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Objective: Barriers can be an effective method for reducing escapement of reservoir sport fish; however, whether the financial benefits of a barrier outweigh the costs of a barrier is unknown. We sought to quantify the costs and benefits associated with constructing barriers to reduce fish escapement while explicitly accounting for variability and uncertainty. Methods: We developed a framework using simulation modeling and discounted cash flow techniques to quantify the costs and benefits of barrier construction on Brushy Creek Lake, Iowa, where a barrier was constructed in 2020 to reduce escapement of stocked Walleye Sander vitreus and Muskellunge Esox masquinongy. We then incorporated this framework into an interactive Shiny application to enable cost–benefit evaluations across a wide range of barrier types, system types, species, and escapement rates. Result: The present value of the parallel‐bar barrier on Brushy Creek Lake, Iowa, over 10 years was US$69,576 (range = $64,484–$73,976), whereas the present value of escaped fish was $316,416 ($253,459–$378,823), indicating a net benefit of $246,840 ($188,975–$304,847) associated with barrier construction. The benefit–cost ratio of barrier construction was 4.55 after 10 years, indicating that for every $1 in present value spent on barrier construction, we saved $4.55 by preventing fish escapement. There was a 99% probability of a positive mean net benefit of the barrier after 3 years. Conclusion: Our results indicate that barriers can be a cost‐effective option to minimize fish escapement, and barrier costs are more predictable compared with the cost of escapement. Quantifying the value of escaped fish and barrier construction on an economic scale enables the use of formal decision‐making tools to address complicated and multifaceted issues associated with reservoir fisheries management. Impact statementWe developed a framework to enable the costs and benefits of barrier construction to minimize reservoir sport fish escapement to be quantified on an economic scale and subsequently applied this framework to a barrier construction project in Iowa. We then integrated this framework into a flexible application to enable the costs and benefits of barrier construction to be assessed across a variety of systems. [ABSTRACT FROM AUTHOR]

According to its advocates, integrated reporting (IR) aims to enhance firms' information environment by placing financial reporting into a much broader perspective in which interrelated non‐financial information of firms' activities are taken into consideration. We examine whether this intended outcome of IR embeds into the stock pricing process using a sample of South African listed firms that mandatorily adopted IR in 2011. Unlike previous studies that explore market valuation implications of IR, we examine the channel through which the IR‐related information flows into firm value. Specifically, we quantify the effects of revisions of expectation about future cash flows (prompted by financial reporting information), revisions of expectation about discount rates (prompted by non‐financial reporting information) and their interconnectedness. We hypothesize and empirically show that the adoption of an IR approach prompted greater market revisions of expectations about future discount rates and a stronger interconnectedness between market revisions of expectations about future cash flows and discount rates. Thus, the change in the stock pricing process after the adoption of IR is determined by non‐financial reporting information and its strong interconnectedness with financial reporting information. We also show that our results are stronger for firms with greater earnings opacity, suggesting that investors find IR more useful when firms' financial reporting is opaque. Results indicate to researchers, practitioners and regulators that IR enhances the firm‐level information environment by providing informative non‐financial reporting which is also well integrated with financial reporting. [ABSTRACT FROM AUTHOR]

This paper aims to investigate how different emotions affect the subsequent index futures returns. We test the forecasting regressions which predict the S&P 500 index futures returns with lagged text‐based emotion (anger, joy, fear, optimism, and gloom) indices and find asymmetric forecasting power exists between pessimism and optimism emotion indices. We show that only the text‐based anger index could reliably perform at predicting index futures return in‐sample and outperform the prevailing unconditional mean out‐of‐sample. Notably, the predictive power of the text‐based anger index persists after controlling for other emotion indices, investor sentiment indices, and fundamental variables known to predict the futures market. And the asset allocation conditioning on text‐based anger index can generate substantial economic benefits. Furthermore, the anger index influences the index futures return through both the discount rate and cash flow channels. [ABSTRACT FROM AUTHOR]

The financial valuation of power plants is an important instrument for investment planning. The environment of the energy sector, which is strongly influenced by renewable energies, is changing. The shift to decentralized supply has an impact on the technical complexity of the energy system and requires congestion management. In such a transitioning system, flexibility is gaining a more important function in the valuation of power plants. Existing valuation methods are examined as to how flexibility and marketing options are taken into account. The comparison of the existing valuation methods showed that the valuation results are strongly dependent on the method used and the technology investigated. There is a lack of validation of the methods through quantitative evaluation. [ABSTRACT FROM AUTHOR]

A large literature now reports the evidence for the profitability of contrarian trading strategies. We investigate the stability of such contrarian trading strategies and their ability to generate large, potentially ruinous, losses for their users. Specifically, we ask, are the annual profits earned by contrarian strategies sufficiently stable and loss‐free to keep their adherents in the game and capable of reaping returns to such long‐run trading strategies? We present tests with more statistical power than hitherto, reflecting practical aspects of the operation of contrarian strategies. Specifically, the strategies are implemented only for years in which the mean return of stocks in the buy portfolio exceeds that of the sell portfolio; in addition, for each strategy, we calculate the Calmar ratio as a measure of downside risk. Using the constituents of the S&P 500 index for the years 1990–2017 inclusive, we examine a variety of simple, ratio‐based strategies and more complicated strategies based on formal valuation models. Overall, our evaluation makes us sceptical about the reliability of contrarian strategies as currently formulated. But of those strategies available, those based on discounted cash flow seem most likely to be profitable. [ABSTRACT FROM AUTHOR]

