Discounted Cash Flow Method Research Articles

An “Enhanced Multiple” Corporate Valuation Model: Theory and Empirical Tests

In this article, we develop an enhanced corporate valuation model based on the implied cost of equity capital (ICC). We argue that the enhanced method extends the standard market multiples and discounted cash flow (DCF) methods to corporate valuation. Specifically, it incorporates positive aspects of the market comparables and DCF methods while mitigating the shortcomings of both. Unlike the traditional market comparables method, the enhanced method takes account of the full-term structure of earnings forecasts. Unlike the DCF method, it does not require estimation of the cost of equity capital. While other applications of the ICC, such as using it to estimate the cost of equity capital, are reported in the literature, our approach differs in that we do not treat the ICC as a discount rate, but rather as an enhanced multiple that allows estimation of equity value for a company based on publicly available information on projections and market prices for comparable companies and publicly available projectio...

A flow-to-equity approach to coordinate supply chain network planning and financial planning with annual cash outflows to an institutional investor

AbstractA common side effect of cross-linked global economies is that well-positioned middle class companies are acquired by institutional investors, which formulate unreasonable return expectations in many cases. As a consequence, the resulting payouts are often not in line with business operations so that even world market leaders get into trouble or close down. In this context, we consider the case of a sanitary company, which had to manage the described situation after a business takeover. In order to coordinate the annual cash outflows to the investor with intra-organizational supply chain planning and financial planning, we propose a mixed-integer non-linear programming model that is based on the flow-to-equity discounted cash flow method. The objective is to maximize the present value of equity while determining annual cash outflows to the institutional investor during his engagement. As the decisions of the investor during his engagement influence possible operations of the company after his engagement, the residual value of equity (that influences the selling price) is taken into account. The modeling is based on cash flow series, which result from supply chain operations and restructuring on the one hand, and from financial transactions on the other. Financing is characterized by interest rates depending on the time period the credit starts, the credit period, the debt limit of the company and the current total debt. As the latter is a result of the optimization, non-linearity arises. Nevertheless, both the expected demand scenario and further randomly generated demand scenarios of the sanitary company could be solved to the optimum with the commercial optimization package GAMS 23.8/SCIP 2.1.1 within acceptable computation times, if capacity profiles are assigned to the locations to depict feasible and/or preferred capacity developments.

Issues on the application of IFRS9 and fair value measurement for Islamic financial instruments

Purpose This paper aims to examine some issues in IFRS9 with regards to classification and measurement of Islamic financial assets. In addition, the paper discusses the Shariah concerns on the use of fair value to measure financial assets. Design/methodology/approach This paper adopts qualitative method via the study of documents and textual analysis of Shariah opinions of scholars and relevant accounting standards. Findings The paper found that the classification and measurement of equity-based Islamic financial assets do not fit into the “default” classification category of amortised cost, as the future cash flow receivable does not constitute solely the payment of principal and interest (fixed rate payment). With regards to fair value measurement, Shariah concern arises during the adoption of fair value at Level 2 (reference of asset values from input other than quoted prices in active markets) and Level 3 (use of discounted cash flow method to arrive to asset valuation) because of the existence of in uncertainty or gharar as compared to Level 1 (fair value referred to quoted prices of similar assets). Practical implications Findings of the paper provide a starting point for a debate and extensive research on issues related to classification and measurement of Islamic financial assets and the use of fair value as a method of subsequent revaluation of Islamic financial assets. The Shariah analysis in the paper is useful for International Accounting Standard Board to engage with Islamic financial institutions and local accounting standard setters to reflect the unique nature of Shariah-compliant financial instruments. The paper serves as a basis to devise technical solutions to address accounting and reporting issues of Islamic financial instruments. Originality/value The paper offers Shariah analysis on the issue of classification, measurement and impairment model for Islamic financial assets. The paper is considered as the first paper that examines areas of possible tensions when applying IFRS9 to the accounting of Islamic financial assets. In addition, the paper has contributed to the literature in Islamic accounting and auditing.

