Valuing Sales, Costs, and Cash Flows

The valuation of companies normally implies valuing the expected free cash flows at the risk-adjusted discount rate, where the risk profile is often derived from the risk profile of comparable firms that are listed on the stock exchange. This (indirect) way of deriving the risk profile of the company's cash flow is referred to as the "top-down" approach.

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In this part of the toolkit, we show how the risk profile of the cash flow can alternatively be derived from the inherent business risk of the company that is present in it's revenues, together with the cost-structure of the company. This way of deriving the cash flow risk profile, and accompanying discount rate, from the fundamentals of revenues and costs, is referred to as the "bottom-up" approach.

A Practitioners Toolkit on Valuation, Part IV: Valuing Sales, Costs, and Cash Flows, De Roon en Van der Veer (2015)