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1 – 10 of 678Discounted cash flow (DCF), whether by capitalisation or by cash flow analysis, has many detractors because of a number of apparent problems such as the reinvestment assumption…
Abstract
Discounted cash flow (DCF), whether by capitalisation or by cash flow analysis, has many detractors because of a number of apparent problems such as the reinvestment assumption and the possibility of multiple rates of return. The capital recovery cum reinvestment aspects of Years' Purchase (YP) factors and DCF are discussed and it is demonstrated that Years' Purchase single rate principle is akin to Internal Rate of Return (IRR) and that Years' Purchase dual rate principle also has a DCF image known as the Modified Internal Rate of Return (MIRR). The difference between the YP models and the DCF models is to do with the level cash flows assumed in the former and the variability of the cash flows measured in the latter. MIRR was developed as an answer to the above problems and it is demonstrated in a case study in which the fallacy of the apparent problems is also demonstrated. MIRR has a place in the analysis of investment strategy, but IRR (equated yield) is shown to be satisfactory in the financial analysis and comparison of individual projects.
Karim Bennouna, Geoffrey G. Meredith and Teresa Marchant
The purpose of this article is to evaluate current techniques in capital budget decision making in Canada, including real options, and to integrate the results with similar…
Abstract
Purpose
The purpose of this article is to evaluate current techniques in capital budget decision making in Canada, including real options, and to integrate the results with similar previous studies.
Design/methodology/approach
A mail survey was conducted, which included 88 large firms in Canada.
Findings
Trends towards sophisticated techniques have continued; however, even in large firms, 17 percent did not use discounted cash flow (DCF). Of those which did, the majority favoured net present value (NPV) and internal rate of return (IRR). Overall between one in ten to one in three were not correctly applying certain aspects of DCF. Only 8 percent used real options.
Research limitations/implications
One limitation is that the survey does not indicate why managers continue using less advanced capital budgeting decision techniques. A second is that choice of population may bias results to large firms in Canada.
Practical implications
The main area for management focus is real options. Other areas for improvement are administrative procedures, using the weighted average cost of capital (WACC), adjusting the WACC for different projects or divisions, employing target or market values for weights, and not including interest expenses in project cash flows. A small proportion of managers also need to start using DCF.
Originality/value
The evaluation shows there still remains a theory‐practice gap in the detailed elements of DCF capital budgeting decision techniques, and in real options. Further, it is valuable to take stock of a concept that has been developed over a number of years. What this paper offers is a fine‐grained analysis of investment decision making, a synthesis and integration of several studies on DCF where new comparisons are made, advice to managers and thus opportunities to improve investment decision making.
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Surveys of capital budgeting practices in the UK and USA reveal a trend towards the increased use of more sophisticated investment appraisals requiring the application of…
Abstract
Surveys of capital budgeting practices in the UK and USA reveal a trend towards the increased use of more sophisticated investment appraisals requiring the application of discounted cash flow (DCF) techniques. Several writers, however, have claimed that companies are underinvesting because they misapply or misinterpret DCF techniques. Such claims have been made on the basis of observations in only a few companies, or anecdotal evidence, without any supporting statistical evidence. Reports on a recent survey conducted by the authors which suggests that many UK firms are guilty of misapplying DCF techniques. Also provides evidence relating to some issues that have not been thoroughly examined in previous studies, namely the impact of company size and the relative importance that firms attach to different investment appraisal techniques.
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The increasing complexity of investment properties has necessitated the application of more advanced valuation and analysis techniques. Following the property cycle of the…
Abstract
The increasing complexity of investment properties has necessitated the application of more advanced valuation and analysis techniques. Following the property cycle of the 1980s/1990s, and the recommendations of several reporters, the DCF method has been promoted in Australia for certain income‐producing properties. The Australian Property Institute disseminated an information paper in 1993 that discussed DCF and suggested a performance approach to its application. Following this, a practice standard was produced in 1996 that was highly prescriptive but which contained a number of confusing passages. With the benefit of hindsight, its publication was premature and it was withdrawn from circulation. A rewrite was commissioned and an exposure draft was circulated in early 1999. It has been prepared as a performance standard in which the valuer is called on to follow a method while disclosing the specifics. However, a number of considerations remain to be finalised, for example, the application of the term cash flow to net operating income, income after finance and income after finance and tax. The preparation of standards is an evolutionary process and the present coverage of the DCF practice standard reflects the market in which it applies.