Compound option valuation for a coal bed methane development project

There are many uncertainties in coal bed methane (CBM) projects: gas price fluctuations according to oil prices, changes of operational and capital costs, development and production lifetimes and production volume from underground conditions. It is well known that ordinary discounted cash flow method cannot consider these uncertainties. The real option method can evaluate them properly by reflecting managerial flexibility in an uncertain environment. The option valuation for unconventional oil and gas assets is thus important since a management design is the key for a successful development. In this context, a compound real option approach is applied to evaluate a CBM development project. We evaluated defer and abandon options considering the different uncertainties in an exploration stage and the other stage. The analysis results reveal expanded value of the CBM project by stage and option. We can thus provide rich information for decision-makers of energy projects through this approach.

Managing the Implementation of Strategic Projects in the Industrial Holding

Background/Objectives: The study is devoted to the influence of factors on the value of a strategic project aimed at diversification of activities and the growth of a large company is studied. Methods/Statistical analysis: The analysis of best world practices in project management, including PMBoK, PRINCE2, P2M and others has made possible the identification of the factors affecting the project costs and outcome. The economic effectiveness of two large potash projects of the Eurochem Company was evaluated on the base of discounted cash flow method. The sensitivity of the project was evaluated through the change of the key factors determining their value. Findings: The implementation of investment projects aiming at diversified growth increases the company value, which requires the calculation of common indicators and taking into account additional effects. Many factors that shape the investment project value in the mineral resources sector are divided into cost-based and value factors. The introduction of the corporate project management system allows creating a balanced portfolio of projects and programs focused on the strategic objectives of the company; monitoring the implementation of all projects and programs; controlling and coordinating the use of resources, time limits and budget of projects, creating a knowledge database of projects, increasing the efficiency of interaction between subdivisions and employees in projects and programs that should enhance the projects value and the company’s market value. According to the results the possibilities for corporate growth through the investment policy of an integrated company were identified. Applications/Improvements: The authors offer a number of project value control methods. These methods are relevant for investors and implementers of high value projects.

Evaluation and Optimization of the Financial Sustainability of Public Rental Housing Projects: A Case Study in Nanjing, China

In recent years, Chinese governments have launched ambitious plans in developing public rental housing (PRH), which are almost impossible to accomplish without the involvement of the private sector. Yet, very few quantitative studies have been carried out to evaluate the financial sustainability of PRH projects in China, especially from the perspective of the private sector. This knowledge gap is bridged through the evaluation of the financial sustainability of a hypothetical privately owned PRH project in Nanjing, China as a case study, utilizing data of a state-owned PRH project and the classic discounted cash flow method. The results indicate that the studied project is financially infeasible, which means that private companies would not be willing to participate in the provision of public rental housing, if they merely focus on profits. Then, the most cost-effective optimization measure of the studied case is quantitatively selected from four possible optimization scenarios, leading to a financial balance. This paper presents the current financial status of Chinese PRH projects, thereby providing policy makers with useful references to effectively accelerate the private sector’s provision of PRH in China.

Optimal exit dates for members of the GSF

Purpose This paper aims to determine the optimal date for an employee to initiate the pension payments from the New Zealand Government Superannuation Fund (GSF), through retirement or job shifting. Design/methodology/approach The paper uses discounted cash flow methods in conjunction with mortality tables, inflation estimates and a range of values for the yield on inflation-adjusted bonds in New Zealand. Findings The paper finds that, if job shifting is costless, then the optimal exit date is between 60 and 65. If job switching is costly, then this paper determines the effective salary reduction arising from continuing to work at the GSF-associated job beyond the optimal job switching age under costless job switching, arising from the adverse impact on the present value of the pension benefits, so as to assist in deciding when to switch jobs or retire. These effective salary reductions are small below 65 but rapidly rise after that, thereby significantly discouraging work much beyond age 65. Originality/value This paper assists GSF members to determine when to switch jobs or retire.

Estimation of Mining Project Values Through Real Option Valuation Using a Combination of Hedging Strategy and a Mean Reversion Commodity Price

