Business Tools for Career Readiness

Finance for
Non-Financial Professionals
Module 4

with David Standen, D.B.A.

Valuation Methods
1. Market Valuation
2. Multiples Method
3. Discounted Cash Flow (DCF) Analysis

3. Discounted Cash Flow

(DCF)
A very thorough way to value a company

3. Discounted Cash Flow

(DCF)
A very thorough way to value a company
Uses a companys free cash flows and a
discount rate to calculate the Net Present Value
(NPV)

3. Discounted Cash Flow

(DCF)
A very thorough way to value a company
Uses a companys free cash flows and a
discount rate to calculate the Net Present Value
(NPV)
Free cash flows can be used to calculate the
Internal Rate of Return (IRR)

Net Present Value (NPV)

Using the time value of money concept,
NPV tells us what the future cash flows of
the company are worth in todays money

Net Present Value (NPV)

Takes into account the companys current
cost of capital in the form of WACC
(weighted average cost of capital)

Net Present Value (NPV)

NPV discounts future cash flows at the rate
of WACC to arrive at a present value. If this
value is greater than zero, then the
investment is profitable.

Internal Rate of Return (IRR)

IRR is the yield of an investment expressed
as a percentage

Internal Rate of Return (IRR)

If the IRR is greater than WACC (i.e. IRR >
WACC), then the projects rate of return is
greater than its costs.

NPV vs. IRR

Entrepreneurs and investors tend to prefer
NPV
Managers tend to like IRR

NPV vs. IRR

IRR gives an investment yield as a percentage
while NPV gives an actual monetary amount
Only NPV can actually value an investment

NPV vs. IRR

If cash flows go positive and then again drop
into the negative, the IRR equation can be
flawed.
At that point, often only NPV can offer a
credible value.

Relationship between
NPV and IRR
IRR is the discount rate at which the NPV = 0
If the IRR is 21% and calculating the NPV
using a 21% discount rate, then NPV should
equal 0.
Excel has functions to calculate both NPV
and IRR.

Discount Rate
A monetization of risk associated with a
venture
Cash flows are discounted by this rate to
determine present value net of risk
At the lowest, we use inflation, at the highest,
we use speculated risk
For an existing business, we can use WACC
(the risk assigned by the market)

Ex.) Weighted Average Cost of

Capital (WACC)
Debt structure of a company:
45% debt at 6% interest
55% common equity at 13%
WACC = (0.45 x 6%) + (0.55 x 13%)
= 2.7% + 7.15% = 9.85%
* This company should take projects that have
estimated returns above 9.85%