Discounted Cash Flow Method Research Articles

Business valuation in times of crisis

Business valuation is very important and complex process, mainly in the current global situation. To determine the company value, we will base our calculations on an analysis of the internal environment of the company, which is affected by macroeconomic and microeconomic influences. The aim of this paper is to determine the value of a selected company using FCFF in an environment of negative and unplanned interventions in the economy. The main source for determining the value of the company is data obtained from the financial statements and annual reports of the limited liability company Pepco, s.r.o. from the period of 2013-2018. The method applied to the selected company is the discounted cash flow method, which is one of the most popular and most frequently used earnings methods. In the first years before the company became known on the Czech market, the value of the FCFF was more often than not in negative numbers. This also affected the value of the business. During next years, with the stable growth of the company, the value of the company also grew. We can expect that due to the global problem of COVID-19, the value of the company will decrease in 2020, but it will not have a very significant effect on its overall value.

The residual income model cannot challenge the discounted cash flow method in stock valuations - an analysis of global manufacturing and service companies

The residual income model cannot challenge the discounted cash flow method in stock valuations - an analysis of global manufacturing and service companies

The residual income model cannot challenge the discounted cash flow method in stock valuations - An analysis of global manufacturing and service companies

The residual income model (RIM) exists in the literature as a theoretical concept for almost a hundred years, however, it could never match the popularity and relevance of the discounted cash flow ...

Comparing Growth Rates Used in Discounted Cash Flow Valuations

Estimating growth in net cash flows is one of the key components in applying the discounted cash flow (DCF) method in valuing any company, reporting unit, or other business unit. This paper explains the underlying assumptions of the DCF method and demonstrates how to compare the most commonly used basis for estimating net cash flows (sometimes referred to as free cash flows), expected organic growth, to historic estimates of growth of the subject company and estimates of earning growth commonly prepared by security analysts.

Financial Feasibility Study of Hydro Power Plant on A River in West Sumatra

As a part of nation worldwide, Indonesia set the target for the renewable energy source. The renewable energy should be 23% of the energy mix generation that mentioned in the RUPTL 2019 -2028. PT. XYZ as the company which have the responsibility regarding the electricity in Indonesia should work hard to find and invest in renewable energy source. In West Sumatra, there is one river that can be potential to create the hydro power plant that expected to generate as much as 296.104.624 kWh. The construction of the hydro power plant itself will be started from the scratch that obviously will cost much money. The company should consider if it is wise to invest in constructing the hydro power plant or not. This research aims to analyze the financial feasibility study of the hydro power plant in West Sumatra, the financial performancef of the project, and find which variable that affect the project greatly. This research performs general environment analysis using PESTEL analysis to identify whether the environment support the project execution or not. The financial feasibility analysis performs using the discounted cashflow method and evaluated using Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period (PP). To identify which variable that affected the financial feasibility of the project, the author use sensitivity analysis and scenario analysis. Furthermore, Monte Carlo simulation also performed in this research to give an information regarding the probability impact of the uncertainty from the selected variable. The calculation result shown that the project is financially feasible with NPV of Rp. 1.832.776.500.481, IRR of 15,77% which is higher than the weighted average cost of capital (WACC), and the payback period for 9,15 years. The financial performance also shown a favourable result with the project’s profitability index of 5,41. Long-term debt interest rate, capacity factor, agreement price, CAPEX need, and inflation rate are the highest five variable that affect the feasibility of the project. According the Monte Carlo simulation result using 1000 iterations, the project has probability of 6,34% in making the project not feasible.

Preliminary techno-economic evaluation of 2G ethanol production with co-products from rice straw

A preliminary techno-economic analysis of 100 KLPD capacity of the second-generation (2G) ethanol with co-products from rice straw through conceptual process design is studied. Various pathways are investigated in this work. They are as follows: scenario 1 (baseline): separate enzymatic hydrolysis and hemicellulose (C5) and cellulose (C6) fermentation; scenario 2: separate hydrolysis and fermentation of C6 sugars and C5 sugar-to-furfural; scenario 3: separate hydrolysis and C5 and C6 sugar co-fermentation; scenario 4: C6 and C5 fermentation separately and hydrothermal liquefaction of lignin to produce biochemical; scenario 5: C6 fermentation, C5 to furfural and lignin to biochemical. The material and energy balances of all the pathways are performed using a steady-state simulation. Based on the results of mass and energy flows of the process, the economic analysis is performed using a discounted cash flow method. It is found that the minimum selling price of ethanol for the baseline scenario is 0.627$/litre whereas other scenarios (2–5) show 0.5, 0.563, 0.35 and 0.25 US$/litre, respectively. The lowest minimum selling price of bioethanol for the last scenario is due to the production of furfural from xylose and various bio-chemicals from lignin along with bioethanol production. Finally, a sensitivity analysis is performed to identify key parameters that influence the economics of the process.