Cash flows generated from mining projects are typically highly volatile and significantly influenced by a number of exogenous factors including commodity price as one of the most influential uncertainties. In addition, mining projects are complex and many of their executed investment decisions are irreversible. Therefore, management needs to address this potential risk exposure before making an investment decision. Due to the deterioration and fluctuation of mineral commodity prices for a successful mining project acquisition or development, an important and appropriate investment strategy should include a hedging strategy for reducing potential losses suffered by a company. The discounted cash flow methods, which are commonly used to calculate mining project values, often fail to respond to this identified economic uncertainty and also to incorporate de-risking hedging strategies. Therefore, this study approximates the numerical value or value ranges of a mining project considering the combination of a mean reverting commodity price and hedging strategies using continuous time modeling. A novel time-dependent partial differential equation has been proposed using a continuous time, mean reverting model, and hedging strategy to approximate the mining project value. Application of a new real options valuation technique demonstrated its superiority by providing the advantage of mitigating financial losses and procuring financial gains. In this study, some key results are deferral option and expansion option enhanced the maximum values of the project which are, respectively, 2.51 % and 4.4 % compared to the base case. Furthermore, the country risk has a great impact on project values, as when we considered the country risk premium is zero in our model, the project value increases up to 0.97 %.

The Capital Budgeting Process of Healthcare Organizations: A Review of Surveys

Several surveys have been administered over the last 40 plus years to learn about capital budgeting practices of healthcare organizations. In this report, we analyze and synthesize these surveys in a four-stage framework of the capital budgeting process: identification, development, selections, and post-audit. We examine three issues in particular: (1) efficiency of for-profit hospitals relative to not-for-profit hospitals, (2) capital budgeting practices of the healthcare industry vis-à-vis other industries, and (3) effects of healthcare mergers and acquisitions on capital budgeting decisions. We found indirect evidence that for-profit hospitals exhibited greater efficiency than not-for-profit hospitals in recent years. The acquisition of not-for-profits by for-profits is credited as the primary reason for growth of multihospital systems; these acquisitions may have contributed to the more efficient capital budgeting practices. One unique attribute of healthcare is the dominant role of physicians in almost all aspects of the capital budgeting process. In agreement with some researchers, we conclude that the disproportionate influence of physicians is likely to impede efficient decision making in capital budgeting, especially for nonprofit organizations.

A Discounted Cash Flow variant to detect the optimal amount of additional burdens in Public-Private Partnership transactions

The Discounted Cash Flow method is a long since well-known tool to assess the feasibility of investment projects, as the background which shapes a broad range of techniques, from the Cost-Benefit Analysis up to the Life-Cycle Cost Analysis. Its rationale lies in the comparison of deferred values, only once they have been discounted back to the present. The DCF variant proposed here fits into a specific application field. It is well-suited to the evaluations required in order to structure equitable transactions under the umbrella of Public-Private Partnership.•The discount rate relies upon the concept of expected return on equity, instead than on those of weighted average cost of capital, although the latter is the most common reference within the scope of real estate investment valuation.•Given a feasible project, whose Net Present Value is more than satisfactory, we aim to identify the amount of the additional burdens that could be charged to the project, under the condition of keeping the same economically viable.•The DCF variant essentially deals with an optimization problem, which can be solved by means of simple one-shot equations, derived from financial mathematics, or through iterative calculations if additional constraints must be considered.

The profile of venture capital investments: the European context

The aim of this paper is to deepen our understanding of the investment valuation process followed by venture capitalists (VCs) at the European level. Its contribution is two-fold. First, we shed light on the manner in which VCs estimate the investee company's value and operationalise the main variables involved in the practical application of the well-known discounted cash flow method. Second, we study whether the different degree of use of valuation methods across European countries may be explained by differences in institutional characteristics related to the underlying legal regime (i.e., English vs. German vs. French-based legal traditions). Using both univariate and multivariate analysis for a sample of 99 responses obtained from a survey addressed to VCs from the UK, France, Germany and Italy, we find that both legal systems and characteristics of VCs (i.e., experience, preferred investment stage, and main source of funds) do influence in the valuation methods used.

Minimum revenue guarantee and toll revenue cap optimization for PPP highways: Pareto optimal state approach

In the Public-Private Partnership highway projects the Minimum Revenue Guarantee and Toll Revenue Cap policies are effective measures for risk and benefit sharing between the government and the private sector. However, if the Minimum Revenue Guarantee and Toll Revenue Cap values are unreasonable, it may lead one part of the investors to take too much risk and financial burden. This paper mainly establishes six objectives from the return and risk perspectives of the government, the concessionaire and the overall situation respectively. Because the traditional Discount Cash Flow method does not consider the risk factors, this paper proposes to use Monte Carlo simulation and scatter search algorithm to calculate the optimal values of the Minimum Revenue Guarantee and Toll Revenue Cap under different objectives. Compared with the statistics of the Net Present Value under different cases, it was summarized that when the objective is minimizing the variance of the total Net Present Value, the investors will realize the Pareto optimal state between the return and risk. In addition, it was found that the government is more sensitive to the Minimum Revenue Guarantee and Toll Revenue Cap marginal values according to the sensitive analysis. Therefore, the model has an effect on improving the fairness of the risk sharing measures, reducing the financial burden of the investors especially the government, and increasing the investment attraction of the private sectors.

