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Valuation: Lecture Note Packet 1 Intrinsic Valuation: Aswath Damodaran Updated: September 2016

This document summarizes key concepts about intrinsic valuation and discounted cash flow valuation from lecture notes by Aswath Damodaran. It outlines that intrinsic valuation values an asset based on its fundamentals and cash flows, with the intrinsic value a function of expected cash flows and uncertainty. Discounted cash flow valuation estimates intrinsic value by discounting expected future cash flows at a risk-adjusted rate or by discounting certainty equivalents at the risk-free rate. The value of a risky asset is the risk-adjusted present value of expected cash flows.

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100 views4 pages

Valuation: Lecture Note Packet 1 Intrinsic Valuation: Aswath Damodaran Updated: September 2016

This document summarizes key concepts about intrinsic valuation and discounted cash flow valuation from lecture notes by Aswath Damodaran. It outlines that intrinsic valuation values an asset based on its fundamentals and cash flows, with the intrinsic value a function of expected cash flows and uncertainty. Discounted cash flow valuation estimates intrinsic value by discounting expected future cash flows at a risk-adjusted rate or by discounting certainty equivalents at the risk-free rate. The value of a risky asset is the risk-adjusted present value of expected cash flows.

Uploaded by

Nic Aurthur
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Aswath Damodaran 1

Valuation: Lecture Note Packet 1


Intrinsic Valuation
Aswath Damodaran
Updated: September 2016
The essence of intrinsic value
2

¨ In intrinsic valuation, you value an asset based upon its


fundamentals (or intrinsic characteristics).
¨ For cash flow generating assets, the intrinsic value will
be a function of the magnitude of the expected cash
flows on the asset over its lifetime and the uncertainty
about receiving those cash flows.
¨ Discounted cash flow valuation is a tool for estimating
intrinsic value, where the expected value of an asset is
written as the present value of the expected cash flows
on the asset, with either the cash flows or the discount
rate adjusted to reflect the risk.

Aswath Damodaran
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The two faces of discounted cash flow valuation
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¨ The value of a risky asset can be estimated by discounting the


expected cash flows on the asset over its life at a risk-adjusted
discount rate:

where the asset has an n-year life, E(CFt) is the expected cash flow in period t
and r is a discount rate that reflects the risk of the cash flows.
¨ Alternatively, we can replace the expected cash flows with the
guaranteed cash flows we would have accepted as an alternative
(certainty equivalents) and discount these at the riskfree rate:

where CE(CFt) is the certainty equivalent of E(CFt) and rf is the riskfree rate.

Aswath Damodaran
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Risk Adjusted Value: Two Basic Propositions
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¨ The value of an asset is the risk-adjusted present value of the cash flows:

1. The “IT” proposition: If IT does not affect the expected cash flows or the riskiness
of the cash flows, IT cannot affect value.
2. The “DUH” proposition: For an asset to have value, the expected cash flows have
to be positive some time over the life of the asset.
3. The “DON’T FREAK OUT” proposition: Assets that generate cash flows early in
their life will be worth more than assets that generate cash flows later; the latter
may however have greater growth and higher cash flows to compensate.

Aswath Damodaran
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