Question

1. Name and describe some of the advantages/disadvantages of both the Discounted Cash Flow (DCF) and the Residual Operating Income (ROPI) valuation models.

Answer 1

The advantages of discounted cash flow method of valuation is that it is a simple and fairly straight forward method to value a company with the laying out of the cash flow and then assigning a cost of capital to discount the same. The difficulty is in finding out the projected cash flows and the future cost of capital to a high degree of certainty. So in absence of a relaible estimate, the DCF method can be prone to errors.

The advantage of the residual operating income method is that if the growth in operating income is fairly predictable and cost of capital is also stable, then one can find out the value of the firm easily. But in a real world scenario, the assets and the capital structure would change and thus its applicability to practical situation is difficult and prone to volatility.