Periodic Cash Flows Research Articles

Unjust and Unreasonable: Misuse of the Dividend Growth Model in Public Utility Rate Setting

The dividend (Gordon) growth model (DGM) is a simple stock valuation equation in four variables: (1) price; (2) next-period cash flow; (3) a perpetual and constant rate of growth in the periodic cash flow; and (4) a perpetually-constant discount rate. The DGM can be expressed to equate the perpetually-constant discount rate to the cash flow yield on the current price plus the perpetual growth rate in the periodic cash flow. But that expression would provide a reliable estimate of a real-world discount rate only if both the cash flow yield and the growth rate used as inputs to the model were perpetually constant. In rate-regulation proceedings, however, utility expert witnesses use the DGM with current (not perpetual) dividend yields and analysts' 3-5 year (not perpetual) earnings growth rates. This practice contributes to approved equity cost of capital awards above plausible cost of capital estimates, shifting wealth from rate payers to utilities.

Drivers of farm business capital structure and its speed of adjustment: evidence from Western Australia’s Wheatbelt

The viability and profitability of a farm business can be influenced by how it chooses to fund its operations and capital investments either using debt or internal funds. This study examines the determinants and speed of adjustment of the capital structure of broadacre farm businesses in Western Australia’s Wheatbelt. Results show that prior period cash flow and equity, farm size and farm location are significant determinants of observed capital structures. Farm businesses are found to quickly adjust their capital structure to desired target levels, suggesting that adjustment costs are not high. The findings support the view that there is a pecking order in the choice of how farm businesses fund working capital and capital investments.

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.

Risk control in maritime shipping investments

In this paper we extend the state-of-the-art stochastic programming models for the Maritime Fleet Renewal Problem (MFRP) to explicitly limit the risk of insolvency due to negative cash flows when making maritime shipping investments. This is achieved by modeling the payment of ships in a number of periodical installments rather than in a lump sum paid upfront, representing more closely the actual cash flows for a shipping company. Based on this, we propose two alternative risk control measures, where the first imposes that the cash flow in each time period is always higher than a desired threshold, while the second limits the Conditional Value-at-Risk. We test the two models on realistic test instances based on data from a shipping company. The computational study demonstrates how the two models can be used to assess the trade-offs between risk of insolvency and expected profits in the MFRP.

Does Mandatory Adoption of IFRS Enhance Earnings Quality? Evidence From Closer to Home

The global accounting convergence and the often discussed probable adoption of International Financial Reporting Standards (IFRS) by U.S. regulators is a timely topic. We contribute to the literature by examining a more recent mandatory IFRS adoption by Canada. Canadian GAAP (CGAAP) is often considered a close substitute for U.S. GAAP. One key feature of this setting is that two earnings numbers are available for fiscal year 2010 since Canadian firms were required to reconcile earnings under CGAAP with earnings under IFRS. We run a “horse race” of earnings quality between earnings under CGAAP and IFRS. We find that on average, relative to IFRS-earnings, earnings under CGAAP have greater association with next period cash flows and higher degree of persistence. Further, when the difference between earnings under CGAAP and IFRS is large, IFRS-earnings are less value-relevant and less persistent. These results strongly support the notion that higher earnings quality is associated with CGAAP. Finally, the results also indicate that differences between CGAAP and IFRS with regard to accounting for financial instruments and investments significantly impair the quality of IFRS-earnings. Our findings are potentially informative to any revival of policy debates on the possible adoption of IFRS by U.S. firms.

Business Model Innovation or Imitation? Strategy Study Based on Real Option Game Theory