Assessing the Environmental and Economic Footprint of Electronic Toll Collection Lanes: A Simulation Study

Electronic toll collection (ETC) plays, as part of transport demand management (TDM) measures, an important role in preventing traffic congestion and improving the environmental conditions in urban and rural areas. An attempt is made in the framework of this paper to evaluate the overall performance of a toll station when a lane is dedicated to ETC. The case study refers to a toll station in the Thessaloniki Metropolitan Area, Greece. Scenarios considered specific traffic characteristics, variable toll booth setups, and different penetration rates of the ETC tag users for car and heavy vehicles. The tool used in the evaluation process was the PTV Vissim traffic simulation software. The operation of the toll station during a specific peak-hour period was simulated with the aid of the specific software. In total, 39 alternative scenarios were developed and compared to determine the level of penetration rate for which the ETC lane would be effective for different toll booth setups. Results showed that when the right lane of the toll station is converted to ETC lane, the penetration rate of this lane must be greater the 15% for the private vehicles and 20% for the heavy goods vehicles (HGV) to reduce traffic congestion and to improve environmental conditions. It was also found that when an additional ETC lane was introduced to the existing toll station set up, traffic congestion and the associated environmental conditions were much improved even for low penetration rates. It must be noticed that the results from the use of discounted cash flow methods like internal rate of return (IRR), net present value (NPV) and benefit–cost ratio (BCR) showed that all economic indicators converge as penetration rate increases in all toll booth setups. Therefore, there is a specific penetration rate threshold above which the economic viability of the investment is secured. These findings can assist the design of an effective policy in terms of the optimized operation of a toll station and sustainable mobility planning.

Identification of Technoeconomic Opportunities with the Use of Premium Efficiency Motors as Alternative for Developing Countries

More than 65% of electricity consumed worldwide by the industrial sector is used in electric-motor-driven systems. For this reason, the efficiency of electric motors is an important factor in improving the energy efficiency of the industry. Additionally, this contributes to reducing energy consumption, production costs, as well as CO2eq emissions. The replacement of motors with efficiency class IE1 by motors of efficiency class IE3 is one possible alternative to increase the efficiency of electric motor systems. When a program to replace motors with others of greater efficiency is initiated, it is necessary to casuistically evaluate all identified opportunities. Economic viability can be evaluated using a variety of methods. Often, the methods recommended by manufacturers or consulting entities focus on simple payback time without accounting for all influencing factors. This paper contributes to the academic discussion by proposing a methodology based on the calculation of energy-saving potential, by performing a preliminary an a priori evaluation and determining the economic opportunities. It avoids evaluating all motors in the studied facility and shows its effectiveness by using the cost of energy saved to distinguish which motors to evaluate. Finally, it provides a complete economic evaluation of the final decision on the basis of discounted cash flow methods. A short-production-cycle sugarcane industry was used in the case study.

The impacts of real options analysis on EU co-financing policy: the case of Ponta Delgada Port in the Azores

Under the EU's cohesion policy, even if investments have negative net present values, they can be co-funded if they are critical for a region's development and economic and social cohesion. Ponta Delgada Port, the most important maritime infrastructure in the Azores, is struggling to keep pace with its growing activity due to its limited capacity. Investment plans to expand its capacity were drawn, but the traditional discounted cash flow method showed that the investment should not be deployed. However, the project will generate positive effects in the economy. The framework used by the EU to figure co-funding rates does not incorporate the flexibility factor. This study uses real options analysis to assess the investment and its potential impact on the EU's co-financing policy. The hypothesis is that real options analysis can result in lower co-funding rates compared to the method currently used by the EU. The results support this hypothesis.