The advantage of using external financing (leverage) to design/build/operate a new chemical plant

This research note includes a significant theoretical extension and minor errata for an earlier publication [Mellichamp, DA. New discounted cash flow method: estimating plant profitability at the conceptual design level while compensating for business risk/uncertainty. CACE 2013; 48:251–63.]. A closed-form theoretical expression is developed that provides a direct estimate of the financial advantage to be obtained by using outside financing rather than internal (enterprise) funds to build a chemical plant. Emphasis is at the conceptual design level, where the reduction in financial profitability (ROIBT) required to justify further work on a project is developed in terms of the financial parameters (enterprise rate, construction rate, bond rate, etc.). An unexpected outcome is that the reduction in required profitability is independent of any specified risk cushion (NPV%) or long-term profitability (NPV); it is solely a function of background financial market rates and project internal timing assumptions vis-a-vis the enterprise’ historic rate of return.

An economic evaluation method of coalbed methane resources during the target selection phase of exploration

Because forecasting a development program during the target selection phase of exploration for coalbed methane (CBM) is impossible, the conventional method that relies on a conceptual (or detailed) development program cannot be used during the economic evaluation of CBM resources. Hence, this study focuses on establishing an economic evaluation model based on the characteristics of the target selection phase. The discounted cashflow method is applied to the construction of the model with the assumption that there is a uniform distribution of production wells. The computational error generated by the assumption is corrected by introducing a correction factor based on the production profile of single CBM wells. The case study demonstrates that the blocks lacking economic value can be screened out, and the most advantageous targets can be found by computing the resource values in the best- and worst-case scenarios. This technique can help to reduce wasted investments and improve the quality of decision-making in selecting targets for exploration.

Earnings Management and Valuation of Biological Assets

The use of fair value to measure the worth of biological assets allows discretionary choices when using discounted cash flow in the absence of an active market, influencing the quality of accounting information. The objective of this study was to investigate evidence of earnings management among Brazilian companies that have adopted fair value based on the discounted cash flow method. The firms were investigated with regard to: a) disclosure of the discount rate, b) BMF and c) adherence to disclosure requirements in the Brazilian accounting standard CPC 29 (IAS 41). We analyzed 31 firms with significant biological assets from 2010 to 2012. The earnings management measurements were calculated according to the modified Jones, the Teoh, Welch and Wong (1998), and the KS models. The Mann-Whitney test of the means was applied and revealed evidence of greater earnings management for companies that use discounted cash flow, and the ones that least meet CPC 29 disclosure requirements, considering the KS model estimates. Regarding the other proposals, testing did not offer enough evidence of differences in discretionary accruals. In this sense, only hypotheses 1 and 4 are partially accepted, demanding more research in this area. We also present evidence in favor of adopting Exposure Draft ED/2013/08 Agriculture: Bearer Plants, Proposed amendments to IAS 16 and IAS 41, which proposes to measure biological assets at cost, because firms already following these rules showed lower earnings management in this study.

Building integrated bioenergy production (BIBP): Economic sustainability analysis of Bari airport CHP (combined heat and power) upgrade fueled with bioenergy from short chain

Harnessing biomass-derived energy can improve environmental and economic sustainability of a Combined Heat and Power production. The paper presents a new decision making policy and its application in meeting the energy up-grading needs of the Bari airport (300 kWe), based on an economic-environmental analysis related to the use of different bioenergy from short chain (<70 km). The main aim of this paper is to demonstrate how a “Zero Kilometer Energy” design model in a CHP plant represents a more sustainable alternative to the conventional approach, in terms of impacts on the local socio-economic system. The study has been carried out in order to promote a synergistic and sustainable relationship between a territory and the infrastructures that service it, in terms of energy supply chain. For this purpose, three different bioenergy production systems (biomass from wood waste, vegetable oil/biodiesel and biogas from food waste) harnessing local agro-energy resources in Apulian region (Italy) were analyzed. The analysis has been integrated by a DCF (Discounted Cash Flow) Method, identifying the economic feasibility to make an informed choice. Finally the theoretical paybacks under different governmental incentive schemes, from 2012 to 2015, have been calculated along with estimated carbon savings to highlight the energy market trends for the different biomass resources.

