Tradeoffs of Multiples versus DCFMultiples analysis utilizes historical and current data of comparable firms to obtain a multiple of firm's value to financial data such as EBITDA and is a relative value. DCF analysis however, gives an intrinsic value of the firm by discounting the future free cash flow projections (which requires estimations of future revenues and costs) using WACC.
Ã¢ÂÂ¢While multiples analysis uses data from the past and current where most of its figures are pro forma hence susceptible to accounting manipulation, DCF analysis delves more into the projection of future revenues and costs which requires thorough understanding of firm and its potential growth and risksÃ¢ÂÂ¢Multiples analysis being a relative value has multiples obtained from comparable firms, and hence results in problem if entire market is over or under valued. On the other hand, DCF analysis is firm centric and requires specific data.
Ã¢ÂÂ¢While multiples analysis is simpler to perform, DCF analysis is much more complicated, requiring prediction of future cash flows which is easily susceptible to error.
It is important to note that DCF analysis is very sensitive to inputs hence error should be minimized if possible.
Assumptions of multiple analysisExhibits 2 and 6 showed figures used in the calculation for the multiples analysis for Cox Communications. Exhibit 2 shows the relevant financial figures for some comparable companies to Cox.
These selected companies were assumed to:Ã¢ÂÂ¢be in the same industry as Cox;Ã¢ÂÂ¢be in the same risk class as Cox;Ã¢ÂÂ¢have similar cash flows (comparable cash flows);Ã¢ÂÂ¢have the same growth rate as Cox; andÃ¢ÂÂ¢have similar accounting principles and methods, as well as the same reporting periodto make them comparable to Cox. These are unrealistic assumptions - Martin has disregarded company capital structure differences and any tax benefits derived from them. Moreover, the figures used in exhibit 6 are transferred...