Problem
Megatron is a high-tech start-up company that produces Artificial Intelligence software that can help companies fine-tune their digital marketing campaigns to bring in more results. After two years of developing the software, Megatron has just completed one full year of software sales on a commercial basis. Both profits and cash flows just barely turned positive as the company is only beginning to gain traction, and revenue is still tiny. The management of Megatron is optimistic that income and profits will grow exponentially in the next few years.
Megatron is at the point where more capital is needed to fund its growth. It has begun talks with a Venture Capital company, which suggests that they would value the company based on the Price Earnings (PE) ratio multiplied by its latest historical Net Income. It is willing to be generous in valuing Megatron at the same PE as similar listed companies. CEO of Megatron, however, felt that perhaps the company could get a better valuation if they were to base it on a discounted cash flow method, valuing Megatron's cash flows in the coming years. You are Megatron's CFO and are asked to advise the CEO.
i. Appraise the two valuation approaches and choose the more appropriate one in valuing Megatron, giving your reasons.
ii. Examine the difficulties involved in employing the valuation method you chose above.