ПРОБЛЕМЫ ОЦЕНКИ СТОИМОСТИ БИЗНЕСА ПРЕДПРИЯТИЙ МЕТОДОМ ДИСКОНТИРОВАНИЯ ДЕНЕЖНЫХ ПОТОКОВ

ПРОБЛЕМЫ ОЦЕНКИ СТОИМОСТИ БИЗНЕСА ПРЕДПРИЯТИЙ МЕТОДОМ ДИСКОНТИРОВАНИЯ ДЕНЕЖНЫХ ПОТОКОВ

Valuation of a Typical Nigerian Crude Oil Reserve Using Real Option Analysis

The activities of the oil and gas industry are flooded with myriads of uncertainties and huge capital investments, right from the initial lease acquisition phase to abandonment. During each of these phases, an oil and/or gas company is confronted with a number of decisions, and accuracy in making these decisions is one of the major factors that determine the profitability, survivability and growth of such firms. Therefore, a firm faces pressure to accurately quantify and incorporate the risks and uncertainties that evolve during each of these phases in order to properly value its assets. It has been recently discovered that the most popular decision criterion, the Discounted Cash Flow (DCF) which is expressed as Net Present Value (NPV) amidst other traditional methods, is not particularly suitable for the valuation of oil and gas assets or projects because it neglects managerial flexibility and does not appropriately incorporate uncertainties and risks. These deficiencies in the DCF method necessitate the development of better valuation methods, which properly account for uncertainty in the valuation of a developed oil reserve. In order to solve this problem, this paper considers the following questions: 1 What are the factors to consider when valuing an undeveloped and a developed reserve? 2 Which factor constitutes the primary source of uncertainty in the two types of reserves? 3 How are the terms of the appropriate valuation model determined?

LTE techno-economic assessment: The case of rural areas in Spain

This paper evaluates whether it is feasible for an LTE operator to deliver a 30Mbps fixed service in rural areas in Spain and if this is not the case, whether passive network sharing could make it feasible, since this is in fact one of the objectives set out in the Digital Agenda for Europe and a key issue in the national broadband strategy. The research is conducted through a techno-economic assessment in an infrastructure competition scenario. A discounted cash flow method is used to determine the total cost of the deployment for the operator and the minimum average revenue per user (ARPU) which would be required to recover the investment in both approaches: passive network sharing and non-sharing. On the other hand, the three demand scenarios that were considered, depending on the envisaged Spanish broadband penetration by 2020, attempt to calculate what take-up and ARPU are likely in the targeted rural areas. As mobile operators׳ coverage obligation stipulates covering 90% of the municipalities with less than 5000 inhabitants, extreme rural areas, which correspond to the final 0.7% of the population, are excluded from this assessment. The results indicate that, given the socio-economic characteristics of the assessed area, demand is very sensitive to price and that the existence of other broadband products forces the operator to lower the ARPU. As a result, only very high take-up ratios would make the deployment feasible. The research shows that passive network sharing does not constitute a solution; nevertheless, a single network deployment could solve the unfeasibility problem in rural areas.

Methods for calculation of compensation for expropriation of a foreign investment

A legal expropriation of a foreign investment without exception includes an obligation of the host state to pay the investor an appropriate compensation for the taking. Bilateral treaties for protection and encouragement of investments which usually serve as a normative basis for arbitration of expropriation disputes contain provisions instructing contracting states to provide 'adequate', 'just' compensation or to pay the compensation in 'full' or 'genuine' value of the expropriated investment etc. However, the sole existence of the standard for payment of compensation is not by itself enough for establishing the precise sum of compensation in particular cases. This purpose is served by mathematical methods of calculation employed used in judicial and arbitral practice. The paper contains an overview of the most important methods for calculation in practice: the market value method, the discounted cash flow method and the book value method. It also identifies the differences between situations in which different methods are used and explains how the nature of an investment and circumstances of particular case affect the choice of a particular method by the arbitral tribunal.