Comparison Between Option Pricing model and Discounted Cash Flow model: A study Case of Electronic Arts Company

Abstract

This paper is a comparative analysis of the Discounted Cash Flow (DCF) model and the binomial option pricing model of Electronic Arts company as a case study. The DCF model will be used to determine the intrinsic value of the firm based on financial and market data obtained through public sources. The value of a call option in the stock of the company within a short period is assessed using the binomial model. These findings indicate that the DCF model gives a firm value of about 36.6 billion USD whereas the binomial model gives an option value of about 14.6 USD. The reason behind this immense difference is the inherent differences in model structure and objectives of valuation. The DCF model is a deterministic and linear model, and the binomial model is a stochastic model with volatility and a convex payoff structure. Further discussion shows that the DCF model is better applied in estimating long-term intrinsic value. The results identify the complementary nature of the two strategies and propose a possibility of having a more in-depth picture of firm value, which might be more relevant in the high uncertainty and innovation industry.