The business model is constantly changing in the enterprise life cycle. A large number of studies show that business model innovation enables enterprises to improve their processes and operation modes, reduce costs, create new markets, improve market efficiency, gain competitive advantages, and achieve higher value and business performance. However, since returns on business model innovation are uncertain and business model innovation can easily be imitated by competitors, it is more difficult to evaluate the value of business model innovation. This paper solves the problem of business model innovation or imitation strategy choice under uncertain conditions by constructing a real option game model. The model is based on the assumption of a duopoly market, namely when enterprise A carries out business model innovation, enterprise B can choose to innovate alone or imitate in the middle period. The results of two-stage binary tree analysis show that the value of business model innovation or imitation is only related to enterprise market share α and base period multiple I（a ratio of base period cash flow to innovation investment）. When the base period multiple is very high and the enterprise shares are not much different, business model innovation is the best choice for both the two companies. When the base period multiple is medium and the enterprise shares are not much different, it is possible that there is a combination of equilibrium strategies that the small enterprise participates in business model innovation and the large enterprise business model imitation. When the base period multiple is not low and the enterprise shares are much different, there is a ‘pig game’ that large enterprise participates in business model innovation, and the small enterprise business model imitation; when the base period multiple is low, both small and large enterprises do not have the motivation for innovation. Therefore, business model innovation or imitation needs to take current market shares and initial returns of a project into account. This paper expands the application of real option, which is of great significance to the construction of business model innovation value evaluation model. In the field of business model innovation, theoretical concept construction, measurement scale development and empirical research have been basically completed, which focus on the impact of business model innovation on business performance. Few studies have analyzed the value of business model innovation from the perspectives of mathematical models and game theory, so it is a relatively new perspective to evaluate the value of innovation and imitation by using the real option game theory. Business model innovation is a systematic change, which is more complex than common project investment. This paper highlights consideration of uncertainty and opponent decision-making, which is more in line with the actual situation. On the other hand, the existing research on real option mostly adopts Black-Scholes option pricing method. However, the returns on business model innovation are sustained, belonging to American-style option, so we adopt the binary tree pricing method to take the revenues during the project period into account, providing a directional basis for future research and development. In the existing literature, the NPV method is commonly used in enterprise investment analysis and business model profit forecasting. The real option game has not been widely used, and more researchers are required to enrich the method for more rational use in practice. Firstly, the problem becomes more complex and closer to reality when considering multiple actors and multiple policy choices. When the binary option is exceeded, the binary tree method will not be applicable. Secondly, another complicated task is about the measurement of uncertainty in real option. There are many factors that have risks. It is a future research direction for scholars to unify them into one variable or independent comprehensive analysis of multiple variables.

Banking system reform and investment–cash flow relation: Case of a small transition economy

This research examines the effect of banking system reform which is measured by foreign bank's presence on investment–cash flow relation in a context of a small transition economy. The U-shape relation between investment and cash flow is found. We also find evidence that the presence of foreign banks in Vietnam results in decreasing in dependence on local banks and has changed corporate investment behaviors. Company investments are less reliant on internal cash flow in the post reform period. Although overinvestment of state controlled firms is not reduced but underinvestment problem of non-state-controlled listed firms is mitigated due to better accessibility to bank loans. The investigated relation between investment and leverage is robust for this conclusion.

Effectiveness of Book Closing Using Web Based Accounting Online System 2.0 to Know the Company's Financial Ratios

Financial ratios are very important in a company, because it is the most effective way to find out financial data on a company by comparing the current financial statements of the company with the previous one. To facilitate this comparison, book closure can be done. Closing the book itself is useful to determine the company's financial position before closing, by looking at the final results of the profit and loss. It is known that the process of closing the book takes a long time with extra precision. However, this has become easier by using WBAOS (Web Based Accounting Online System) 2.0, because companies are more flexible in preparing financial statements, starting from the lane balance sheet, income statement, to the periodic cash flow, where this cash flow provides relevant information regarding cash in and out of the company.
 
 Keywords: ​WBAOS, Financial Ratios and Book Closure.

The Real Problem with Appraisal Arbitrage

In the controversial practice of appraisal arbitrage, activist investors buy up the shares of a corporation to be acquired by merger in order to assert appraisal rights challenging the price of the deal – which may already have been approved by the target stockholders. The practice is controversial because the appraisal remedy is widely seen as intended to protect existing stockholders who are (or will be) forced to sell their shares in the merger – because the majority rules. But the real puzzle is why appraisal arbitrage is profitable since the goal of an appraisal proceeding is to determine the fair price of target shares using the same techniques of valuation used by financial professionals who advise the parties to such deals. Thus, commentators have argued that the profit derives from (1) a free option to assert appraisal rights at any time until target shares are cancelled (and indeed for short time thereafter), (2) the award of pre-judgment interest at a too-generous rate, and (3) the use of a too-low supply-side discount rate in the valuation of shares. As shown in this article, none of these explanations has merit, but the third may be on the right track in that it has become almost standard practice among appraisal courts to reduce the discount rate by the projected rate of inflation and general economic growth for the so-called terminal period beyond five years into the future. The fallacy in doing so is that the discount rate implicit in market prices already incorporates these factors because investors demand and expect returns commensurate therewith. While it may be appropriate to adjust the terminal period discount rate for company-specific growth funded by the plowback of returns at a rate implicit in projected terminal period cash flow, it is incorrect to assume that growth will simply happen in lock-step with the economy as a whole. Thus, appraisal arbitrage is likely encouraged by awards that are skewed to the high side by erroneous valuation practices.