There has been substantial growth in investments for startup firms to develop agricultural technology. Although investing in startups can produce significant returns, the risk of failure is high, and the commercial strategies are largely unknown. Traditional valuation methodologies, such as discounted cash flow (DCF) and multiples, are not well suited for startups. Real options provide a methodology to quantify the value of growth opportunities and managerial flexibility, two critical features of startups. This study develops a model that integrates decision trees and a stochastic binomial lattice to quantify the value of growth opportunities and managerial flexibility in a prerevenue AgTech startup. Utilizing a binomial lattice and decision trees allows for the quantification of private and market risk. The result is a valuation that quantifies the upside optionality that other methodologies disregard. [EconLit Citations: O32, O34, Q140, Q16, C6, G11]. [ABSTRACT FROM AUTHOR]

Based on the innovative database, we use a discounted cash flow model to study the rent sharing and the mining tax design in African gold‐producing countries. Two main tax designs emerge: those that favour production‐based taxes in order to secure government's revenues and those that favour profit‐based taxes to support economic efficiency. From the estimation of a panel model regression, we show that tax design depends essentially on the evolution of world prices and not on institutional variables. The recent 'innovations' in mining taxation to introduce more progressivity have had mitigated results. In the best of cases, the regressivity of tax regimes has been reduced. [ABSTRACT FROM AUTHOR]

Valuation experts have recommended using the finance formula equating real growth in net cash flows (g) to the plowback rate (k) times the real return on investment (r) as a more reasonable basis for estimating plowback in the steady‐state perpetuity period of the standard value‐driver DCF formula. Unfortunately, practitioners make two errors when estimating implied plowback as k = g ÷ r. The first error is to use the incorrect nominal formula k = G ÷ R that is still found in finance and valuation textbooks. The second error arises because there are two ways to define plowback in the value‐driver DCF model. The problematic traditional definition measures plowback ratio as a function of accounting NOPAT (before it has been transformed into cash NOPAT by deducting incremental working capital), thereby including in the numerator not only net new investment, but also changes in incremental working capital. The authors call this accounting plowback, and show why it is generally inappropriate to estimate implied accounting plowback using the formula k = g ÷ r. The authors explain in detail why the cash plowback presented in Bradley Jarrell (2008) is generally appropriate for estimating implied plowback and why accounting plowback is more problematic in this application. [ABSTRACT FROM AUTHOR]

More wood for technical valorization is to be expected in Europe over the coming years, due to climate change and the bark beetle. To further independence from fossil‐fuel resources a novel approach to the base‐catalyzed depolymerization (BCD) of organosolv lignin into monomers and oligomers, while maximizing yields and minimizing coke formation, was scaled up in a theoretical wood‐based biorefinery with a yearly input of 40 000 t of wood chips. Other process steps were modeled from the literature. A novel work‐up approach was evaluated under laboratory conditions, implemented, and compared with a simulation‐based pervaporation technique. The life‐cycle assessment (LCA) showed that the biorefinery provided a significantly lower global warming potential (GWP) (excluding biogenic carbon) than its fossil counterparts. Moreover, the majority of impacts on the other midpoint categories was also smaller than for the fossil reference. However, after allocating the GWPs, it was evident that subsequent conversion of the C6 fraction to value‐added products is necessary for optimal results. The discounted cash flow analyses for the biorefinery setups (40 to 400 kt year–1) showed that they were not profitable with prices based on fossil references. However, when using higher prices/t from the literature, such as €1615 for monomers, €2000 for oligomers, and €510 for C6 sugars, a positive net present value could be reached at approximately 100 000–120 000 t processed annually. Hence, the conclusion was that a biorefinery utilizing wood not only brings environmental benefits and a reduction in the use of fossil resources but can also be financially beneficial. © 2021 Society of Chemical Industry and John Wiley & Sons, Ltd [ABSTRACT FROM AUTHOR]

The viability of converting wood chips and plastic to power via compact integrated catalytic fast/slow pyrolysis, combustor, and Stirling engine technologies was determined using modeling analysis. Aspen simulations followed by sizing analysis were performed to determine the size, weight, and net energy efficiency of upgrading wood chips and plastic to power using a compact energy system with a feedstock processing capacity of 1 kg h−1. The equipment and tooling to fabricate individual components of a compact energy system were identified. The total costs of fabricating all the individual components of compact energy systems were assessed. A discounted cash flow analysis with an internal rate of return of 20% was used to assess the minimum selling price of compact energy systems. The specific energy (Wh kg−1) of the compact catalytic fast pyrolysis system, compact slow pyrolysis system, and compact plastic conversion system were assessed at 20, 29, and 63, respectively. The assessed capital and annual costs of manufacturing 10 000 compact energy systems per year were $51 million and about $11 to $13 million, respectively. The calculated minimum selling price of a catalytic fast pyrolysis system, a compact slow pyrolysis system, and a compact plastic conversion system were $3055, $3021, and $2980, respectively. The sensitivity analysis results showed that the internal rate of return, capital investment, materials cost, annual operating costs, and capital cost have significant impacts on the minimum selling price of compact energy systems. © 2021 Society of Chemical Industry and John Wiley & Sons, Ltd [ABSTRACT FROM AUTHOR]

