Two techniques fall under the income approach umbrella when valuing a private business interest: the discounted cash flow (DCF) method and the capitalization of earnings method. How do these two commonly used methods compare — and which one is appropriate for a specific investment? Fundamentals of discounting The DCF method estimates the present value of future expected net cash flows using a discount rate. It entails these basic steps: Compute future cash flows. Potential investors are generally trying to determine what’s in it for them in terms of cash flow and an acceptable return on investment. Historical earnings are often the starting point for estimating expected cash flow over a discrete discounting period of, say, five or seven years. Then, the valuation expert calculates a terminal (or residual)...
