First Chicago method: Difference between revisions

Revision as of 07:36, 5 July 2012

Revision as of 10:48, 25 October 2012

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The [[valuation (finance)|valuation]] proceeds as follows.<ref>See, for example, Schumann (2006).</ref>

*First, for each caseof the three cases, a [[Scenario_planning |scenario specific]], ''internally consistent'' forecast of [[cashflow]]s - see [[Financial_modeling#Accounting| discussion]] under [[Financial modeling]] - is constructed for the years leading up to the assumed [[Divestment#Divestment_for_financial_goals |divestment]] by the private equity investor.

*Next, a divestment price - i.e. [[Terminal value (finance)|Terminal value]] - 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 [[Private_equity#Investments_in_private_equity|Investments in private equity]] under [[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, each of the three scenario-values are multiplied through by a [[probability]] corresponding to each scenario (as estimated by the investor). The value of the investment is then the [[Weighted mean|probability weighted sum]] of the three scenarios.

==Use==