Money-Weighted Rates of Return that are Better than the IRR - What I've Learned from the Academics Part 1

Common knowledge is that the IRR is some sort of an average rate of return but, in fact, it is a constant rate of return. The distinction may sound immaterial, but the IRR’s fixation on a constant rate of return is a major shortcoming. The fact that, in certain circumstances, it can result in multiple solutions or no solutions is well-known, but is deemed unlikely enough as to be inconsequential to most. However, what is not well known at all is that, in forcing the rate of return to be constant for each cash flow period, in essence, IRR is concocting interim valuations for the investment that contradict the true valuations of the investment at the end of each and every cash flow period that have likely either been estimated (e.g., real estate appraisals) or may even be precisely known (e.g., stock prices). Less obvious, but no less valid, is that these concocted values render the constant IRR result artificial which, in this case, is another way of saying that the IRR is simply the wrong rate of return answer.Where IRR’s more subtle failings are more evident is when one attempts any sort of attribution, even if only informally, meaning that one wants to reconcile how the IRR result has changed when either another asset has been added to the portfolio or when another time period has been added to the investment horizon. In short, the requirement of IRR to always produce a constant answer for each cash flow period forces it to retroactively ‘change its mind’ about the values of the assets in all prior time periods. This chameleon-like property of IRR is a serious flaw that, in effect, makes IRR unworkable for any sort of incremental analysis.Fortunately, in 2011, a more flexible money weighted rate of return (“MWRR”) metric was created by a scholar named Carlo Alberto Magni [see Magni, 2011], a metric which avoids all of the IRR’s flaws by computing a simple 'weighted-average' of the periodic rates of return which, as a result of the aforementioned information on periodic valuations of the investment, are inherently variable. Not only is this metric simpler to calculate in that it does not require a computer iterating in search of a solution; but, in fact, it can be calculated on the back of an envelope. Yet, it has none of the problems that the IRR has, the most prominent one being that, unlike the IRR, it always produces a single, unique rate of return solution.

Sustainable financial reporting practice in Australian companies - does quality matter?

This study explores whether accounting and disclosure quality have been achieved in the current reporting practice (i.e. post-IFRS period) in Australian non-financial listed companies and whether stock market is sufficiently responsive (i.e. value relevance) to quality accounting numbers. Given the role of IFRS in enhancing reporting quality, it explores whether post-2005 reporting practice sufficiently effective (i.e. sustainable) in mitigating earnings management concerns of the investors and stakeholders’ at large, as well as explaining predictive value and return under the current regulatory environment. Applying GLS regression in a full sample of 2000-2014 and sub-samples of pre-IFRS and post-IFRS adoption periods, we document that accounting quality has been improved marginally in explaining change in profitability and cash flow in post-IFRS period as compared to pre-IFRS period. However, there is no significant progress in explaining change in receivables and sales between the pre and post-IFRS periods. Despite expectation of high value relevance of accounting information in post-IFRS period, our results suggest the opposite, i.e. value relevance is either disappeared or counter active in post-IFRS period as compared to pre-IFRS period. However, significant accounting quality improvement is observed in restraining earnings management practices in post-IFRS period. Overall, the findings highlight a mix representation of accounting/disclosure quality in post-IFRS period, which suggest that accounting quality still remains as a matter of concern in delivering quality financial reporting. Our findings raise questions, in an asymmetric information environment, about long-term decision usefulness of accounting numbers and sustainable financial reporting practice in Australia. Policy makers, regulators, accounting standard setters, investors and other stakeholders should understand that for Australian companies the accounting quality journey has not fully achieved yet as per expectation even after adopting IFRS and more to be done in this direction. While some improvements are commendable, further road-map is warranted for sustainable financial reporting practices in Australian companies.