FINANCING OF RESIDENTIAL ROOFTOP PHOTOVOLTAIC PROJECTS UNDER A NET METERING POLICY FRAMEWORK: THE CASE OF THE COLOMBIAN CARIBBEAN REGION

The inclusion of photovoltaic energy in the Colombian energy matrix has had several difficulties due to the lack of energy policies and regulations in renewable energy projects. The lack of government support with subsidies that extend the coverage of PV energy projects in residential areas has made the collection of funds more challenging. This paper presents a techno-economic analysis for the implementation of grid-connected photovoltaic projects on the roofs of residential areas, under the net metering policy framework. For the profitability analysis, the discounted cash flow (DCF) method was used. The revenues were obtained from the forecasts of the electrical power production of the PV system, based on the characteristics of the Colombian Caribbean Region. For this purpose, the meteorological data (2013-2017) of this region were used as an input for the calculation of the economic benefits that can be achieved with the implementation of PV systems. Based on the technical sizing and economic assumptions, it was proved that the DCF method allows to accurately determine the optimal debt ratio. After evaluating the three scenarios proposed, it was demonstrated that profitability and self-sustainability, with investment from creditors, is obtained from the implementation of PV systems of at least 3 kWp.

Evaluation of the introduction of a hydrogen supply chain using a conventional gas pipeline–A case study of the Qinghai–Shanghai hydrogen supply chain

A large-scale hydrogen supply chain is an alternative for the transportation of energy generated from a renewable energy source. Utilizing this technology would drastically improve the generation of clean energy. Therefore, an analysis method to estimate the economic and environmental benefits of the introduction of a hydrogen supply chain using an existing pipeline is developed. The proposed method first estimates the energy and exergy flows in the system to calculate the overall efficiency of these quantities. Afterward, the payback period is estimated based on the overall energy efficiency using the discounted cash flow (DCF) method. The overall efficiency of the system, based on the energy analysis presented, would seem to be the final delivered electrical, fuel and useable heat energy delivered to end use divided by the input solar and wind energy. Furthermore, the environmental effects due to the introduction of the systems are evaluated considering the reduction of global warming and air pollution gases, such as CO2 and PM2.5. The proposed analysis method was applied considering a natural gas pipeline that connects Qinghai and Shanghai. As a result, conversion ratios of 24.9% for electricity and 17.5% for heat were achieved, with the overall efficiency of the system of 42.4% based on the electricity obtained from photovoltaics. 3.02 Gt of CO2, 104 kt of SOx, and 134 kt of NOx, which represent 3.3%, 0.5%, and 0.6% of the annual discharge in China, respectively, and 8.66 kt of PM2.5 would be reduced every year. Furthermore, a reduction of 953 Mt in coal consumption is expected. The payback period of the proposed system using the DCF method is 4.17 and 2.28 years for the two alternatives evaluated in this work. The cash flow of the DCF is influenced by installation cost and operation cost of equipment.

Multi-Year High-Voltage Power System Planning Considering Active Power Curtailment

Integrating active power curtailment (APC) of renewable energy sources (RES) in power system planning reduces necessary investments in the power system infrastructure. In current target grid planning methods, APC is considered by fixed curtailment factors without considering the provided flexibility to its full extent. Time-series-based planning methods allow the integration of the time dependency of RES and loads in power system planning, leading to substantial cost savings compared to the worst-case method. In this paper, we present a multi-year planning strategy for high-voltage power system planning, considering APC as an alternative investment option to conventional planning measures. A decomposed approach is chosen to consider APC and conventional measures in a long-term planning horizon of several years. The optimal investment path is obtained with the discounted cash flow method. A case study is conducted for the SimBench high-voltage urban benchmark system. Results show that the time-series-based method allows for reducing investments by up to 84% in comparison to the worst-case method. Furthermore, a sensitivity analysis shows the variation in total expenditures with changing cost assumptions.

