![]() The DCF model for interests of businesses is, like the model applied to businesses, a two-stage model, which can be described in the following figure. The discount rate to reduce interest cash flows to the present is the equity discount rate (R) plus an increment of risk associated with the interest that is not present with the business itself. The value of a minority interest in a business is the present value of the expected cash flows to the interest over a reasonable expected holding period, including the realization of the terminal value at market value at the end of the expected holding period. The Discounted Cash Flow Model for Interests of Businesses We do so in the same manner as with the business DCF model. However, we now look at the discounted cash flow model as applied to minority interests of businesses. The discussion should not be controversial to this point. We can describe the enterprise DCF model in the following table. The right side expression develops the terminal value in the numerator while the denominator reduces that future value in year f to the present. The left side expression is the sum of present value of expected cash flows for a finite forecast period, discounted to the present at the equity discount rate appropriate for the business. The two-stage model can be summarized in the following figure from Chapter 9 of Business Valuation: An Integrated Theory Third Edition. For simplicity, we will focus on the DCF model as applied to equity cash flows. These cash flows are discounted to the present at an appropriate discount rate and equity value is determined. The value of all remaining cash flows after the finite forecast period is captured in the terminal value, which is, effectively, a capitalization of earnings or cash flows at the end of the forecast period. ![]() First, there is a forecast of cash flows for a finite period, say five years, or until the cash flow forecast stabilizes. In practice, valuation analysts routinely use a two-stage discounted cash flow model to develop value indications for businesses. The value of a business is defined by its expected cash flows and their growth, forecasted into perpetuity, and discounted to the present at a discount rate reflective of the risks associated with achieving those cash flows. The Discounted Cash Flow Model for Businesses The same valuation theory applies to both. ![]() This 10th post in the series looks back at the discounted cash flow model for businesses, then summarizes the model as it can be applied to interests in businesses or illiquid minority interests. Deja Vu #9: Pre-IPO Discounts Do Not Provide Valid Evidence for Marketability Discounts.Deja Vu #8: Review of the FMV/Stout Restricted Stock Database.Deja Vu #7: The Mandelbaum Factors and “Benchmark Analysis” (1995).Deja Vu #6: The Silber Restricted Stock Study (1981-1988) (Average Discount = 34%).Deja Vu #5: The Maher Restricted Stock Study (1976) (Average Discount = 35%). ![]()
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