Key terms

Firm value can be found by adding the market value of debt to the calculated equity value: $V_{firm} = V_{equity} + V_{debt}$.

The first step is to forecast the firm's financial performance for a reasonable future period, typically three to five years, by creating pro forma financial statements.

Terminal Value represents the estimated value of all cash flows beyond the explicit forecast horizon, allowing for a valuation of the firm's long-term existence.

It is calculated as $V_t = \frac{CF_t(1+g)}{k_{cf} - g}$, assuming cash flows grow at a constant rate ($g$) indefinitely beyond the forecast period.

The No-Growth Model assumes that cash flows will remain constant indefinitely beyond the forecast period, calculated as $V_t = \frac{CF_t}{k_{cf}}$.

The fourth step is to compute the appropriate discount rate, which is either WACC for FCFF or the cost of equity ($k_e$) for FCFE, ensuring consistency with the cash flow measure.

It's a market-based approach that values a firm by comparing it to similar companies that are publicly traded or have been recently involved in M&A activities.

It is practical when detailed financial forecasts for a DCF model are difficult to obtain, relying instead on market data from similar firms.

It may not be suitable for valuing unprofitable firms, as many common valuation multiples rely on earnings or profitability metrics.

The P/E ratio indicates how many dollars investors are willing to pay for every dollar of a company's earnings, calculated as $\frac{\text{Price per share}}{\text{EPS}}$ or $\frac{\text{Market value of equity}}{\text{Net income}}$.

You multiply the comparable company's P/E ratio by the target company's earnings per share (or total earnings for market value).

The P/S ratio is particularly useful for valuing companies where earnings are negative or non-existent, as it does not require profitability.

Sales alone do not always reflect a company's profitability or efficiency, making it a less comprehensive measure of value compared to earnings-based multiples.

It measures a company's valuation relative to its earnings before interest, taxes, depreciation, and amortization, often used for early-stage companies to assess operational cash flow.

It occurs when a private firm owner doesn't take a formal salary, understating operating expenses and overstating earnings; appraisers add a hypothetical salary expense to correct this.

It's a reduction in the valuation of private firm shares because they are harder to sell quickly compared to liquid public shares, typically resulting in a 40-50% lower valuation.

It's an additional amount paid to acquire a majority stake in a company, compensating existing shareholders for relinquishing control, typically 30-35% above the per-share value.

It estimates a property's value by calculating the current cost to construct an identical property, including the structure and additional features like landscaping.

It relies on market data from recently sold similar properties ('comps') in the same area to estimate the subject property's value.

'Comps' are comparable houses that have recently sold in the same area, used as benchmarks in the Comparables Approach to estimate market value.

Adjustments are made to account for differences between the subject property and the comparable homes, such as variations in square footage, features, or condition.

To estimate a firm's value by determining the cost to build an identical business from scratch using current market prices for its components.

An asset's worth is equal to the present value of all the cash it is expected to generate in the future.

FCFF represents the cash flow available to all capital providers, and WACC is the appropriate discount rate to use when valuing the entire firm based on FCFF.

FCFE represents the cash flow available only to equity holders, and $k_e$ (the cost of equity) is the appropriate discount rate to use when valuing the equity portion of the firm.

Pro forma statements help project future revenues, expenses, and investments to accurately calculate future free cash flows for the DCF model.

FCFF is available to all capital providers (debt and equity), while FCFE is available only to equity holders after debt obligations are met.

The Comparables Method is simpler and more practical when detailed financial forecasts required for a DCF are difficult to obtain.

It is useful for valuing companies with negative or no earnings because it relies on sales, a metric that is typically positive even for unprofitable firms.

It makes reported earnings appear higher than they truly are because the owner's compensation is not recorded as an operating expense.

Private firm shares typically face a liquidity discount of 40-50% compared to their publicly traded counterparts.

A control premium, paid for a majority stake, is typically 30-35% above the per-share value.

Both methods rely on comparing the subject asset (firm or property) to similar assets that have recent market transaction data to estimate value.

Intrinsic value represents the true, underlying worth of an asset, calculated based on its expected future cash flows and risk, independent of current market price.

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization; it's used in valuation multiples to provide a measure of operational cash flow before certain non-cash expenses and financing costs.

