THE DISCOUNTED CASH FLOW APPROACH TO FIRM VALUATION

Abstract

This thesis presents a critical discussion concerning shortcomings of the discounted cash flow (DCF) model as it is used in firm valuation. It focuses on the estimation of the future performance of a firm. The implications of the shortcomings are discussed and methods to overcome them are argued for. The thesis aims at contribute to the ever present process of improving firm valuation. The information used to implement this thesis comes primarily from secondary data sources in the form of financial literature as well as figures from databases. The study was conducted in two parts, one theoretical and one empirical part. In the literature study it was found that one way to improve the DCF model would be to forecaste the future sales of a firm by utilizing a causal method approach (CMA). The CMA was applied on the case company Peab AB through a multiple regression model. The empirical implications were found to, somewhat, limit the merits of the CMA. The general conclusion of the study is that analysts should strive to make the valuation process as scientific as possible. This minimizes the valuation’s exposure to subjectivity from the analyst and, hence, improve the reliability of the valuation. It could be achieved by applying the suggested CMA when transforming a qualitative strategic perspective of the firm’s future development into a quantitative financial perspective. Furthermore, by explicitly stating assumptions and views, the reliability of the valuation can be assessed by the investors acting on the information. These measures will improve the DCF model as a tool in the decision-making situation.