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To: The Other Analyst who wrote (180)	12/20/1999 6:54:00 PM
From: Chuzzlewit	Respond to of 214

TOA, Let me take your points one at a time: Are you saying you prefer to run projections out until the Terminal value does not matter? Almost. What I like to do is to forecast the company up until it becomes a mature entity and then apply some reasonable multiple of FCF to arrive at a terminal value. Second, I have a real problem with the term "free cash flow" because it means so many different things to people. True. I define free cash flow as cash flow from operations less cash expended for capital expenses. I don't use estimates of depreciation because they are generally meaningless. I use a strict cash on cash basis. Remember that cash used for acquisitions and capital expenditures funds future growth, so it is naive to believe that a company can continue hypergrowth without such expenditures. Obviously, this approach does not work with "story stocks" such as RHAT. There is no operating history upon which to guide us, and the size of the potential market is ill-defined. Third, on the topic of discount rate. I think the discount rate ought to be varied depending on the risk profile of the company in your projections. A company in its "hypergrowth" phase would have a higher risk premium than it would when it has reached its mature stage. So the discount rate should vary over time. I like to add a line to the spreadsheet with a "cumulative discount factor". Each year's cash flow can be brought back to the present value by applying the cumulative discount factor to it. I partially agree. The discount rate should reflect the riskiness of the venture plus the risk-free interest rate. But I think your approach is in error if you are suggesting the use of multiple discount rates before the fact for a single company because future cash flows depends on the success of the current business plan. If a company is executing well I think it is proper to adjust the risk premium down, but only after that fact has been determined. For example, suppose a company is engaged in research on a drug for a particular disease. The size of the potential market is known. But there are at least four critical factors that are unknown at this stage: 1. Will the research lead to a marketable product; 2. Will the product be accepted by the medical profession and consumers; 3. What impact will yet to be developed competitive products have on the market for this drug; 4. What is the life-cycle of the product. At the outset there is obviously a great deal of risk, but as each one of these unknowns is revealed with time, the risk (and hence the discount rate) decreases. TTFN, CTC