[MUSIC] in this session, we will talk about various valuation methods. So here's a Good Beer Pub, GB Pub. Suppose that you run a craft beer pub in your hometown, the name is GB Pub, Good Beer Pub. And your business is doing very well, and so you have a plan to expand your business to the capital city. And a customer wants to invest $100,000. The question is how much share should you give? So you need to value the GB Pub, and your thinking that I invested my own $300,000. And during the last two years, I worked very hard with almost no salary. So I could have received a salary of $200,000 in the past two years. So the value of GB Pub should be at least $500,000, 300 for my initial investment money and 200,000 salary. So with this, the share the investor would get will be 16.7%. So would you agree with this reasoning? So you want to be compensated for your hard work just like many other entrepreneurs. But think about why your customer wants to invest on GB Pub. I guess the investor is not interested in compensating for your past hard work. The investor instead would be interested in the future of GB Pub, and hope to have nice return from this investment. Then how should we value GB Pub? So, just like we discussed in these three core things in valuation, you need to estimate the future free cash flow of the pub. So let's suppose this table shows the free cash flow of the future of GB pub. So in the first two years no free cash flow, because you need to invest on the new business in the capital city. And then from the year three, it will generate $100,000 and they do increase to 300, and $400, 000. And from the year six and afterwards, you expect a stable free cash flow of half a million dollars every year Then let's calculate the present value using these free cash flows and assume that GB Pub's cost of capital is 15%, and this 15% is related to the risk of the business. So the present value would be discounted cash flows. So this is the cash flow in the future distant to get the present value between year 1 and 5. And then, since after five years you going to have the same perpetual free cash flow, so it's called the residual value. So the present value of the residual value in year 5 is the discounted value of $500,000 per year perpetually. So present value of perpetual cash flow is like this. So, So if there's an annual cash flow C, forever with the cost capital of d. Present value is expressed like this, and then you multiply equation one with our 1 + d, and then you get this relationship. Okay, and then, you subtract equation 1 from equation 2. And then on the left side, you have just PV, present value. And on the right side, you have only C and all the other terms are cancelled. So d times the separating value is C, so present value is c over d. So c is annual cashflow and d is cost of capital. So let's go back to the previous slide. And so residual value in year 5 is 500,000 divided by 0.15 which $3,333 million. Okay, so present value will be these free cash flows year 3, 4 and 5, plus this residual value. Again, discounted for five years, because if you're estimating the present value, and we get the present value of GB Pub, $2.1 million. So this is much higher than the previous reasoning, an investment of $100,000 will be a share of 4.5%. So it is much lower than the previous estimation. So this method is called the discounted cash flows because we discount future cash flow to obtain the present value. And this is the most widely used valuation method. The second method is called valuation by multiples. And this table shows the companies in wholesale industry, and we have already seen Walmart and Costco and the average are price to earning ratio in this industry is 20.6. And suppose there's a new company in this wholesale industry, and suppose there's a new company which is not a public company, and this company has a $3 per share net profit, and has 50 million shares. And then the stock price will be 3 times 20.6, and if you multiply this by the total number of shares and we can get the evaluation of this company which is about $300 million. So this is the valuation by multiples and it's a very simple method. And so this method is frequently used by investors and bankers. And one drawback of this method is that we don't consider the individual company share problems. And the third method that we talk about will be valuation by venture capitals. And when we talked about funding, we saw a score card of venture capital. We know that venture capital's return dependents on few successes. So, in each investment venture capitals target a very high return, like a 10 to 20 times in Series A. So, when venture capital considers an investment, they consider whether this startup would be worth $5 million at exit. Like an MNA or initial public offering or $200 million based on the comparable companies they experienced before. So if they think this startup could be $500 million at exit, and if they target the return of 20 times, and then the post-money valuation of Series A would be $25 million. So this is how they value a startup. So in summary, we know that investors invest for the future, and we have looked at DCF, Discounted Cash Flow method. Valuation by multiples and Venture Capital valuation method.