Simulation discounted cash flow valuation for internet companies

Abstract

Discounted cash flow (DCF) is the most accepted approach for company valuation. However, the DCF approach presents a number of serious weaknesses within the internet companies' context. One of these weaknesses is tackling the uncertainty that characterise future cash flows of these companies. This paper looks at the way in which uncertainty can be incorporated into the DCF approach so that the latter, which is otherwise conceptually sound, becomes relevant. This is done by utilising a probability-based valuation model (using Monte Carlo simulation) to incorporate uncertainty into the analysis and address the shortcomings of the current model. The process leads to a probability distribution of the valuation criterion used, giving investors a quantitative measure of risk involved. The paper takes the case of a real internet company to illustrate the approach and highlight the benefits and the difficulties, which are encountered.