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Life Cycle Costing (LCC) offers many advantages over other techniques but the time‐span over which the study must be undertaken and the uncertainty involved probably detract from…
Abstract
Life Cycle Costing (LCC) offers many advantages over other techniques but the time‐span over which the study must be undertaken and the uncertainty involved probably detract from its usefulness. However, this is one area where Discounted Cash Flow (DCF) techniques have great scope for application. The most important influences on decision making, in practice, are consistency and feedback; the challenge remains to prevent organisational decision making being resistant to new ideas and techniques.
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The question that inevitably surfaces in practice, and certainly in lecture halls, is which equity valuation method is superior. Popular opinion holds that academia and investment…
Abstract
The question that inevitably surfaces in practice, and certainly in lecture halls, is which equity valuation method is superior. Popular opinion holds that academia and investment practitioners may have different preferences in this regard. This article investigates which primary minority and majority equity valuation methods are advocated by academia, and how well these preferences are aligned with the equity valuation methods that investment practitioners apply in practice. The research results reveal that, contrary to popular belief, academia and practice are fairly well aligned in terms of preferred equity valuation methods, with notable differences in their respective approaches.
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Todd M. Alessandri, Diane M. Lander and Richard A. Bettis
Strategy is ultimately aimed at creating shareholder value. We examine the relationship among intrinsic (DCF) value, market value, and the value of growth options using a “perfect…
Abstract
Strategy is ultimately aimed at creating shareholder value. We examine the relationship among intrinsic (DCF) value, market value, and the value of growth options using a “perfect foresight” model. Our findings suggest that Kester's (1984) initial assessment of growth option values may not hold under alternative valuation models. We highlight important issues in the valuation of growth options related to market expectations, modeling assumptions and estimation methods. The findings suggest that the firm's growth option value depends on three factors, each of which impacts investor expectations: (1) the macroeconomic environment; (2) the industry in which the firm participates; and (3) firm specific factors.
Spike Boydell and Stuart Gronow
The Australian Institute of Valuers and Land Economists Incorporated introduced a mandatory discounted cash flow practice standard on 1 September 1996. Reviews the new standard…
Abstract
The Australian Institute of Valuers and Land Economists Incorporated introduced a mandatory discounted cash flow practice standard on 1 September 1996. Reviews the new standard, highlighting the strengths and weaknesses. Offers early constructive commentary for the refinement of the standard at its 12‐month review. As no such mandatory “practice standard” has yet emerged from the US Appraisal Institute or the UK Royal Institution of Chartered Surveyors, it is reasonable to assume that these bodies as well as their membership will view the Australian initiative with interest.
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J. Stuart Wood and Gordon Leitch
Proposed projects whose financing will cause capital structure to change across time cannot be accurately evaluated by the ordinary Weighted Average Cost of Capital‐Net Present…
Abstract
Proposed projects whose financing will cause capital structure to change across time cannot be accurately evaluated by the ordinary Weighted Average Cost of Capital‐Net Present Value technique. The required rate of return on a new project depends on the firm’s capital structure through the effect of capital structure on the required rates of debt and equity suppliers. But the capital structure depends on these required rates, which are themselves functions of capital structure. There is no general analytical solution to this circularity, so the ordinary weighted average cost of capital cannot capture the effects of changing capital structure on the cost of capital, and the computed NPV is not correct: the wealth of the shareholders will change by a different amount, and may have a different sign as well.
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Michel Baroni, Fabrice Barthélémy and Mahdi Mokrane
The aim of this paper is to use rent and price dynamics in the future cash flows in order to improve real estate portfolio valuation.
Abstract
Purpose
The aim of this paper is to use rent and price dynamics in the future cash flows in order to improve real estate portfolio valuation.
Design/methodology/approach
Monte Carlo simulation methods are employed for the measurement of complex cash generating assets such as real estate assets return distribution. Important simulation inputs, such as the physical real estate price volatility estimator, are provided by results on real estate indices for Paris, derived in an article by Baroni et al..
Findings
Based on a residential real estate portfolio example, simulated cash flows: provide more robust valuations than traditional DCF valuations; permit the user to estimate the portfolio's price distribution for any time horizon; and permit easy values‐at‐risk (VaR) computations.
Originality/value
The terminal value estimation is a core issue in real estate valuation. To estimate it, the proposed method is not based on an anticipated growth rate of cash flows but on the estimation of the trend and the volatility of real estate prices.
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