First Chicago method: Difference between revisions

Revision as of 09:05, 31 May 2012

Revision as of 09:09, 31 May 2012

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* A "downside" or "worst case scenario"

The [[valuation]] proceeds as follows. First, for each case, a [[Scenario_planning |scenario specific]], ''internally consistent'' forecast of [[cashflow]]s is constructed for the years leading up to the assumed [[Divestment#Divestment_for_financial_goals |divestment]] by the private equity investor; see[[Corporate_finance#Quantifying_uncertainty| Corporate finance: Quantifying uncertainty]]; [[Financial_modeling#Accounting| Financial modeling: Accounting]]. (TheNext, a divestment may take various formsprice - seei.e. [[Private_equity#Investments_in_private_equity| PrivateTerminal equity: Investments in private equityvalue]]). Next, a divestment price- is modelled by assuming an [[Terminal_value_(finance)#Exit_Multiple_Approach |exit multiple]] consistent with the scenario in question. (Of course, the divestment may take various forms - see [[TerminalPrivate_equity#Investments_in_private_equity| valuePrivate equity: Investments in private equity]]).) The cash flows and exit price are then [[present value|discounted]] using the investor’s [[Required rate of return|required return]], and the sum of these is the value of the business under the scenario in question. Finally, the three values are multiplied through by a [[probability]] corresponding to each scenario (as estimated by the investor). The value of the investment is then the probability weighted sum of the three scenarios.

The method is used particularly in the valuation of [[growth company|growth companies]] which often do not have historical financial results that can be used for meaningful [[comparable company analysis]]. Multiplying actual financial results against a comparable valuation multiple often yields a value for the company that is objectively too low given the prospects for the business.