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I don't fully understand how the math works out, particularly how the opportunity cost factors in. What does an opportunity cost of 10% mean and how does that f
by cstejerean 18y ago
I don't fully understand how the math works out, particularly how the opportunity cost factors in. What does an opportunity cost of 10% mean and how does that factor in to the valuation equation?
- mdasen 18y agoSo, opportunity cost is what you could get doing something else. For example, if I put $15B into an S&P500 index fund, I'd probably get returns around 10% per year. Since Facebook is a risk greater than an index fund, 10% is definitely fair. So, if I just took that money and suck it in a stock index fund, in 100 years I'd have over $206trillion at the end. So, it's not enough for Facebook (or anyone) to make money off of money invested. It must make more money off that investment than the investment could get at a standard investment rate. If Facebook is worth $100trillion in 100 years, it doesn't justify a $15B valuation because that $15B would become over $200trillion in average stocks. Specifically, the math is: sigma[1,100,$profit/1.1^k] Sorry for the notation. In plain English, for year 1 through 100, add the profit for that year ($profit) divided by 1.1 raised to the year number. In python: value = 0 proft = 100000000 for i in range(1,100): value += (profit/pow(1.1, i)) print value To summarize: Facebook needs to be able to beat a blind investment by their valuation in order to justify that price.