We propose a novel measure of investment plans, namely expected investment growth (EIG), and find stocks with high EIG outperform stocks with low EIG by 17% per annum. This premium can be generated in a neoclassical model with the investment plan friction, in which a firm's expected returns increases with its planned investment due to an embedded leverage effect. We provide empirical evidence on the interaction of the cash flow effect and discount rate effect in driving this EIG premium. Our findings highlight the investment plan friction as an important economic channel to understand the cross‐sectional risk premium. [ABSTRACT FROM AUTHOR]

We 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. [ABSTRACT FROM AUTHOR]

In the literature, the integration of the cash and risk effects of executive compensation into company valuation is discussed only marginally. This paper addresses the question of how these effects can be integrated into corporate valuation. Several methods for solving the problem are discussed and a method free of circular references, similar to the adjusted present value approach to company valuation, is identified. Contrary to a common assumption in the literature, there is no uniform and constant cost of capital for a company that uses employee stock options. Cost of capital needs to be adjusted to the cash and risk impact of equity‐based executive compensation. Making recourse to the treasury stock method, which is used to calculate diluted earnings per share, is not recommended here even though a corrected version of this method is used. I discuss different forms of equity‐based executive compensation, including the resulting allocation of risk and net present value between owners and managers. [ABSTRACT FROM AUTHOR]

Liming is a common management practice, but there exists uncertainty about the economic benefits. An economic analysis of the costs and profitability of liming arable crops was undertaken using data from the long‐term liming experiment at Rothamsted and Woburn. There was a strong liming effect on gross margins, but large differences in the economic benefit between crops. For some crops (such as spring barley), liming greatly improved the gross margin, while for spring oats liming provided very little increase. Most economic benefit was achieved with the high lime treatment, but the cumulative discounted cash flow indicated that it took approximately 20 years before a distinct difference developed between the lime treatments. Therefore, lime should be considered a capital investment and economic evaluation undertaken over a long period. Liming rate increased the net present value expressed as an annual equivalent (NPVa). An additional £436 ha−1 year−1 at Rothamsted and £208 ha−1 year−1 at Woburn of profit was gained from the adoption of the most profitable liming treatments over not liming. Sensitivity analysis indicated that total liming costs had a weak effect on NPVa, but crop price had a strong effect. The economic performance of liming differed between sites and was higher at Rothamsted than at Woburn, mostly because of soil differences. Liming greatly improves economic returns of most arable crops, but the magnitude of the long‐term economic benefit depends upon the sequence of crops within a given rotation. [ABSTRACT FROM AUTHOR]

Under International Financial Reporting Standards, managers can use two approaches to increase the estimated fair value of goodwill in order to justify not recognizing impairment: (1) make overly optimistic valuation assumptions, and (2) increase future cash flow forecasts by inflating current cash flows. Because enforcement constrains the use of optimistic valuation assumptions, we hypothesize that enforcement influences the relative use of these two choices. We test this hypothesis by comparing a sample of 1,958 firms from 36 countries that are likely to delay recognizing goodwill impairment (suspect firms) to a sample of control firms. First, we find that firms in high‐enforcement countries use a higher discount rate to test goodwill for impairment than firms in low‐enforcement countries. We also find a more positive association between discount rate and upward cash flow management for suspect firms than for control firms. This result is consistent with suspect firms substituting optimistic valuation assumptions with inflated current cash flows. Second, we find that, relative to control firms, suspect firms exhibit higher upward cash flow management in high‐enforcement countries than in low‐enforcement countries. Third, we show that suspect firms in high‐enforcement countries are more likely to eventually impair goodwill. [ABSTRACT FROM AUTHOR]

The development of offshore wind farms depends on many technical and economic parameters, which requires an integrated planning approach. Some parameters can be controlled by the wind farm developer, and some are determined by the regulatory authorities. Others can be outside control of both. One aspect of optimizing wind farm development is overplanting, which represents the capacity optimization between installed generation capacity and transmission capacity, which allows for a minor share of energy curtailment to increase the overall value of the farm. Quantifying this value also depends on the regulatory framework, which is analyzed here by comparing United Kingdom and Danish conditions. Using a discounted cash flow model, we find that UK conditions are favorable to overplanting from the developer perspective, where the benefit of using the transmission cable more efficiently supports overplanting. In the Danish case, the private‐economic incentive to overplant is minor due to the constraint of linking subsidies to a certain energy output. On the other hand, when the cost of turbines declines relative to transmission system costs, overplanting tends to become more attractive. This is mostly the case when installing wind farms further offshore compared to projects closer to the coast, which has been exerted more and more exerted in the recent years. In a socioeconomic perspective, overplanting is also a viable method to optimize the wind farm technically and economically, if the cost of the additional turbines is less than the value of the additional generation that can be fed into the grid by the transmission line. This article is categorized under: Wind Power > Economics and PolicyWind Power > Systems and Infrastructure [ABSTRACT FROM AUTHOR]

The article uses empirical evidence to show the reliability of intrinsic value estimates derived from three theoretically equivalent valuation models, the discounted dividend (DIV) model, the discounted free cash flow (FCF) model, and the discounted abnormal earnings (AE) model. The authors of this article use Value Line (VL) annual forecasts of the elements in these models to calculate value estimates for a sample of publicly traded firms followed by Value Line during 1989-93. The authors contrast the reliability of value estimates in terms of their accuracy and in terms of their explainability.

