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IESE Research Papers,
IESE Business School

No D/1062: Valuing Companies by Cash Flow Discounting: Fundamental Relationships and Unnecessary Complications

Pablo Fernández ()
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Pablo Fernández: IESE Business School, Postal: IESE Business School. Research Division, Av Pearson 21, 08034 Barcelona, SPAIN

Abstract: Company valuation using discounted cash flows is based on the valuation of government bonds: it consists of applying the procedure used to value government bonds to the debt and shares of a company. This is easy to understand (sections 1, 2 and 3). But company valuations are often complicated by "additions" (formulae, concepts, theories…) to complicate its understanding (see sections 4 to 15) and to provide a more "scientific," "serious," "intriguing," "impenetrable" … appearance. Among the most commonly used "additions" are: WACC, beta ( ), market risk premium, beta unlevered, value of tax shields…. Most of these "additions" are unnecessary complications and are the source of many errors (section 16).

Keywords: Valuation; discounted cash flow; required equity premium; WACC; expected equity premium; beta; VTS

26 pages, February 22, 2013

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