TITLE:
Discounted Cash Flow (DCF) as a Measure of Startup Financial Success
AUTHORS:
Erkki K. Laitinen
KEYWORDS:
Discounted Cash Flow, Startup, Profitability, Growth, Payback Period, Risk Aversion
JOURNAL NAME:
Theoretical Economics Letters,
Vol.9 No.8,
December
26,
2019
ABSTRACT: The
purpose of the study is to investigate the characteristics of the discounted
cash flow (DCF) as a measure of startup financial success. In general, DCF is
found the most popular method in startup valuation followed by the internal
rate of return (IRR) and the payback period methods. However, the consequences
of using this method in startup valuation are rarely analyzed in financial
research. In this study, a simplified mathematical model is developed to
describe the time-series development of the cash flow. This model is based on
the growth of expenditures and their ability to generate revenues from the
founding of the startup. The model employs IRR as the measure of true
profitability and the average lagin revenue generation as a proxy of the payback period. Numerical experiments are
used to show the sensitivity of DCF to the parameters of the model. The results
indicate that the use of DCF favors startups that grow slowly and have a short
payback period but that also exhibit a
high IRR. The longer the time series of the startup used in the analysis, the
more significant role IRR tends to play in DCF. Empirical evidence extracted
from a sample of Finnish startups supports the numerical findings.