Most companies rely heavily on earnings to measure their financial performance, but earnings growth has at least two important weaknesses as a proxy for investor wealth. Current earnings growth may come at the expense of future earnings through, say, shortsighted cutbacks in corporate investment, including R&D or advertising. But growth in earnings per share can also be achieved by "overinvesting"—that is, committing ever more capital to projects with expected rates of return that, although well below the cost of capital, exceed the after‐tax cost of debt. Stock compensation has been the conventional solution to the first problem because it's a discounted cash flow value that is assumed to discourage actions that sacrifice future earnings. Economic profit—in its most popular manifestation, EVA—has been the conventional solution to the second problem because it includes a capital charge that penalizes low‐return investment. But neither of these conventional solutions appears to work very well in practice. Stock compensation isn't tied to business unit performance, and often fails to motivate corporate managers who believe that meeting consensus earnings is more important than investing to maintain future earnings. EVA often doesn't work well because increases in current EVA often come with reduced expectations of future EVA improvement—and reductions in current EVA are often accompanied by increases in future growth values. Since EVA bonus plans reward current EVA increases without taking account of changes in expected future growth values, they have the potential to encourage margin improvement that comes at the expense of business growth and discourage positive‐NPV investments that, because of longer‐run payoffs, reduce current EVA. In this article, the author demonstrates the possibility of overcoming such short‐termism by developing an operating model of changes in future growth value that can be used to calibrate "dynamic" EVA improvement targets that more closely align EVA bonus plan payouts with investors' excess returns. With the use of "dynamic" targets, margin improvements that come at the expense of business growth can be discouraged by raising EVA performance targets, while growth investments can be encouraged by the use of lower EVA targets. [ABSTRACT FROM AUTHOR]

Utilizing lignin feedstock along with cellulosic ethanol for the production of high‐energy‐density jet fuel offers a significant opportunity to enhance the overall operation efficiency, carbon conversion efficiency, economic viability, and sustainability of biofuel and chemical production. A patented catalytic process to produce lignin‐substructure‐based hydrocarbons in the jet‐fuel range from lignin was developed. Comprehensive techno‐economic analysis of this process was conducted through process simulation in this study. The discounted cash flow rate of return (DCFROR) method was used to evaluate a 2000 dry metric ton/day lignocellulosic ethanol biorefinery with the co‐production of lignin jet fuel. The minimum selling price of lignin jet fuel at a 10% discount rate was estimated to be in the range of $6.35–$1.76/gal depending on the lignin and conversion rate and capacity. With a production capacity of 1.5–16.6 million gallon jet fuel per year, capital costs ranged from $38.0 to $39.4 million. On the whole, the co‐production of jet fuel from lignin improved the overall economic viability of an integrated biorefinery process for corn ethanol production by raising co‐product revenue from jet fuels. © 2018 Society of Chemical Industry and John Wiley & Sons, Ltd [ABSTRACT FROM AUTHOR]

This article presents an analysis of the three dominant theories of Human Resource Accounting (HRA), Historical Cost, Replacement Cost, and Discounted Cash Flow, and the inherent advantages and disadvantages of each theory as they relate to both internal and external reporting techniques. The article is divided into three major sections, referenced to the theories, with a brief explanation of the methodology and requisite inputs to each system followed by the expected associated costs and benefits to be derived upon installing any of the systems into a small engineering consulting firm. The historical cost model focuses upon the investment made in human assets. The characteristic which distinguishes a business investment from a current expense is futurity. The advantages of a Replacement Cost Model of accounting for human resources are that it gives external users current value information which should be easy to understand and use in the evaluadon of financial statements. The Discounted Cash Flow Model is probably the best conceptual model of the three. Its basic premise is that of quantifying the future service potential of an asset.

