Real options allow you to better value projects with negative cash flows but which are taken for strategic reasons. Particularly, in a start-up phase, you may find a start-up angel willing to invest, in these cases u cannot show a historical statement of Profit and Loss that has a logical value, in these situations DCF is nearly impossible. With real options, you recognize the benefits of acquiring a toehold first by investing in minority stake and waiting until uncertainty unravels before making full acquisition. They are essential to quantify firm’s strategic choices. It helps you to take advantage of future uncertainty by investing in real option now. Now we will discuss about Real Option Valuation Approach:Ī real option refers to choices on whether and how to proceed with a business investment. WACC Method, Free Cash Flows to Equity (FCFE) Method, Adjusted Present Value (APV) Method. For calculating free cash flows variety of DCF methods can be applied viz. Under DCF Approach, first step is to forecast free cash flows. Where present value of growth options does not have a lot of conditionality in it, Where Present Value of Growth Option is less than assets in place or, DCF valuation is not sufficient to capture the full market value of a company. It is used when we are fairly certain of future trends. DCF analysis is used for valuation of mature businesses where they have tangible assets in place, market sizing, sales reports etc. DCF value assets when we are projecting future cash flows from some historical concepts. DCF analysis is typically considered as now or never deal, in other words either we are investing in the proposal or not. DCF Approach is mainly used when we can forecast about future cash with reasonable certainty. It is the basic analysis used by the valuers for company valuation. Both methods have their merits side by side.įirstly, we discuss Discounted Cash Flow (DCF) Valuation Approach: Most of us have a belief that these two methods are mutually exclusive but this belief is somewhere wrong. Here in this article we will briefly discuss about two valuation approaches i.e Discounted Cash Flow (DCF) Valuation Approach and Real Option Valuation Approach. In other words, it is an estimation of something’s worth. A word valuation means to derive value of something.
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