Total Beta—Where Does It Fit in Valuation Theory

The valuation of any company by the discounted cash flow method is divided into two different tasks: forecasting cash flows and discounting these same cash flows using the appropriate discount rate. The latter requires a good understanding of the risks faced by the subject company's cash flows to be able to determine the appropriate risk premia to compensate a typical willing buyer and satisfy a typical willing seller. There is a high level of ambiguity and dispersion of opinions about how to quantify these risks especially when valuing closely held companies. To avoid dealing with the task of identifying and measuring components of the appropriate risk premia for the subject company, some practitioners have turned to a measure that, supposedly, lumps all risks together (which they term Total Beta) and purportedly then allows one to estimate a total cost of equity. The proponents of total beta believe that by using a “total risk” beta there is no need to consider size premia, lack of marketability premia or company specific risk premia. Critics of total beta argue that there is no theoretical basis for total beta as a measure of total risk. This paper argues for the camp of the critics of total beta because we believe it represents a major departure from finance theory and does not adjust the cost of capital correctly for Company Specific Risk. Then, we examine academic research to show that the two major arguments used by total beta proponents to discredit the existing model do not hold. We do not argue that the existing models are absolute truth. We recognize the limitation of the CAPM and/or Modified CAPM models and we admit their inability of answer all questions regarding the cost of equity. However, we believe that total beta is not a step in the right direction.

Providing a Framework for Testing the Reasonableness of Terminal Period Cash Flow Investments

Whether using the traditional Gordon Growth formula or the value driver formula, it is common for a valuer to neglect testing the reasonableness of the capitalized free cash flow used in determining the terminal value and, therefore, derive a terminal value that is incorrect. This is troubling considering how important the terminal value is when concluding an equity value; the terminal value most often accounts for a majority of the concluded enterprise value when applying the Discounted Cash Flow method. The purpose of this article is to provide a framework for testing the reasonableness of the amount of terminal cash flow that is reinvested to support the operations into perpetuity. In general, there are three potential areas for a company to reinvest into its future operations: (1) net working capital, (2) purchases of property, plant, and equipment (PP&E), and (3) other investments (e.g., research and development [R&D]). Our article provides an overview of a suggested method for analyzing and calculating the appropriate amount of investments in net working capital and PP&E under the Gordon Growth formula. We also provide an example analysis to illustrate potential issues resulting from expensed investments (e.g., R&D) when applying the value driver formula.

From point through density valuation to individual risk assessment in the discounted cash flows method

AbstractWe review the developments and practice of the discounted cash‐flow method in finance with an intermediate goal of presenting parsimonious methods of generating density valuation rather than point forecasts. Our ultimate aim is to select, propose and discuss some density‐based risk measures that may be used by appraisers and investment analysts when conducting discounted cash‐flow valuation for broad group of heterogeneous (by risk appetite) final users or investors. Such a toolbox may be applied directly by the latter group without necessity to rely on aggregated point valuations and recommendations.

On the Differential Analysis of Enterprise Valuation Methods as a Guideline for Unlisted Companies Assessment (I): Empowering Discounted Cash Flow Valuation

The Discounted Cash Flow (DCF) method is probably the most extended approach used in company valuation, its main drawbacks being probably the known extreme sensitivity to key variables such as Weighted Average Cost of Capital (WACC) and Free Cash Flow (FCF) estimations not unquestionably obtained. In this paper we propose an unbiased and systematic DCF method which allows us to value private equity by leveraging on stock markets evidences, based on a twofold approach: First, the use of the inverse method assesses the existence of a coherent WACC that positively compares with market observations; second, different FCF forecasting methods are benchmarked and shown to correspond with actual valuations. We use financial historical data including 42 companies in five sectors, extracted from Eikon-Reuters. Our results show that WACC and FCF forecasting are not coherent with market expectations along time, with sectors, or with market regions, when only historical and endogenous variables are taken into account. The best estimates are found when exogenous variables, operational normalization of input space, and data-driven linear techniques are considered (Root Mean Square Error of 6.51). Our method suggests that FCFs and their positive alignment with Market Capitalization and the subordinate enterprise value are the most influencing variables. The fine-tuning of the methods presented here, along with an exhaustive analysis using nonlinear machine-learning techniques, are developed and discussed in the companion paper.

A Real Options Approach to Valuate Solar Energy Investment with Public Authority Incentives: The Italian Case