The literature ON capital budgeting has not generally reserved a specific role for the rate of price inflation in the analysis of capital investments. In the taxless world of most textbook discussions of the subject, inflation would presumably only augment both future cash flows and discount rates by comparable amounts, thus having no effect on present value calculations. Under the U.S. tax code, however, after-tax present values are not neutral with respect to different rates of inflation, because depreciation charges are based on historical costs. This complication may have been of little practical importance during much of the post-war period, but rates of inflation such as those experienced in recent years will generally be a material factor in present value calculations. In order to focus on the role of the tax effects of inflation in the capital budgeting decisions of the firm it is necessary to hold constant both real pretax cash flows associated with alternative investment projects (including capital costs) and real discount rates. The question of whether real pretax cash flows and real discount rates are in fact systematically related to the rate of inflation is essentially an empirical one and goes beyond the scope of the present paper. Some evidence to the contrary in the case of cash flows is given by Kessel and Alchain [5]. The hypothesis that real discount rates are unrelated to the rate of inflation, of course, goes back to Fisher [3, 4] and enjoys support from a large body of empirical literature. The analysis presented here does not distinguish between actual and expected future rates of inflation or cash flows. Whether the reader wishes to regard the discussion as an analysis under perfect certainty or prefers to interpret future magnitudes as certainty equivalents accompanied by appropriate discount rates is immaterial for present purposes. The paper is organized around five propositions dealing with the impact of inflation, ceteris pari... [ABSTRACT FROM AUTHOR]

The article compares the investment performance of apartment houses to that of common stocks. An overview of the discounted cash flow method is presented. The author examines the investment performance of 20 residential projects financed by the Federal Housing Administration (FHA) with that of 76 industrial stocks from 1952 to 1962 using the discounted cash flow method. An explanations for yield differentials is presented. It is noted that the sample's after-tax rate of return on total capital investment in the FHA was similar throughout the ten-year time period observed.

Discounted cash flow has its roots in compound interest, actuarial science, engineering economy, and capital theory. The net present value approach was applied to financial investments by Simon Stevin of Bruges as early as 1582. Bond tables incorporating the equivalent of the internal rate of return were in use by the second half of the 19th century by which time economists and engineers were beginning to discuss the application of discounting to nonfinancial investments. It was not until the 1950's, however, that interest in the use of D.C.F. techniques began to quicken and it is only in the 1960's that this use has become at all widespread. It is suggested that the bias towards historical recording in the education and training of accountants may have been partly responsible for this long delay. [ABSTRACT FROM AUTHOR]

Much of a firm's market value derives from expected future growth value rather than from the value of current operations or assets in place. Pharmaceutical companies are good examples of firms where much market value comes from expectations about drugs still in the development “pipeline.” Using a new osteoporosis drug being developed by Gilead Sciences, Inc., the author combines discounted cash flow methods values and real option models to value it. Alone, discounted cash flow (DCF) calculations are vulnerable to the assumptions of growth, cost of capital, and cash flows. But by integrating the real options approach with the DCF technique, one can value a new product in the highly regulated, risky and research‐intensive Biopharmaceutical industry. This article shows how to value a Biopharmaceutical product, tracked from discovery to market launch in a step‐by‐step manner. Improving over early real option models, this framework explicitly captures competition, speed of innovation, risk, financing need, the size of the market potential in valuing corporate innovation using a firm‐specific measure of risk and the industry‐wide value of growth operating cash flows. This framework shows how the risk of corporate innovation, which is not fully captured by the standard valuation models, is priced into the value of a firm's growth opportunity. The DCF approach permits top‐down estimation of the size of the industry‐wide growth opportunity that competing firms must race to capture, while the contingency‐claims technique allows bottom‐up incorporation of the firm's successful R&D investment and the timing of introduction of the new product to market. It also specifically prices the risk of innovation by modeling its two components: the consumer validation of technology and the expert validation of technology. Overall, it estimates the value contribution per share of a new product for the firm. [ABSTRACT FROM AUTHOR]

The present study examined financial market risk exposure of human capital returns, which are represented by the returns to education, using panel data for Korea. Overall, financial market shocks seem to be irrelevant to returns to education. However, when we divide a financial market shock into cash flow news and discount rate news leading to a negative risk premium, returns to education increase after positive news about future cash flows and unexpected increases in discount rates Therefore, the risk exposure to cash flow shocks is offset by the exposure to discount rate shocks. The returns to education of low‐income workers were significantly exposed to the cash flow risk as compared to those with a high income, but they were offset by the positive correlation to discount rate shocks. In contrast, considering the gap between generations, the old generation was not only less exposed to the cash flow risk compared to the young generation regarding returns to education but also positively correlated with the discount rate shock, resulting in less exposure to financial market risks. [ABSTRACT FROM AUTHOR]

The theory underlying Discounted cash flow (DCF) models is uncontroversial in academia, the economic intuition behind them is straightforward, and the mathematics reassuringly simple. Nevertheless, in practice, they are applied inconsistently with very different valuation results. Because of the assumed infinite life (“going concern”) of a business enterprise, DCF models implicitly assume the ability to forecast future cash flows forever. This forces analysts to make assumptions about the terminal period using simplistic metrics such as P/E or EV/EBITDA to estimate terminal values or to embed a perpetual stream of excess profitability and value creation in the terminal period. The author offers an uncomplicated alternative to these unrealistic assumptions. The first step is to introduce an adjustable fade rate called f. A fade rate of 100% brings about immediate convergence, and a fade rate of 0% specifies no fade and perpetual excess profitability. The notion that excess profits get competed away over time can be modeled by assuming that the spread of (ROIC ‐ r) fades to zero and that economic profit dissipates. Intrinsic value is very sensitive to the fade rate assumption and this helps explain the risk premium for quality stocks. The risk of owning quality stocks is that they lose their economic moat and competitive advantage. An adjustable fade rate provides an excellent means to value the effect of profitability attenuation in a DCF model. [ABSTRACT FROM AUTHOR]

