Valuation Question - Cumulative Cash flow cagr
All,
I have recently entered the M&A realm and I have a question for my fellow finance monkeys. I do not like using npv as a metric to gauge value. Instead, I was thinking that the more effective measure of return would be a cumulative cash flow CAGR, for say years 1-10, using your initial investment as your base year? Has anyone ever used this as a metric? My thought is, you in theory have cash in your bank account of the time of the acuqisition of X dollars. You want a certain annual rate of return on those X dollars year over year. Now this CAGR has got to exceed what would be your cost of debt plus the rate of return your looking for. Does anyone see the logic in the above approach?
NPV tells you how much you should pay today for a future cashflow, whereas your technique (if it worked correctly) would only give you a yes/no. I'm not a finance whiz, but on the surface level that seems to be a huge problem.
Seriously? There are two famous/must-know/ don't roll out of bed without it/ valuation metrics. The first is NPV, the discounted value of a series of cashflows. Always discount those cashflows by WACC, otherwise you're wacked. The second, and it's what you're describing, is called IRR, or the discount rate that sets your aforementioned cashflow series to ZERO. If your cost of capital exceeds your IRR, you don't do the investment (you'll end up with a negative NPV).
Google: NPV and IRR
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