Thread 1.1 discussed about balance sheet based valuation methodologies. Now, in this thread 2.1 we want to understand better the group of Discounted Cash Flows (DCF) valuation based methodologies. Very specifically let’s focus on discussing the valuation methodology that provides the Enterprise Value (value of the assets) of a company by discounting its expected free cash flows (FCFs) using a discount rate based on computing a WACC. I have the following question for you:
Why the DCF methodology described provides the enterprise value of a company? In other words, why following the process (formula, if you want) involved in DCF valuation we end up with the value (of the assets) while doing (Inventory * Fixed Assets)/(Liabilities-Cash) does not provide it?
I am looking for two types of answers:
a) One based on basically common sense: how will you go about determining how much money you need to receive in a bag today in exchange for giving me the right to get the money that your company, which you are selling to me, will be generating from today on.
b) Another (very much related to the first) based on the consideration that an acquisition of a company is nothing but investment projects that have to end up being good, i.e., generating a positive NPV.