OK, revision time for finals week. Net Present Value. Discounted Cash Flow. Gordon’s Dividend Growth Model for pricing shares.
Discounted Cash Flow is a common method of valuing an investment. You take a look at what profit that investment will produce in years to come, ‘discount’ it accordingly back to the present day (the further out it is, the riskier it is) and you get a Net Present Value. If the NPV is positive, it’s a project worth investing in, dependent on a number of other factors like inflation, interest rates, and normal returns. This method is used almost universally by large investment firms as a means of legitimising their investments and making them look good to their clients.
And you know what? It’s a complete con job.
The impressive-looking spreadsheets DCF and NPV produce disguise the fact that both models – two basic and interrelated concepts of corporate finance used daily in billion-dollar takeovers – are a fistful of COMPLETE GUESSWORK. In fact, it’s worse than guesswork: both ideas generally use the one assumption you can’t make, namely that things are going to be the same next year.
That’s what the world financial system is based on: a pack of guesses given legitimacy by bigass spreadsheets, the same way supernatural imaginings were given legitimacy by impressive buildings and Latin language in medieaval Europe. The bigger the snow job, the more concrete the result looks.
Hey, if you can’t beat ’em, join ’em. I’ve got an exam on this stuff in ten days, and then I’m going to start using it.