Welcome to this video on discounted cash flow. This video is a part of my valuing companies series. If you haven't seen the introductory video on three ways to value a company, I recommend watching it first for some background. In today's video, I will be discussing the third technique. Before we begin, let's clarify that we won't be covering the bottom-up approach or the multiples-based approach. Instead, we will focus on valuing a company based on its future cash flow, similar to valuing a property based on its rental income. This approach is called discounted cash flow. Now, let's imagine a simple scenario. Suppose we have a company with a five-year lifespan. I understand that this may seem artificial, but please bear in mind that making assumptions is a crucial part of the discounted cash flow method. We'll discuss this further later on. To value the company, we need to forecast its cash flows over the next five years. Let's assume that we have managed to do that, and our projected cash flows for the next five years are 100 million each year (in British pounds). At this point, you might think that the company is worth a total of 500 million (100 million x 5 years). However, there's a crucial factor to consider: the time value of money. Inflation erodes the value of money over time, so receiving 100 million in five years is not worth the same as receiving it today. To account for this, we need to apply a discount rate. Let's assume an interest rate of 10% over the next five years. This means that 100 million received in a year's time is worth more than 100 million received in two years, and so on. The earlier you receive the money, the more it's worth because you have the opportunity...
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Video instructions and help with filling out and completing Form 8854 Valuation
