Author Topic: Valuation - McKinsey  (Read 17029 times)

LR1400

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Re: Valuation - McKinsey
« Reply #10 on: July 14, 2015, 10:33:14 PM »
I am in 100% agreement with Vinod.


undervalued

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Re: Valuation - McKinsey
« Reply #11 on: July 17, 2015, 10:27:32 PM »
Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it. - Will Rogers

undervalued

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Re: Valuation - McKinsey
« Reply #12 on: July 22, 2015, 10:45:33 AM »
So I've been reading the 5th edition of Valuation by McKinsey and I have a question. In Ch 2 Fundamental Principles of Value Creation - Cash flow risk pg 36.

Quote
Deciding how much cash flow risk to take on What should companies look out for? Consider an example, Project A requires an up-front investment of $2000. If everything goes well with the project, the company earns $1000 per year forever. If not, the company gets zero. (Such all or nothing projects are not unusual). To value Project A, finance theory directs you to discount the expected cash flow at the cost of capital. But what is the expected cash flow in this case? If there is a 60 percent chance of everything going well, the expected cash flows would be $600 per year. At a 10 percent cost of capital, the project would be worth $6000 once completed. Subtracting the $2000 investment, the net value of the project the investment is made is $4000.

This is probably a basic question to most of you. Trying to understand everything slows me down a lot in trying to figure how these stuff works.

How did he get $6000? Is 10 percent cost of capital the same as the DCF discount rate in this case?
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vinod1

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Re: Valuation - McKinsey
« Reply #13 on: July 22, 2015, 12:35:11 PM »
So I've been reading the 5th edition of Valuation by McKinsey and I have a question. In Ch 2 Fundamental Principles of Value Creation - Cash flow risk pg 36.

Quote
Deciding how much cash flow risk to take on What should companies look out for? Consider an example, Project A requires an up-front investment of $2000. If everything goes well with the project, the company earns $1000 per year forever. If not, the company gets zero. (Such all or nothing projects are not unusual). To value Project A, finance theory directs you to discount the expected cash flow at the cost of capital. But what is the expected cash flow in this case? If there is a 60 percent chance of everything going well, the expected cash flows would be $600 per year. At a 10 percent cost of capital, the project would be worth $6000 once completed. Subtracting the $2000 investment, the net value of the project the investment is made is $4000.

This is probably a basic question to most of you. Trying to understand everything slows me down a lot in trying to figure how these stuff works.

How did he get $6000? Is 10 percent cost of capital the same as the DCF discount rate in this case?

Yes. Cost of capital is essentially the same as discount rate or required return.

Cost of capital is from the company perspective while discount rate or required return is from investors point of view. Assuming all equity funding, they become one and the same.

So $600/0.1 = $6000

Vinod
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undervalued

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Re: Valuation - McKinsey
« Reply #14 on: July 22, 2015, 01:06:16 PM »
Is there an equation anywhere for that Vinod? Why do we divide the expected cash flow with cost of equity?
« Last Edit: July 22, 2015, 01:08:01 PM by undervalued »
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Jurgis

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Re: Valuation - McKinsey
« Reply #15 on: July 22, 2015, 01:57:13 PM »
https://en.wikipedia.org/wiki/Terminal_value_%28finance%29

T0 = FCF/(k – g)

Your g is zero, so it's just FCF/k
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undervalued

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Re: Valuation - McKinsey
« Reply #16 on: July 22, 2015, 03:11:06 PM »
Thanks Vinod and Jurgis.
Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it. - Will Rogers

innerscorecard

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Re: Valuation - McKinsey
« Reply #17 on: August 01, 2015, 08:37:40 PM »
I just received Hooke's book and have begun to read it. I am learning a lot already.
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Liberty

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Re: Valuation - McKinsey
« Reply #18 on: August 02, 2015, 10:30:06 AM »
I just received Hooke's book and have begun to read it. I am learning a lot already.

What do you like about it so far, and what have you learned about?
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feynmanresearch

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Re: Valuation - McKinsey
« Reply #19 on: August 09, 2015, 08:46:20 PM »
Most of my favorite books on valuation are mentioned above.

The books mentioned above cater to different sets of needs and provide different perspectives.

Damodaran's investment valuation is most comparable to McKinsey's book, in that they do a deep dive on the minutia of valuation. Except for the part about using beta to estimate required returns, it is useful to know almost all the other facets of valuation covered in these books. You might not actually make LIFO to FIFO adjustments or currency translation adjustments in real world valuation - it is one thing to know how these are impacting the financial statements and consciously ignore them for simplification and not knowing what is going on and if it is a positive or negative or if these effects cancel out over the long term. Even if you end up just using multiples, knowing the underlying assumptions behind them helps you to think more clearly. I found out I had been abusing the DCF method before I read Damodaran's book in depth - one of many many but this is most glaring.

I personally liked Damodaran's book much better than McKinsey. Perhaps because I started with Damodaran's book and breezed through McKinsey as they cover very very similar material with a slightly different terminology.

I also like Jeffrey Hooke's book and Greenwald a lot. They provide a completely different perpective, Hooke's a high level overview and how to value different types of businesses using industry specific methods. Greenwald comes about from a completely different angle based on moat vs. no moat and reinvestment opportunity.

I think reading Damodaran or McKinsey's book and both Hooke's and Greenwald provides a nearly comprehensive valuation toolkit for investors.

Vinod
If you had to chose between the McKinsey book and Damodaran's book, which would you chose?