Cash Flow Based Methods

Discounted cash flow analysis and leveraged buyout analysis are cash flow based methods of valuation which use time value of money fundamentals. With discounted cash flow analysis and leveraged buyout analysis, value is determined based on the projected cash flows that the company or asset generates, discounted by the company’s (or asset’s) cost of capital. Since DCF and LBO analyses are based on forward looking projections, they are valuation methods which allow a company’s operating strategy and growth strategy to be included in the analysis. Valuation using DCF and LBO analysis is determined intrinsically, based on what the asset or company generates itself, not based on multiples or metrics from comparable companies or comparable transactions.

A derivation of DCF analysis is discounted equity value analysis or DEV. The difference between DCF and DEV is that DEV considers only the cash flows to and the value for equity holders, whereas DCF considers cash flows to and the value for both debt and equity holders. LBO analysis goes a step further and makes a determination of value based on how much leverage (or amount of debt) the asset or business can support, thereby maximizing returns to the equity holders.