- Published: September 21, 2022
- Updated: September 21, 2022
- University / College: University of Strathclyde
- Level: Undergraduate
- Language: English
- Downloads: 21
work, Finance and Accounting Investment Appraisal under Uncertainty Table for Cash Flows TWO STAGE DISCOUNTING CASH FLOW
Initial Cash Flow
$100, 000, 000
Years:
1 – 3
4 – 6
Rate of Growth
10%
10%
Final Growth Rate:
1%
Discounting Rate:
15%
Outstanding Shares :
10, 000, 000
Safety Margin:
30%
Level of Debts:
$0
Pay Back Year
Flows
Growth
Value
1
110, 000, 000
10%
$95, 652, 174
2
121, 000, 000
10%
$91, 493, 384
3
133, 100, 000
10%
$87, 515, 411
4
145, 813, 619
10%
$83, 369, 410
5
159, 741, 634
10%
$79, 419, 824
6
175, 000, 043
10%
$75, 657, 348
Terminal Year NPV
$1, 750, 000
PV of Yr 1 to 6 Cash Flows:
$513, 107, 550
Terminal Value:
$5, 404, 096
Total Cash Flow PVs:
$518, 511, 646
NO of Shares
10, 000, 000
Intrinsic Value:
$51. 85
Intrinsic Value Safety Margin
$36. 30
% age Intrinsic Value from the Terminal Value
1%
Table 1: Cash Flow Discounting
Reasons for Reluctance
One of the reasons for being reluctant in decision-making on the investment is the uncertainties related to the discounting of cash flows. Discounting implies that the future cash flows of the company have been discounted back to its current position to determine the company’s valuation. The Discounting Cash Flow Model is not reliable as a perfect tool for valuation because it is practically not able to predict the growth rate of the company’s cash flows. However, it can give an estimate of the value of the company in combination with other parameters.
Secondly, reluctance to invest is justifiable because it compels the user to keep in mind the Intrinsic Value of the investment. Intrinsic value is merely a numbers introduced into this model. It is possible for one to assume unrealistic terminal value based on overstated or understated growth rates. According to Nitzan and Bichler (2009), this generates unrealistic intrinsic value outcomes.
The third reason for reluctance is the Limitations of Discounting Cash Flow Model in relation to the payback period. It can only function for a limited number of years, suitably, 5-year time payback period. Again, it cannot function if the growth rate is higher than the discounting rate (Nitzan & Bichler, 2009).
References
Nitzan, J. & Bichler, S. (2009), Capital as Power. A Study of Order and Creorder., RIPE Series in Global Political Economy, New York and London: Routledge.