Does Mandatory Adoption of IFRS Enhance Earnings Quality? Evidence from Closer to Home

Canada adopted IFRS in 2011 and firms were required to provide reconciliation from Canadian GAAP (CGAAP) to IFRS for the fiscal year before the adoption. We run a “horse race” of earnings quality between CGAAP and IFRS. Further, by making use of a natural experiment and a single country focus, our study does not suffer from potential omitted variables arising from differences in socio-economic, political, and legal environments across sample firms. We find that on average, relative to IFRS-earnings, earnings under CGAAP has greater association with next period cash flows. Further, when the difference between earnings under CGAAP and IFRS is large, IFRS-earnings is less value-relevant and less persistent. The results strongly support the notion that higher earnings quality is associated with CGAAP. Finally, our results indicate that differences between CGAAP and IFRS with regard to accounting for financial instruments and investments significantly impair the quality of IFRS-earnings.

Recognition of Future News in Earnings and Price Bubbles in Experimental Asset Markets

In this article, we use an experimental approach to examine the effect of reporting regimes on asset prices. We examine four different reporting regimes: the no recognition (NR) regime where no expected future cash flows are recognized; the full recognition (FR) regime where both the expected good news and expected bad news pertaining to the next period cash flows are recognized in current earnings; the good news recognition (GR) regime where only the expected good news pertaining to the next period cash flows are recognized in current earnings; and the bad news recognition (BR) regime where only the expected bad news pertaining to the next period cash flows are recognized in current earnings. We find that the NR, BR, and GR regimes are associated with more intense asset price bubbles than the FR regime. We also find that between the BR and GR regimes, the BR regime is associated with more intense asset price bubbles than the GR regime. Our findings shed insights about how biased (non-neutral) reporting regimes could affect the price formation process.

The relative predictive ability of earnings and cash flows

Purpose – The purpose of this paper is to examine the relative predictive abilities of current earnings (and its components) and cash flows for next period cash flows in case of Shariah-compliant companies in India. Design/methodology/approach – The study uses the list of CRISIL NSE Index (CNX) Nifty Shariah Index companies as its sample for a period of 10 years for conducting the analysis. The study utilizes the cash flow prediction models to examine the relative predictive abilities of current earnings (and its components) and cash flows for next period cash flows. Findings – The study report that contrary to Financial Accounting Standard Board assertion, current cash flows have superior predictive ability of next period cash flows than current aggregate earnings in case of Shariah-compliant companies in India. The results further show that there are no gains from decomposing earnings into accruals and cash flows in predicting future cash flows. There is no increase in explanatory power (measured by adjusted R2) when aggregate earnings are disaggregated into accruals and cash flows to predict next period cash flows. Practical implications – The empirical findings of the study will enable the Shariah compliant investors to understand the role of current earnings (and its components) and cash flows in predicting next period cash flows in case of Shariah-compliant companies in India. Originality/value – To the best of author’s knowledge, this is the first study which examines the relative predictive abilities of current earnings (and its components) and cash flows for next period cash flows in case of Shariah-compliant companies in India.

Is Mandatory Alternative Dispute Resolution a Panacea to Attain Effective Payment Dispute Resolution?

