return for the cost of capital. To request the difference between
the rate of return and growth rate as the discount rate to convert the residual value of
the eternal in the first 6 years after five years when the value of the value (terminal
     11. Five years later the value (terminal value): the value of the company after five
     12. After five years of discount parameters (discount factor as of year 5): the first
five years the value of the company into the present value of the first year =
     (9) / (10)
     13. Discounted residual value of the company: for the first year of the commuted
value of the company's residual value
     The company's intrinsic value: the first 5 years the sum of discounted
cash flows and discount the residual value of the company and its response to the full
value of the company's current
     ================= Different voices from non-authoritative though
     Discounted free cash flow method of valuation is wrong
     Only the cash dividend is the only company using the present value formula to
calculate the intrinsic value of the cash flow. Popular at home and abroad to use stock
market gains and free cash flow discounted to compute the intrinsic value method, is a
violation of the basic principles of the present value of the error formula to use.
     The definition of a present value formula:
     Present value formula, the first was John Burr Williams in his "Theory
of Investment Value", the proposed valuation of the mathematical formula,
we enrichment as: any stocks, bonds, value of the company and entities are
determined by the assets of the remaining time, can expect to generate cash inflows
and outflows, converted into an appropriate present value discount rate, this method is
also known as discounted or present value.
     The present value of defined formula that discounted cash flow for the inflow and
outflow is the cash flow, so by definition the point of view, only the cash dividends
and interest-bearing-type bonds pay interest each year is expected to generate cash
outflows, can be used to calculate the discounted stocks, bonds and the value entity
company should not be a book does not have all the outflow of earnings and free cash
     Second, the mathematical principles of the present value formula
     Present value formula is compound interest formula combinations.
     First of all, let's look at the compound interest formula, compound
interest formula present value of the form
     Compound interest formula: FV = PV (1 + i) n
     Compound interest formula can be written in present value form: PV =-------------
                             ?(1 + i) n
     This formula shows an initial capital PV, with i as the rate of growth, after n
cycles of compound growth, maturity of the final value FV. It can also be a fund due
to i as the discount rate FV after n-period discounted present value of PV. We are here
to clear that: compound interest formula is a complete a cash flow into a formula.
     Here we have three different document term compound interest formula to
combine them to look at their situation:
   (1) As a second compound of the formula: FV1 = PV1 (1 + i)
   Can also be written in the form of the present value of: PV1 =-------------
                   (1 + i)

   (2) 2 compound interest into account the formula: FV2 = PV2 (1 + i) 2
   Can also be written in the form of the present value of: PV2 =-------------
                   (1 + i) 2
   (3) total 3 times compound interest formula: FV3 = PV3 (1 + i) 3

    Can also be written in the form of the present value of: PV3 = --------------
                     ?(1 + i) 3
    We put three items form the present value of compound interest added to the
formula, you can write the following formula:
                  ?CF1 CF2 CF3
    PV1 + PV2 + PV3 = PV =----------+ ------------- + -----------
                   1 + i (I + i) 2 (1 + i) 3
    FV is the final value of the English abbreviation, as superposed into the middle of
the cash flow to pay, so they are said to use CF code. Obviously three items form the
present value of compound interest formula is the result of adding the present value of
the basic form of the formula.
    The basic form of the present value formula:
        ?CF1 CF2 CFn-1 CFn
    PV =------------+ ----------- + ... ... .. + ---------------- + - ----------
        ?1 + i (I + i) 2 (1 + i) n-1 (1 + i) n
    Derived by the present value formula we can clearly see that the present value of
the molecular part of the CF formula that they are separated from the
system's cash flow, and should not be carrying any of the indicator data.
    Assessment of the three project loans to use
    Some may say that bank loans of the assessment report is used to predict future
profits discounted net present value and internal rate of return, are also wrong? .
    Of course yes, because, according to the relevant provisions of China, project
loans can be pre-tax profit plus depreciation to repay the loan, so the assessment of
project loans, the projected profits are all used to pay out money to the bank, of course,
you can use now Formula for calculation.
    4 calculated using the treasury method
    Let us look at interest-bearing type of book-entry treasury bonds is calculated,
interest-bearing type of book-entry treasury bonds is to use it to pay the interest each
year is calculated using the present value of its yield to maturity or the present value,
and for once also due The interest-bearing book-entry treasury bonds will not be able
to use it on the books of the annual interest rate calculated using the present value of
its yield to maturity or the present value, which can not use the book listed company
earnings and free cash flow discounted at calculation of their intrinsic value is a truth.
     Five wrong reasons to use
     The original John Burr Williams introduced the application of the present value
formula to effectively solve the traded yield to maturity of the calculation. For stock
dividends in the dividend-based system of time to calculate the intrinsic value of
companies also played a very important role.
     With fierce competition in the market economy, enterprises in order to survive and
might resume reap higher profits, gradually gains the Dabu Fen stay at Le business
expanded reproduction, Shao Bufen for dividends, for the Mu Qian Guo Neiwai the
public are taking a Duo less dividends distributed to mention retention system, using
historical data to predict future dividend dividend discounted the intrinsic value of
companies, will not have much meaning.
     Therefore, the use of proceeds and generated free cash flow discounted compute
the intrinsic value method, the history of earnings and free cash flow growth, is
retained as corporate investment in the effect produced by Sheng, and we forecast the
future earnings out and free cash flow should also be retained in the corresponding
situation can be achieved. If we forecast earnings or free cash flows discounted using
the present value formula, it means starting from the first time we put all of the
discount or free cash flow benefits to the sub-out, then no internal retention Health
investment, which would have continued to grow under the historical growth rate of
yield? .
     Traditional academic calculation method is based on the valuation of capital asset
pricing model, beta Yiji the variation number of Securities remuneration Lv,
Qituliyong statistics Jiqiao to determine a reasonable discount rate, Shi Yong Qi Ye
present value formula calculate the intrinsic value . But no matter how precise we use
statistical methods to calculate the discount rate, in addition to dividends, no
discounted cash flow can be used to calculate the company's intrinsic value,
dividend discount could not be true reflection of the company's intrinsic
value, then the fold current rate will not have much meaning.
     So we have to be out this conclusion: the present value formula can not be the
final valuation of the stock pricing model. The investment in academic science has so
far only taught in the traditional valuation pricing, and an endless stream of transport
to the capital markets of their out students. Today's stock market is still
popular, free cash flow discounted using the assessment of the enterprise's
intrinsic value, so this is also the root causes of stock market valuation of confusion.
     In addition, I also set ourselves a fundamental question with fear and trepidation,
after all, what they are not experts, but with people doing right, so I chose the
first-line exposure, hoping to find resonance, this does not mean I am not confident
Through the back I will study the basic theory of compound interest, it applied the
shape, number of analytical methods combined with the introduction of two analytical
models to further demonstrate my point.
   Summary             of        segmentation          =======================
   Margin of safety (SAFETY
   MARGIN), if you calculated to the value of 100 yuan, you get as much as
possible the price of 50 yuan to buy, so even if you calculate the 20% to 30% in error,
you have 20% -30% to fault-tolerant space. This is the core concept of value for

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