This intrinsic value template will demonstrate the calculation of intrinsic value using the discount rate method and the certainty factor method.
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The intrinsic value of a business (or any investment security) is the present value of all expected future cash flows discounted at the appropriate discount rate. Unlike relative forms of valuation that look at comparable companies, intrinsic valuation looks only at the inherent value of a business on its own.
Risk Adjusting the Intrinsic Value
The task of risk adjusting the cash flows is very subjective and is a combination of both art and science.
There are two main methods:
Discount rate – Using a discount rate that includes a risk premium in it to adequately discount the cash flows.
Certainty factor – Using a factor on a scale of 0-100% certainty of the cash flows in the forecast materializing. (This approach is believed to be used by Warren Buffett. Learn more by reading Buffett’s annual letters to shareholders)
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