Alternative dispute resolution (ADR) techniques like mediation, adjudication, and conciliation often appear as a voluntary option in construction contracts (Cheung 2006; Chau 2007). Essentially, a neutral third party who has relevant experience is invited to give professional advice or decision based upon the evidence and pleadings provided from the disputants (Jones 2006). However, researchers pinpointed that nonbinding decision made by the neutral third party as the major shortfall of applying ADR techniques in resolving construction payment disputes (Kennedy 2006, 2008; Tanielian 2013). In construction contracts, ADR is usually set out as a method that should firstly be adopted before disputants are empowered to proceed to arbitration or litigation. Nevertheless, contract provisions in many building contracts did not restrict main contractors and employers from overriding dissatisfactory decisions made by the neutral third party (Gaitskell 2007). Because mediation, adjudication, and conciliation are not legally binding, there is minimal enforcement to protect and ensure periodic cash flow of the contractors and the subcontractors. With this background, the Housing Grants, Construction and Regeneration Act (HGCRA) was enacted in the United Kingdom in the late 1990s. Kennedy (2006) points out that the HGCRA improved the efficiency and productivity of resolving payment disputes by way of: 1. Providing a statutory right to refer disputes to adjudication, 2. Providing the right for periodic, interim or stage payment, 3. Providing a system to determine means of valuing payments, 4. Providing the establishment of the date for payment periods, 5. Prohibiting unfair terms including pay-when-paid clauses in the contract, 6. Providing limited rights to withhold payments, and 7. Providing the right of suspending performance without penalties. Many countries have followed suit and passed their own legislation to impose a statutory use of adjudication to resolve paymentrelated disputes. Australia adopted a similar piece of legislation to tackle the growing frustration and discontent of resolving payment disputes by using arbitration and litigation (Jones 2006). The Building and Construction Industry Security of Payment Act was enacted in the State of New South Wales in 1999. Other states and territories introduced similar acts during early 2000s. During the same period of time, mandatory adjudication was also introduced into countries like New Zealand and Singapore (Cheung et al. 2010). Research efforts have attempted to investigate the effect of mandatory ADR on resolving payment disputes (Gaitskell 2007; Doncaster 2008). Diverse views were obtained from these studies. Indeed, countries that do not have mandatory ADR have been undergoing different pathways to tackle the problems arising from payment disputes. In the United States, the use of ADR has been confined at the contractual level. If either of the contracting parties refuses, ADR can be bypassed. A recent study also indicated that the practitioners used to rely on sophisticated process like arbitration and litigation to resolve payment disputes (Jaffe and McHugh 2010). In Hong Kong, voluntary mediation has been introduced in the standard forms of construction contracts for public projects since the early 1990s (Cheung 2006). In 2005, the private sector followed the government’s footsteps, and voluntary mediation was for the first time included in the Joint Contract Working Committee’s Standard Form of Building Contract (Cheung et al. 2010). As such, ADR is not mandatory for resolving payment disputes. The fact that different approaches are used to tackle payment disputes makes it interesting to study the underlying reasons. Studies from jurisdictions with statutory ADR suggested diverse views of mandatory use of ADR in construction dispute settlements (Jones 2006; Ndekugri and Russell 2005; Chau 2007). Case studies conducted in Australia indicate that the time limits for responding to claims through adjudication are too restrictive (Jones 2006). Similar findings were reported in a case study conducted in the United Kingdom (Ndekugri and Russell 2005). The findings indicate that some clients defied their subcontractors’ right to adjudicate. Furthermore, the adjudicator’s decisions may not be enforceable (Ndekugri and Russell 2005). Although agreeing that statutory ADR is a practical and equitable solution for resolving construction disputes, Chan (2006) asserted that the legislation inevitably violated the doctrine of freedom of contract in Singapore. As such, is mandatory adjudication a panacea for attaining effective payment dispute resolution? This special issue is aimed at publishing a collection of papers representing current research in payment dispute resolution. It focuses on the practices of payment dispute resolutions; analysis of payment in disputed cases; studying the practicability of the Security of Payment Acts and the like in various jurisdictions; the roles of adjudicators in resolving payment disputes; and the design and application of a decision support model/system in resolving payment disputes. Hopefully the articles published in this special issue can help to gain insights and shape future research direction in resolving payment-related disputes in construction projects.

Significance Of Residual Value In Asset Valuation

Abstract The construction of residual value is a key element of income methods in asset valuation. Its main task is to include asset value at the end of the forecasted cash flow period. Although it is common to apply simplified models of residual value in valuation practice, its meaning in shaping the final outcome is substantial. The aim of the article is to emphasize the role of using an appropriate formula in determining residual value in the valuation process. Moreover, alternative methods of estimating residual value will be presented together with scenarios of applying them.

On Regret Theory, and Framing Anomalies in the Net-Present-Value and the Mean-Variance Models.

Investment Decision Analysis using NPV and or the Mean-Variance Model has become the primary method of investment evaluation. However, these approaches are deeply flawed and are very sensitive to the time horizon, the signs of the periodic cash flows, and discount rates that exceed 100% or are below -100%; and do not account for Real Options, Regret or Rejoice in decision making. This article contributes to the existing literature by: i) explaining behavioral and psychological biases inherent in financing decisions which contradict the NPV-MIRR model, ii) explaining existing and new Framing Effects inherent in the NPV-MIRR model – and critiquing Iturbe-Ormaetxe, Ponti, Tomas & Ubeda (2010); iii) surveying the recent and relevant literature on Regret Theory which explain how Regret Theory can serve as an alternative to the NPV-MIRR model for decision making; iv) explaining how the use of the NPV-IRR model is similar to ultimatum games and Rights-of-First-Refusal (ROFR) and critiquing Grosskopf & Roth (2009); v) explaining the biases and Framing Effects inherent in the Mean-Variance model.

