The intrinsic value of an organization focuses on the current value of the expected cash flows. In most cases, the intrinsic value is discounted based on the discount rates. Primarily, this discussion seeks to determine the variations of the intrinsic value when compared to the price given by the stock markets and identifies instances when the discounted cash flows are used.
Reasons Why Intrinsic Value May Differ From the Stock Market Value
Intrinsic values and market values are methodologies of estimation and calculation of the value of a company. Importantly, depending on the methodology employed to signify the value of a company, there is a rare chance that both values would be similar. Intrinsic values represent the metric analysis of the value of a company by investors as often seen in its calculations. The basis of the analysis relies on the actual value of the company. In this concept, the worth generated is employed using tangible factors such as the company's assets and the intangible factors such as the value and productivity of those assets. Calculation of intrinsic value is dependent on the analysts as the quantification of the intangible factors varies from one analyst to another (Gilbert et al., 2015). Nonetheless, in most cases, the factors employed in the calculation of the value include a detailed analysis of the current financial statement of an organization, the market analysis, as well as the business plan of the organization.
Market value, on the other hand, does not rely on the current value of the company assets, but rather the confidence or reputation of an organization in the market. Mainly, this is often reflected in the stock price of the company. In consequence, the market value tends to be higher or lower than the intrinsic value and does not reflect the actual worth of the company. For instance, if the company's reputation is damaged, the stock value of the company reduces based on the level of public confidence hence reducing the market value. Consequently, market values and intrinsic values rarely reflect each other. The stock market value could be higher
Discounted cash flows
The value of a company determines its future earnings. Thus, it affects any investment towards the company as well as its market value. Discounted cash flow analysis is therefore deployed in the attempt to underscore the future profitability of a company and its overall value. For example, investors seeking to buy stock shares of a corporation use discounted cash flow analysis (Pintaric & Kravanja, 2017). In consequence, the value calculated based on the present value of the stock would be a representation of the future of the company's stock. Therefore, the employment of free cash flow of the company in this calculation is critical to the final value of the stock.
Secondly, discounted cash flow analysis is deployed in the valuation of a project and its impact on the company's objectives. The discounted cash flow, in this case, is deployed as a primary level analysis of a company to its investment in assets. Also, it is used in the research and developmental process of new products. New products are the lifeline of any organization. Thus, the capacity of those products to generate profits for the company is critical for the future value of the company (Pivoriene, 2017). Consequently, discounted cash flows are deployed in the determination of the future value of products depending on the current investments towards the product.
A third example of a discounted cash flow analysis is the determination of investment value in money markets such as Bond pricing. Based on the volatility of the money market, bond prices are highly dependent on interest rates. Discounted cash flow analysis is integral in the calculation of the future value of a bond while considering the prevailing interest rates.
To conclude, this paper seeks to answer two questions. First, the paper provides some reasons why the intrinsic value differs from the market value. Some of the reasons provided include the fact that they both have different purposes. The intrinsic value measures the worth of a company while the market value measures the reputation of a corporation in the market. The second question answered relates to the situations when discounted cash flows could be used. From the analysis carried out, discounted cash flows can be used to evaluate a project, determine the value of an investment, and identify the future profitability of a corporation.
Gilbert, T., Scotti, C., Strasser, G., & Vega, C. (2015). Is the intrinsic value of a macroeconomic news announcement related to its asset price impact?. Journal of Monetary Economics, 92, 78-95. https://www.federalreserve.gov/econresdata/feds/2015/files/2015046pap.pdf
Pintaric, N. Z., & Kravanja, Z. (2017). The importance of using discounted cash flow methodology in techno-economic analyses of energy and chemical production plants. Journal of Sustainable Development of Energy, Water and Environment Systems, 5(2), 163-176. http://dx.doi.org/10.13044/j.sdewes.d5.0140
Pivoriene, A. (2017). Real options and discounted cash flow analysis to assess strategic investment projects. Economics and Business, 30(1), 91-101. DOI: 10.1515/eb-2017-0008
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