This paper studies the problems associated with the construction of price indexes for commercial properties that could be used in the System of National Accounts (SNA). Property price indexes are required for the stocks of commercial properties in the Balance Sheets of the country. Related service price indexes for the land and structure input components of a commercial property are required in the Production Accounts of the country if the Multifactor Productivity of the Commercial Property Industry is calculated as part of the SNA. The paper reviews existing methods for constructing an overall Commercial Property Price Index (CPPI) and concludes that most methods are biased (due to their neglect of depreciation) and more importantly, not able to provide separate land and structure subindexes. A class of hedonic regression models that is not subject to these problems is discussed. [ABSTRACT FROM AUTHOR]

This study examines how accrual manipulations affect firm valuation in the years surrounding the passage of the Sarbanes-Oxley Act (SOX). We compare the absolute percentage pricing errors of RIM and DCF valuation models for a group of US firms suspected to have engaged in accrual manipulations to avoid a small loss or a small earnings decline vs. 'Normal' firms matched on industry, year and size. We find that RIM can better estimate intrinsic value than DCF for the matched Normal firms in the pre-SOX period, but not so for accrual manipulators, and that SOX mitigates the harmful effect of accrual manipulations, completely eliminating the difference in RIM's accuracy advantage over DCF between Normal firms and accrual manipulators. As a further analysis, we redefine Suspect firms as real-activity manipulators and find a significant across-group difference in accuracy wedge in both sample periods, implying that SOX has prompted firms to favor real-activity manipulations over accrual manipulations. [ABSTRACT FROM AUTHOR]

The valuation of companies or their assets is at the heart of most financing and investment decisions. Over the last five decades, academics have developed several simple and sophisticated models for corporate valuation. Yet valuation estimates of a firm or its assets appear to vary widely among practitioners. It is unclear whether these differences arise from practitioners' use of different valuation models or from differences in their assumptions about the inputs used in those models. To provide some insights into this issue, the authors recently surveyed 365 European finance practitioners with CFAs or equivalent professional degrees. They find that almost all survey respondents use the Discounted Cash Flow (DCF) model (along with some version of Relative Valuation that relies on the use of 'comparables'). But the estimation methods of such practitioners for almost all inputs in the DCF model, including beta, the equity market risk premium, leverage, cost of debt, and terminal value, vary widely. This can be a serious problem because even small differences in inputs can cause huge variations in valuations. Such differences arise primarily because theory provides little guidance on how to estimate parameters, leaving practitioners to make their own assumptions and judgments. In sum, the authors' findings suggest that the process of estimating valuation parameters can be as important as the choice of the valuation model itself, and requires the serious attention of academics and practitioners. The authors recommend that key valuation parameter estimates be disclosed in financial and valuation reports. Their findings are also relevant to policy makers because the concept of 'fair value' plays such a central role in post-crisis regulation. [ABSTRACT FROM AUTHOR]

A method is proposed by which the goodwill of a business may be valued whenever the conventional accounting method is not available. This 'restoration' methodology involves using a combined cost and income approach to value the benefits a hypothetical purchaser of an operating business obtains, by reference to the costs, delays and risks it avoids, by acquiring the operating business rather than the business's identifiable assets alone. Such a value approximates that of the goodwill of the business. To provide some guidance as to how the restoration methodology might be used in a real situation, the actual sale of an interest in the Gove bauxite and alumina joint venture business is considered, where the existence and value of the business's goodwill was a factor in determining whether land-rich stamp duty was payable in respect of the transaction. When the benefits gained by the purchaser of the Gove business are identified by reference to the costs, delays and risks it avoided by purchasing the business rather than the assets, it is not difficult to understand why such a sophisticated purchaser paid (and a pre-empted purchaser was prepared to pay) an amount equal to or greater than the value of the business's identifiable assets in order to obtain those benefits. [ABSTRACT FROM AUTHOR]

Empirical evidence has suggested a 'resource curse' exists, in which countries with abundant resources may have higher initial consumption but then grow more slowly. The effect appears to be dependent on a country's political structure. Theoretical models not typically accounted for historical exceptions, or have not shown the effect exists in a dynamic growth setting. We derive the resource curse effect in an optimal growth model augmented with a political process. The economy has a finite nonrenewable resource, and the government planner can choose to over-extract natural resources relative to the efficient path by distorting the discount rate, but in so doing incurs political costs that depend on the presence of democracy. Government planners in non-democratic countries usually have more autonomy in policymaking than those in democratic countries; therefore, the political cost is lower for non-democratic countries. We show that the incentive for the planner to distort the extraction path is larger, the higher is the initial resource endowment. Consistent with empirical evidence, the distortion raises short-term consumption but lowers the long-term growth rate, and institutional differences create corner solutions that explain why some resource-abundant countries avoid the curse. These results are robust to the inclusion of autonomous technological change. [ABSTRACT FROM AUTHOR]

