Discounted Cash Flow Valuation Technique

Hard Alternative Investment Evaluation Valuation Techniques

In the realm of alternative investments, effective valuation techniques are crucial for accurately assessing the worth of assets that do not trade in public markets. One prevailing method commonly utilized for valuing private equity investments is the Discounted Cash Flow (DCF) approach.

Consider an investment firm that is evaluating a private company expected to generate cash flows of $5 million, $6 million, and $7 million over the next three years. The firm employs a discount rate of 12% to determine the present value of these future cash flows. Additionally, they expect a terminal value of $50 million at the end of year three, which will also be discounted back to today’s value.

Which of the following calculations represents the best approach for determining the value of this private investment using the DCF method?

Calculate the present value of cash flows for the years and the terminal value, then sum all present values.

Add the future cash flows directly without discounting, then subtract the terminal value.

Use a market multiple based on similar public companies and apply it to the expected cash flows.

Hint

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