Solar energy investment represents currently a valid reason to support sustainable economic development. In fact, over the last few years, governments have applied different measures to incentivize private consumers and firms to use renewable energies. Photovoltaic (PV) projects are characterized by uncertainty due to meteorological conditions, the unpredictable behavior of government, and managerial flexibility. Since the Net Present Value (NPV) approach is not able to capture these uncertain factors, it was replaced with the Real Options Approach (ROA). The latter method manages to embed flexibility in PV investment using binomial trees. This paper valuates PV investment in all regional areas in Italy using an integrated approach between the discounted cash flows method and real option value, called Expanded Net Present Value (ENPV). We fit the probability of tax benefits into a binomial lattice model after analyzing the geographical position and weather conditions of all regional capitals of Italy. The results show that the cities with high irradiance/temperature have positive NPV and high investment values. On the other hand, while most cities have negative NPV, the inclusion of the flexibility in investment decisions gives additional value to the project, making the ENPV positive and implying an attractive investment opportunity with the possibility of delaying the project. We also propose a sensitivity analysis that shows how the real option value changes when incentive policies of the government become more attractive. This paper contributes to the existing literature in the way of considering financial, meteorological/geographical, and political factors to valuate PV investment.

Determination of Business Port Terminal Value Using Income Approach

Under PT X’s long-term plan to increase the company’s value, PT X plans to acquire one of PT Y’s container terminal business units. The acquisition requires several stages of the process from due diligence to estimation of the acquisition value obtained from the valuation results. Business valuation as a critical stage is a process to produce an opinion or an estimate of the fair value of a company. The results of the business appraisal can then be used in investment \\ decision making, generally for business development, mergers, and acquisitions. There are 3 (three) approaches in conducting business valuation, namely asset-based approach, market-based approach, and income-based approach. This research will focus on the company’s acquisition plan using income approach (income-based approach). This approach is used by considering the going concern assumption, or the business that is being assessed will continue to run and generate revenue. Two methods can be used to determine the value of a business in income approach (Income-based approach), namely the method of income capitalization (capitalized of income method) and discounted cash flow method (discounted cash flow). This study aims to determine the business value of PT Y’s container terminal business unit and the maximum acquisition value used as a consideration in the acquisition. This research uses an income-based approach with a discounted cash flow (DCF) method. The making of financial models begins with making a profit and loss terminal container service projection, then the free cash flow calculation is performed. Furthermore, based on the free cash flow that has been calculated with a discount rate from the Weighted Average Cost of Capital (WACC) which provides the total value of all company capital, the company value that represents the value of the container terminal unit is Rp. 9,171,633,437,067. To find out the maximum acquisition value obtained by calculating the company’s return on investment that refers to the cost of capital of PT X. To get a positive rate of return, the IRR value must be greater than the WACC. Under the calculations, the maximum acquisition price of Rp. 7,500,000,000,000 (IRR 9.66%) with a WACC value of PT X of 7.6%. The results of this calculation become material in the acquisition process with PT Y as the owner of the container terminal.

Analysis of IP Valuation on Technology Food Processing as Strategy Business in New Product Development

<p class="Abstract"><em>Valuation IP of IDS000001555 analysed the economic impact and to measure the financial benefits of the asset if implemented in a business. This patent is about technology that used to produce of Mangosteen peel nano-tea. This technology is to product nano particle with ball-mill method. This research used qualitative and quantitative methods with description analysis. By using the qualitative method, this research focused on scoring of the IP in a several aspects, while the quantitative method conducted by income approach used the Discounted Cash Flow method. The qualitative method showed the technology IDS000001555 had a high opportunity and low risk value. This patent also has the best marketing strategy by a licensing agreement. However, the quantitative method showed the technology IDS000001555 had 6.1% for royalty rate with value of NPV (Net Present Value) Rp 605,227,434. It was estimated that this patent will generate the turnover of about Rp 617,000,000 for 10 years of useful economic life.</em></p><p><em>Keywords: valuation IP, economic impact, qualitative and quantitative methods, royalty rate, turnover</em></p><p class="Abstract"><br /><br /></p>

REAL OPTION ANALYSIS OF VENTURE CAPITAL INVESTMENTS

Venture capital investments play an important role in the development and growth of start-up companies that are characterized by a high degree of uncertainty and growth potential, and venture capital is also one of the major sources of financing for entrepreneurial businesses. In the case of venture capital investment, staging has a huge potential, so the venture capitalists keep the right to participate in further financing rounds. The real option approach as an evaluation method provides an opportunity to evaluate this kind of investment with the help of flexibility in the case of a high degree of uncertainty. The paper puts the emphasis on the evaluation and the effectiveness of venture capital investments primarily from the aspect of real option theory tested on Hungarian venture capital cases. The paper concludes that the option-based valuation methods are more suitable for evaluating venture capital investments than others, especially the discounted cash flow method.