We formulate a generalized constant growth valuation model incorporating inflation and capital maintenance. We find that in general there are two sources of growth: growth due to capital maintenance and growth due to net new investments. The generalized version of the constant growth model allows the reconciliation of the existing literature, particularly the works of Gordon and Shapiro (1956), Lally (1988), and Bradley and Jarrell (2008), which all employ particular definitions of capital maintenance. Evaluating the practical relevance of either model we find that each model is best suited for a very particular company set-up, which does not necessarily correspond to the commonly observed business models. The generalized version of the constant growth valuation model, however, presents a flexible approach that is capable of capturing various conceptions of capital maintenance. [ABSTRACT FROM AUTHOR]

This paper develops an inventory model for exponentially deteriorating and imperfect quality items when a trade credit is offered by the supplier. As it has been seen that the changing rates of inflation do not just have an effect on the ordered quantity but they also stimulate the demand for products, so this paper considers the combined effect of inflation, deterioration, imperfect quality and ' [ABSTRACT FROM AUTHOR]

We present an algorithm to compute the set of perfect public equilibrium payoffs as the discount factor tends to 1 for stochastic games with observable states and public (but not necessarily perfect) monitoring when the limiting set of (long-run players') equilibrium payoffs is independent of the initial state. This is the case, for instance, if the Markov chain induced by any Markov strategy profile is irreducible. We then provide conditions under which a folk theorem obtains: if in each state the joint distribution over the public signal and next period's state satisfies some rank condition, every feasible payoff vector above the minmax payoff is sustained by a perfect public equilibrium with low discounting. [ABSTRACT FROM AUTHOR]

The discounted cash f low valuation method relies on expected cash flows. But because they often ignore low-probability downside events, the forecasts of expected cash flows that are provided by corporate managers and analysts are often excessively optimistic, or upwardly biased. As a result, such forecasts need to be adjusted when used in valuations. Whereas academics generally prefer adjustments of the cash flow forecasts, practitioners typically account for such downsides by increasing the discount rate above the market-based cost of capital. This article suggests that the appropriate adjustment to the DCF formula should depend on the nature of the omitted downside. The author shows that when the downside is assumed to be "temporary"—say, a large, weather-related loss— the appropriate adjustment to the DCF formula is to reduce the forecasts by the expected downside and set the discount rate equal to the market-based cost of capital. But when the omitted downside scenario is expected to be "permanent"— in the sense that the event reduces all subsequent future cash flows— the appropriate adjustment is to reduce the cash flows and increase the discount rate to reflect the probability that such a downside occurs. By endor sing bot h of these prescriptions, the author effectively acknowledges that there is a reasonable conceptual basis for both the academic approach of adjusting the forecasted cash flows and the practitioner approach of inf lating the discount rate. The appropriate approach depends on the characterization of the omitted downside as either temporary or permanent. [ABSTRACT FROM PUBLISHER]

Standard valuation models forecast cash flows or earnings, add a growth rate, and discount the cash flows to their present value with a discount rate that typically reflects the cost of capital. But as the author argues, projecting the long-term growth rate is essentially speculative; and along with uncertainty about the growth rate, analysts generally do not have a good grasp of the discount rate either. Thus, instead of reducing uncertainty, these two features effectively compound uncertainty in valuations in the sense that slight changes in the growth rate or discount rate can change the valuation considerably. In this article, the author proposes an alternative approach that views the investor's problem as one of challenging the speculations that are built into the current market price, particularly the speculation about growth. Rather than building in a speculative growth rate (and thereby treating it as if it were a certainty), the author's approach turns the problem on its head by using an accounting analysis of the firm's current earnings and cash flows that provides a basis for recognizing the speculative component of the current stock price. More specifically, the author's analysis identifies the future earnings growth path that is implied by the market price, which can then be evaluated with the question: Do I want to pay for this growth? Because growth expectations are risky, additional analysis can be used to provide an understanding of the risk and return to buying growth, and of the upside and downside if risk growth expectations are not realized. By taking such an approach, investors incorporate their understanding of risk not by increasing the discount rate, but by recognizing that the primary risk in investing is the risk of overpaying for growth. [ABSTRACT FROM PUBLISHER]

The classic DCF approach to capital budgeting—the one that MBA students in the world's top business schools have been taught for the last 30 years—begins with the assumption that the corporate investment decision is "independent of " the financing decision. That is, the value of a given investment opportunity should not be affected by how a company is financed, whether mainly with debt or with equity. A corollary of this capital structure "irrelevance" proposition says that a company's investment decision should also not be influenced by its risk management policy—by whether a company hedges its various price exposures or chooses to leave them unhedged. In this article, the authors—one of whom is the CFO of the French high-tech firm Gemalto—propose a practical alternative to DCF that is based on a concept they call "cash flow@risk." Implementation of the concept involves dividing expected future cash flow into two components: a low-risk part, or "certainty equivalent," and a high-risk part. The two cash flow streams are discounted at different rates (corresponding to debt and equity) when estimating their value. The concept of cash flow@risk derives directly from, and is fully consistent with, the concept of economic capital that was developed by Robert Merton and Andre Perold in the early 1990s and that has become the basis of Value at Risk (or VaR) capital allocation systems now used at most financial institutions. But because the approach in this article focuses on the volatility of operating cash flows instead of asset values, the authors argue that an internal capital allocation system based on cash flow@risk is likely to be much more suitable than VaR for industrial companies. [ABSTRACT FROM PUBLISHER]

