Valuation based on Discounted Cash Flow Analysis

Orange

The true test of proper of an income producing investment is to calculate the present worth of projected future positive and negative cash flow at a satisfactory minimun rate of return. Market conditions may permit you to purchase the property cheaper or to sell it for more but you should always calculate what it is actually worth in order to judge whether the market price is high or low relative to actual value. This is how good investments are found. You do not have to buy everything you evaluate. Risk and uncertainly often make the projection of cash flow dificult but it must be done.
Apply this approach to deterrmine the share value of 3.000.000 shares of common stock in XYZ Corporation if the following future postive and negative cash flows are projected: $50.000.000 will be borrowed this year to build a plant that is projected to generate $12.000.000 annual after-tax cash flow for each of the next 10 years. Note that the valuation technique is the same if we want to determine the value of a mineral lease or real estate property instead of common stock value. The minimum DCFROR is 12% in escalated dollars. Using a 12% after-tax discount rate implicity assumes that any annual cash flow paid out in dividends to the investor can be invested elsewhere at 12% by the investor, and any cash flow not paid out in dividends can and will be invested at 12% annually compounded DCFROR by the XYZ Corporation.

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