Of Valuation Model Employed

Justify the choice of valuation model employed (eg. Free cash flow valuation model), relative to any other potential valuation methods available.

Our company has chosen the discounted free cash flow (DFCF) valuation model to measure the value of Aer Lingus.

Free cash flow (FCF) refers to the cash that a company is able to generate after deducting capital expenditures from operating cash flow. FCF is important as it allows the company to pursue opportunities that enhance shareholder value. While the DFCF analysis applied in the previous section has discounted the future free cash flow projections of the company and into present value, in order to estimate the value of Aer Lingus.

There are many advantages in adopting such valuation analysis in general. Firstly, the DFCF method is forward-looking and depends on more expectations rather than historical results. To a company, what is going to happen is the key element in decision making, with the anticipation of growth, competitive advantage period etc., the model could provide sufficient information on that, the estimated value will be more accurate and reliable. Secondly, the DFCF metrics has the ability to run the sensitivity analysis. The key drivers of the value can be identified and the company can put more focus on those inputs. Sensitivity analysis is useful in negotiating and agreeing what the value of a company is as it allows justifying the valuation with a range of scenarios, and hence increases the reliability. Thirdly, this valuation method is consistent in itself. Investors and shareholders can value the company individually, the value stands on its own and does not need to compare with other companies or the industry.

Furthermore, the DFCF method also stands out when comparing with other potential valuation methods. Followings are the major advantages of DFCF model over other alternatives.

The first example is the Price / Earnings Ratio (P/E) valuation method. A firms value is calculated by P/E ratio times the Net Income. Although it is relatively simple, it excludes risk, which is very important in valuation terms. On the other hand, the DFCF valuation model considers risks in cost of capital (will be mentioned in next part of the report). The relationship between risk and return is crucial to investors, when the possibility that actual future returns will deviate from expected returns is too high, investments may be given up. Besides, the P/E ratio valuation ignores the time value of money whereas the DFCF valuation takes this into account. Net income of a firm tends to increase year after year if the general price level keeps rising. We may overestimate the value of the firm if the percentage change is smaller than the percentage change in price level. But, the method we have used discounted the future cash flow into present value, so the final value