Company Valuation Under IFRS : Interpreting and Forecasting ...

Chapter One – It’s not just cash; accounts matter
Now, suppose that we know what is an appropriate discount rate to apply to the
dividend (free cash flow) stream that we expect to receive from our company. We
can use the standard discounting formula to convert all the future cash flows into
present values, as follows:
PV = CF t / (1+k) t
where PV is the present value of a cash flow in year t (CF t ) discounted at a cost
of equity (k).
Companies are not generally expected to be wound up at any particular date in
the future. So, unlike the situation with a bond, we are discounting a stream that
continues to infinity. This is one of the particular problems of valuing equities,
the other being that even the medium term cash flows are uncertain. So unless we
want to use an infinitely large spreadsheet, somewhere we have to call a halt, and
assume that from that point onward the company will grow at a constant speed.
This could be negative, or zero, or positive, but is generally taken to be positive.
So how do we calculate a present value for a stream that is going to grow to
infinity? Exhibit 1.2 illustrates the problem.
Exhibit 1.2: Nominal dividend projection
Nominal Dividends
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