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To: Chuzzlewit who wrote (30499)	2/19/1998 8:11:00 PM
From: Reginald Middleton	Read Replies (1) \| Respond to of 176387

First, why are you discounting at the cost of capital rather than a risk-adjusted discount rate (and if you can justify the cost of capital how have you calculated it?); I welcome the constructive criticisms:-0 I find the cost of capital the most comprehensive measure of opportunity cost. It is also a risk adjusted discount rate. For instance, the cost of equity capital equals the opportunity cost of investing in that company less the additional risk of leverage (deleveraged beta is used). This equity capital cost therefore would be the risk free rate + the historical market risk premium (I use S&P 500 from 1923 to present) multiplied by the cost of capital for business risk (the deleveraged beta if you are using a public company or a proprietary statistical process I developed in the case of a private company). Thus, this formula produces the discount rate for a riskless asset and adjusts it for the specific equity risk of the company/entity in question. This reasoning follows CAPM (Capital Assets Pricing model) theory and with slight modification, APM (the arbitrage pricing model). Companies that have debt capitalization can use a similar capital cost method by taking the discount rate rate of the debt (which will be adjusted by the market for risk, ex. a BBB bond will carry a 2.5% premium to the riskless rate, thereby resulting in a risk adjusted discout rate) and adjusting it for the cash benefit the entity recieves in tax shields. The process is detailed in the business risk and cost of capital drop down controls found at rcmfinancial.com . Second, the uncertainties in looking past the next year are huge, so how in the world can you come up with meaningful terminal values? This is a problem any company faces. That is why I did not use terminal values for valuation measures (such as P/EBIT or P/EBITDA), but instead used the perpetual(constant) growth method. This was then placed in a sensitivity matrix that illustrates "what if" scenarios in both positive and negative directions, under a variety of discounting rates. If one were to use terminal values in lieu of perpetual growth methods, a historical trend would be taken of the EBTIDA multiples and be extrapolated out into the future - tempered of course by your opinion of what unique occurrences may take place. <Third, I don't believe you segregated the cash flow derived from non-operating sources (ie, interest and gains made on short-term investments).> Reference the reconciliation to net income report, the levered cash flow statements, and the adjusted unlevered cash flow statements. Non-op income is also projected explicitly in the income statements. I see why segration would be necesary for performance measures, but I don't see why non-op cash flow needs to be segregated for reasons of valuation. I don't believe it's possible to value a growth company using DCF techniques, but I'm always willing to be convinced. I look forward to your response in detail. Cash is king, and the primary value driver of any company is money. DCF simply takes projected money flows and applies the appropriate risk adjustment and time value to them. In my opinion, DCF (or modified DCF) is the most appropriate method of valuing growth companies, for it allows for even comparison across sectors and encompasses the knowledge of the entire market (if WACC is used) instead of the arbitrary application of a risk adjustment. The primary advantage of DCF is that it circumvents the ambiguitites and inconsistencies of the capitalized earnings methodology. I hope I have answered your questions satisfactorily. If you have followed my (very) early posts, I have used modified DCF to show the EXTREME over valuation of NSCP when it was flying high (and even when it was not so high) as well as the share value potential of MSFT.