A valuation method that estimates a firm's value by determining the current market price required to acquire or replicate all of its tangible components and capital structure.

Physical assets owned by a firm, such as property, plant, and equipment, which have a physical form and can be valued using market prices.

The specific mix of debt and equity used to finance a company's assets, which also incurs costs to replicate.

Non-physical assets such as patents, trademarks, brand recognition, teamwork, or synergy, which are difficult to quantify and value directly.

A valuation method that calculates an asset's intrinsic value as the present value of its expected future cash flows, discounted at a rate that reflects the risk of those cash flows.

The symbol representing the value of an asset in the DCF formula.

The symbol representing the cash flow generated in period $t$ in the DCF formula.

The symbol representing the relevant discount rate that matches the risk of the cash flows in the DCF formula.

Cash flows distributed to shareholders, often used in the Gordon Growth Model (GGM) to value common stock.

The cash flow available to all providers of capital (both creditors and stockholders) after all operating expenses and necessary investments in operating assets have been made.

Earnings Before Interest and Taxes, a measure of a company's operating profit.

Capital Expenditures, the funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, industrial buildings, or equipment.

Net Working Capital, the difference between current assets and current liabilities, representing the liquidity available to a business.

Weighted Average Cost of Capital, the average rate of return a company expects to pay to all its security holders to finance its assets, used as the discount rate for FCFF.

The symbol representing the value of the entire firm.

The cash flow available solely to equity holders after all operating expenses, debt payments, and necessary investments have been made.

Net Income, a company's total earnings or profit.

The cost of equity, the rate of return required by equity investors, used as the discount rate for FCFE.

The symbol representing the value of the equity portion of the firm.

Projected financial statements (income statement and balance sheet) that forecast a firm's future financial performance.

The estimated value of a firm's cash flows beyond the explicit forecast horizon in a DCF model.

A model used to calculate terminal value, assuming cash flows grow at a constant rate indefinitely: $V_t = \frac{CF_t(1+g)}{k_{cf} - g}$.

A model used to calculate terminal value, assuming cash flows remain constant indefinitely: $V_t = \frac{CF_t}{k_{cf}}$.

The symbol representing the constant growth rate of cash flows in the terminal value calculation.

The symbol representing the appropriate cost of capital (WACC or $k_e$) used in the terminal value calculation.

The true, underlying value of an asset, calculated by discounting its expected future cash flows.

A valuation method that estimates a firm's value by comparing it to similar companies that have recently been sold or are publicly traded, using valuation multiples.

Ratios derived from comparable companies' market data, used to estimate the value of a target firm.

Mergers and Acquisitions activities, which provide market data for valuation multiples.

A valuation multiple that indicates how much investors are willing to pay for every dollar of a company's earnings, calculated as $\frac{\text{Price per share}}{\text{Earnings per share}}$ or $\frac{\text{Market value of equity}}{\text{Net income}}$.

Earnings Per Share, a company's profit divided by the outstanding shares of its common stock.

A valuation multiple used for companies with negative or non-existent earnings, calculated as $\frac{\text{Market Cap}}{\text{Total Sales}}$ or $\frac{\text{Price per share}}{\text{Sales per share}}$.

A company's total sales divided by its shares outstanding.

A valuation multiple often used for early-stage companies where cash flow generation is key, calculated as $\frac{\text{Price}}{\text{EBITDA}}$.

Earnings Before Interest, Taxes, Depreciation, and Amortization, a measure of a company's overall financial performance.

The symbol representing the Payout Ratio, which is $\frac{\text{Dividends}}{\text{Earnings}}$.

The symbol representing the current stock price.

The symbol representing current earnings per share.

The symbol representing the cost of common stock.

A valuation challenge in private firms where owners do not formally pay themselves a salary, instead taking dividends, which distorts the true operating expenses.

A reduction in the valuation of private firm shares due to their illiquidity, meaning they are harder to sell quickly compared to publicly traded shares.

An additional amount paid by an entity to acquire a majority stake in a company, compensating existing shareholders for relinquishing control.

Techniques used by appraisers, particularly for real estate, to estimate market value.

Short for 'comparable houses,' used in real estate appraisal to refer to similar properties whose market data is used for valuation.