What is an Absolute Valuation Formula?

The term “absolute valuation” refers to the business valuation method that utilizes DCF analysis to determine the firm’s fair value. This method helps determine a company’s financial worth based on its projected cash flows. The formula for discounted cash flow is calculated by adding up the cash flow in each period divided by one plus the discount rate, which is again raised to the power of the number of periods.

Absolute Valuation Formula

This equation and the stock are represented as follows: –

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#1 –Absolute Valuation Formula of Business

Mathematically, the absolute valuation equation can be represented as,

Where,

Absolute Value = CF1/(1+r)1 + CF2/(1+r)2 + … + CFn/(1+r)n + Terminal Value/(1+r)n

Absolute Value = ∑ni=1 [CFi/(1+r)i + Terminal Value/(1+r)n]

  • CFi = Cash flow in the ith yearn = Last year of the projectionr = Discount rate

#2 – Absolute Valuation Formula of Stock

Finally, the absolute value of a stock equation is calculated by dividing the absolute value of the business by the number of outstanding shares of the companyOutstanding Shares Of The CompanyOutstanding shares are the stocks available with the company’s shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner’s equity in the liability side of the company’s balance sheet.read more in the market, and the absolute value of a stock is represented as,

Absolute value Stock = Absolute value Business / Number of outstanding shares

Explanation of the Absolute Valuation Formula

Example of Absolute Valuation Formula (with Excel Template)

  • Firstly, the company’s financial projections noted the projected cash flow during the year. The cash flow can be in dividend income, earnings, free cash flow, operating cash flow, etc. CFi denotes the cash flow for the ith year. Next, a company’s weighted average cost of capital (WACC) is usually taken as the discount rate because it denotes an investor’s expected required rate of return from investment in that company, represented by r. Next, determine the terminal value by multiplying the cash flow of the last projected year by a factor, which is usually the reciprocal of the required rate of return. The terminal value denotes the value of the assumption that the business will continue after the projected periods. Terminal value = CFn * Factor Next, calculate the present values of all the cash flows by discounting them using the discount rate. Next, the equation of absolute valuation calculation for the particular company is done by adding up all the present values of the cash flows and the terminal value calculated in step 4. Finally, one can calculate the absolute value of a stock by dividing the value in step 5 by the number of shares outstanding of the company. Absolute valuation Stock = Absolute valuationu00a0Business / Number of outstanding shares

Terminal value = CFn * Factor

Absolute valuation Stock = Absolute valuationu00a0Business / Number of outstanding shares

So, from the above-given data, we will first calculate the CF for CY19.

CF CY19 = NOPATNOPATNOPAT, or Net Operating Profit after Tax, is a profitability measure in which a company’s profit is calculated excluding the effect of leverage by assuming that the company has no debt in its capital and, as a result, ignores the interest payments and tax advantages that companies receive by issuing debt in their capital.read more + Depreciation & Amortisation expense – Increase in Working Capital – Capital Expenditure during the year – Debt Repayment + Fresh Debt raised during the year

  • $150.00 million + $18.00 million – $17.00 million – $200.00 million – $35.00 million + $150.00 million$66.00 million.

Now, using this CF of CY19 and CF growth rate, we will calculate the projected CF for CY20 TO CY23.

Projected CF of CY20

  • Projected CF CY20 = $66.00 million * (1 + 7%) = $70.62 million.

Projected CF of CY21

  • Projected CF CY21 = $66.00 million * (1 + 7%)2  = $75.56 million.

Projected CF of CY22

Projected CF CY22 = $66.00 million * (1 + 7%)3  = $80.85 million.

Projected CF of CY23

  • Projected CF CY23 = $66.00 million * (1 + 7%)4  = $86.51 million.

We will calculate the Terminal ValueCalculate The Terminal ValueThe terminal value formula helps in estimating the value of a business beyond the explicit forecast period. It includes the value of all cash flows, regardless of duration, and is an important component of the discounted cash flow model (DCF).read more.

  • Terminal value   = CF CY23 * (1 / Required rate of returnRequired Rate Of ReturnRequired Rate of Return (RRR), also known as Hurdle Rate, is the minimum capital amount or return that an investor expects to receive from an investment. It is determined by, Required Rate of Return = (Expected Dividend Payment/Existing Stock Price) + Dividend Growth Rateread more)=$86.51 million * (1/6%)=$1,441.88 million.

Therefore, the calculation of absolute valuation will be as follows: –

Calculation of Absolute Valuation of Company

  • Absolute Value = $1,394.70 million

Now, we will calculate the fair value of the stock, which is as follows: –

  • The Absolute Valuation of the Stock = Absolute Valuation of the Company / Number of Outstanding Shares= $1,394.70 million/60,000,000

Calculation of Absolute Valuation of Stock

  • The Absolute Valuation of the Stock= $23.25.

Relevance and Use

From a value investor’s perspective, it is very important to understand the concept of an absolute valuation equation because it is used to check whether a stock is over or undervalued. However, it is very challenging to forecast the cash flows with certainty the growth rate and assess how long the cash flows will continue to grow in the future. Therefore, one should use this method but with a pinch of salt.

This article is a guide to the Absolute Valuation Formula. We discuss absolute value calculation and absolute value equation, examples with Excel template. You may learn more about valuations from the following articles: –

  • Value Formula in ExcelIn Excel, the value function returns the value of a text representing a number. So, if we have a text with the value $5, we can use the value formula to get 5 as a result, so this function gives us the numerical value represented by a text.read moreTop Valuation MethodsTop Valuation MethodsDiscounted cash flow, comparable company analysis, comparable transaction comps, asset valuation, and sum of parts are the five methods for valuing a company.read moreDCFDCFDiscounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company’s future performance.read morePost Money ValuationsPost Money ValuationsThe term “post-money valuation” refers to determining the value of a firm after it has received a capital injunction. In basic terms, post-money valuation is the process of determining the worth of a company after increasing its capital flow. As a result, post-fund infusion valuation indicates the company’s worth at any point in time.read more