Valuation is a decision-making process aimed at making smart bets on the “least bad” way to “put a number” on a business model, taking into account what is known, what is believed and the remaining ambiguities and uncertainties. Numbers are a necessary evil.
The net present value (NPV) method is a very powerful but also very dangerous technique for valuing a business model based on its expected riskiness and potential cash flows. It can in particular be effectively used to compare multiple business models under similar cost of capital and terminal value assumptions.
Sensitivity analysis and scenario planning approaches can be used to integrate known risks and potential uncertainties and to reduce the scope of managerial ignorance, provided they are based on challenging business conversations regarding “what you need to believe” rather than black box models and/or blind number-crunching.
Keywords: ambiguity, IRR (internal rate of return), mathiness, sources of uncertainties, ROI (return on investment), uncertainty, valuation methods
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Keywords: cost of capital, Discounted Cash Flow, Final Value, Net Present Value, opportunity cost, real options, risk premium, WACC
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Keywords: black swans, Monte-Carlo simulations, risk management, scenario planning, sensitivity analysis
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(c) Prof. Benoit Gailly, Louvain School of Management