Valuation of a Company

C 1805 –Valuation of companies: discounted cash flow, adjusted present value, decision tree analysis

and real options

Luc Keuleneer[1]

Wouter De Maeseneire[2]

Table of contents

1. Introduction

2. Discounted cash flow-method

1. Description of DCF-method

2. Projected free operating cash flows

3. Essential for the WACC: cost of equity

Capital asset pricing model (CAPM)

Small firm premium (SFP)

Arbitrage pricing theory (APT)

Importance of WACC in EVA

4. Enterprise-DCF versus equity-DCF

5. Where to find specific parameters of valuation?

6. Criticism on the DCF-method

3. Adjusted present value-method

1. Description of the method

2. Criticism on the APV-method

3. Criticism on the DCF and APV

4. Decision tree analysis (DTA) and real options (RO)

1. Observations

2. Wrong interpretation of the DCF-method (and APV-method)

3. Real options and the analogue with financial options

4. When is the value of the option important?

5. What types of options exist?

6. Decision tree analysis (DTA) and real options

7. A few examples of real options

The option to wait

Valuation of a goldmine

Valuation of an R&D project

Valuation of a start-up

8. Criticism on the real option method

5. Summary and conclusions

References

1. Introduction

It is important to know the correct value of a company and her shares, in the context of mergers and acquisitions, capital raising and market introduction. This is also relevant in possible disputes among different parties (e.g. conflicts with minority shareholders in public buy out offers, because there are a lot of arguments about the fact whether the price they get for a share is fair or not). Even for fiscal goals the value of a firm has to be known sometimes.

The valuation of companies, adequately applied, is essential in...