The pricing and valuation of swaps

Swaps are financial agreements between two parties to exchange period cash flows and are mostly used as a tool for hedging risk and speculation. They are derivative contracts that derive their value from an underlying asset (the most common underlying assets are the interest rates in the plain vanilla case, but it can be almost anything). These OTC products (over the counter) are traded directly between the two parties or with a financial institution acting as an intermediary. Some banks in Serbia already offer these derivative instruments, but the markets are still in an emerging phase. The private sector is severely affected by credit and interest rate risk which currently lacks sufficient knowledge and understanding of such products and their importance. This paper aims to present and demystify the structure of these financial derivatives by presenting their valuation methods and by showing how they are used in practice. Ultimately, we shall discuss the credit risk the counterparties are facing in developed financial markets nowadays.

Accruals and the prediction of future cash flows

PurposeThe purpose of this paper is to examine the comparative abilities of current period cash flows and earnings (and its components) to predict one‐year‐ahead cash flow from operations in Egypt.Design/methodology/approachThe study uses the cash flow prediction models developed by Barth, Cram, and Nelson to examine the predictive abilities of earnings and cash flows for future cash flows. The first set of prediction models uses cross‐sectional regression to compare the predictive abilities of cash flows and aggregate earnings for one‐year‐ahead cash flow from operations. The second set of prediction models tests whether disaggregating earnings into cash flows and the major components of accruals enhances the predictive ability of earnings for one‐year‐ahead cash flow from operations.FindingsThe findings of the study reveal that aggregate earnings have superior predictive ability than cash flows for future cash flows. Also, the results reveal that disaggregating accruals into major components – changes in accounts receivable and payable, and in inventory, depreciation, amortization, and other accruals – significantly enhances predictive ability of earnings.Research limitations/implicationsThe study provides empirical evidence on the superiority of earnings in predicting future cash flows. The findings of the study should be considered in explaining the results of value relevance research Egypt. However, owing to relatively small sample size, given the thinness of the Egyptian capital market, these findings should be interpreted with caution.Originality/valueThe paper contributes to the limited body of research on the superiority of earnings and cash flows in predicting future cash flows by examining the predictive abilities of earnings and cash flows for future cash flows in Egypt as one of many emerging markets.

The valuation of privately held firms and litigation: a case study

PurposeThe purpose of this paper is to discuss the questions arising from the use of discounted cash flow (DCF) method in the context of the valuation of a Portuguese subsidiary of a German firm. The process ended up in courts. Expert valuation was called. Two points are of particular relevance. First, given the past performance of the company and the external environment it faced, what would be a reasonable growth rate for free cash flow in the residual value period. Second, what questions arise form the assumption of seeing the subsidiary as a going concern, given that the German parent company had been opening new factories in India, China, Romania and Slovakia, and its presence in Portugal was far from guaranteed.Design/methodology/approachThe paper is based on case study which rests on a real legal and financial business situation. The case is used to illustrate the conceptual questions related to the use of the DCF method in valuing closely held firms, particularly the very significant impact of terminal value in the process of equity valuation.FindingsIt was found that very small variations in the growth rate assumed for the residual value period make a great difference in share valuation. Thus, the work of experts had to be very finely balanced, and the judge, when deciding on the fair value to be paid to the plaintiff based on expert opinion, should give careful consideration to scenarios.Practical implicationsA relevant point of the paper is to highlight the effect on business valuation of potential growth rates forecasted for the perpetual growth phase. That rate is, in this case influenced by eventual location changes that can result from globalization of industrial activity. Portuguese shareholders in foreign controlled joint ventures, and all the other stakeholders are facing important challenges from a new world economic order, and this case clearly illustrates some characteristics of this trend.Originality/valueThe paper is useful for managers that deal with business valuation cases that end in courts, by highlighting cash flow based methods and its central assumptions, and exploring critical areas that influence the final outcome of a lawsuit that is based on differences of hypothesis used in financial forecasting.