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The arithmetic Brownian motion in corporate valuation

  • In this paper we expand the Discounted Cash Flow (DCF) framework for the valuation of an unlevered firm when the free cash flows are modeled by an arithmetic Brownian motion (ABM).We approximate the ABM by a binomial lattice in order to keep the typical time discrete framework of the DCF methodology. In contrast to the typical multiplicative process assumption for modeling earnings figures and free cash flows the ABM implied additive process admits for possible negative free cash flow values and grows by an absolute amount rather than a growth rate. But this process assumption has important implications on firm valuation. After the binomial lattice approximation we derive valuation formulas based upon an additive process assumption, touch the topic of the determination of CAPM consistent cost of capital and show a possible equivalence between the multiplicative and additive process assumption. We finish our analysis by calculating some numerical examples.

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Document Type:Working Paper
Author:Alexander LahmannORCiD
Chairs and Professorships:Chair of Financial Management
Year of Completion:2013
Page Number:36
Tag:Arithmetic Brownian motion; Corporate valuation; DCF
Content Focus:Academic Audience
Licence (German):License LogoUrheberrechtlich gesch├╝tzt