Cash Flows

Starting at basics ---- Why do we specifically use only cash flows for the purpose of valuation?

Well, as a starter, I don’t think cash flows are the only thing that is used for valuing/pricing an asset. It may be the case for some securities, like fixed income, that predominantly are valued based on their cash flow, but in the case of public (or private) equities, for example, there are market-based and asset-based valuation approaches that don’t explicitly consider the cash flows (e.g., price/earning multiples). These alternative methods that don’t explicitly specify cash flows are, for obvious reasons, even more relevant for securities or assets that simply don’t generate cash flow by default (like a residential property).

Now for an asset that does generate (or can be expected to generate cash flows), can you think of any better, more homogenous way to measure what it is worth other than discounting the cash flows it may generate? … I can’t.

My two cents on the thought!

Well, if you could model cash flows (somewhat reasonably), an investment (in any asset, even a company) can be thought of a cash outflow, which you as an investor pay, in order to get a series of benefits in the form of cash inflows (to pay for the investment itself and your required return).

As you’ll notice in L2, there are many ways to model various types of investments, but many of those models seek to adjust accounting data to approximate cash flows to one stakeholder or another (e.g. fcfe vs fcff, EBITDA, FFO, etc), for the very reason stated above.

V= D(1+g)/(r-g) No cashflows used.

A dividend is a cash flow? however: b0+b0(ROE-r)/(r-g)

Um . . . yup.

No, there are infinite cashflows in this formula.

V = Present Value of ( D1+D2+…Dn+… ) and Di =D*(1+g)i

Expected cash inflows are the best reference (but not the only) for valuation simply because investments are cash outflows :smiley:

If I pay 50 for an investment position, I expected more than 50 in future discounted cash inflows in order to be willing to invest (I mean to get a positive rate of return).

The problem here is to forecast future cash flows with certainty. Even bonds are risky (not considering USA treasury bills). So we must always think in relative terms: Risk & Return.