Companies can supplement their traditional capital budgeting techniques with a strategic analysis that helps align both short- and long-term goals. In fact, a strategic analysis of this kind may be the only technique applicable for decisions in which cash inflows are difficult to estimate. Because a strictly financial analysis may lead to different decisions than a strategic analysis, managers need to develop appropriate review criteria that can take into account both strategic and financial analyses, when appropriate. © 2011 Wiley Periodicals, Inc. [ABSTRACT FROM AUTHOR]

Climate change has in recent years gathered traction on the business, political and social agenda. From the business perspective, research has shown that climate change impacts on company value are uncertain, significant and strategically important. The challenge therefore is for the business community to apply financial valuation models that support the incorporation of the climate change impacts in strategic planning. However, the commonly used discounted cash flow techniques in capital budgeting are seen as failing to address the high levels of uncertainties inherent in climate change impacts. Real options thinking has been touted as having the potential to enhance understanding of these impacts via its direct handling of uncertainty, although not much research has been done to demonstrate this. Using an illustrative case study, this research presents an argument for introducing the real options approach, a new method for valuing options of future strategic action by companies in a setting that exhibits climate change impacts. The objective of this research is to contribute to the literature on strategic tools for addressing climate change and ultimately offer some management insights that can narrow the gap between finance theory and business practice. Copyright © 2009 John Wiley & Sons, Ltd and ERP Environment. [ABSTRACT FROM AUTHOR]

The article offers information on real-option valuation method and discusses how the technique can efficiently value capital asset projects. Real-option valuation technique trusts on the discounted cash flow (DCF) method and does not alter the DCF computations. The DCF techniques offer a very significant result which is the anticipated value of the project. Real-option approach is generally regarded as an extension of financial option theory used in investment options on real assets.

The balanced scorecard has become an essential part of the strategic arsenal of many organizations. When a balanced scorecard is designed well, it can build resilience during challenging times. This article points out some of the problems organizations often have in planning and implementing a balanced scorecard—and how to avoid them. © 2009 Wiley Periodicals, Inc. [ABSTRACT FROM AUTHOR]

Real options are valuable sources of flexibility that are either inherent in, or can be built into, corporate assets. The value of such options are generally not captured by the standard discounted cash flow (DCF) approach, but can be estimated using a variant of financial option pricing techniques. This article provides an overview of the basics of real option valuation by examining four important kinds of real options: 1. The option to make follow-on investments. Companies often cite “strategic” value when taking on negative-NPV projects. A close look at the payoffs from such projects reveals call options on follow-on projects in addition to the immediate cash flows from the projects. Today's investments can generate tomorrow's opportunities. 2. The option to wait (and learn) before investing. This is equivalent to owning a call option on the investment project. The call is exercised when the firm commits to the project. But often it's better to defer a positive-NPV project in order to keep the call alive. Deferral is most attractive when uncertainty is great and immediate project cash flows—which are lost or postponed by waiting—are small. 3. The option to abandon. The option to abandon a project provides partial insurance against failure. This is a put option; the put's exercise price is the value of the project's assets if sold or shifted to a more valuable use. 4. The option to vary the firm's output or its production methods. Companies often build flexibility into their production facilities so that they can use the cheapest raw materials or produce the most valuable set of outputs. In this case they effectively acquire the option to exchange one asset for another. The authors also make the point that, in most applications, real-option valuation methods are a complement to, not a substitute for, the DCF method. Indeed DCF, which is best suited to and usually sufficient for safe investments and “cash cow” assets, is typically the starting point for real-option analyses. In such cases, DCF is used to generate the values of the “underlying assets”—that is, the projects when viewed without their options or sources of flexibility. [ABSTRACT FROM AUTHOR]

Fair value is considered here with respect to the two primary objectives of financial statements proposed in the joint conceptual framework that is under development by the FASB and the IASB, namely (a) informativeness—to assist providers of capital in predicting, evaluating, and comparing the amounts, timing and uncertainty of future cash flows, and (b) stewardship—to assist in evaluating how efficient and effective managers have been in enhancing shareholders’ value. More specifically, a comprehensive set of accounting measures and a set of corporate governance reforms intended to align corporate insiders’ and auditors’ behaviour and decisions with the interests of investors is outlined. Suggested reforms show how to present a mix of effectively historical quantifications, exit values, and the discounted values of future cash flows expected from the particularized use of combinations of assets within the firm. Additionally, the article describes how markets can be reformed in order to align the interests of the officers who prepare such accounts, and the auditors who certify them, with those of investors. These market-based reforms would require auditors to insure misrepresentations, and managers to take equity to induce truthful reporting. Also included is a radical extension to earlier proposals by the author, requiring an officer of the company to make the market in shares in a way that would place limits upon the value of the insider's private information. [ABSTRACT FROM AUTHOR]

Different valuation methods can lead to different corporate investment decisions, and the conventional “static, single discount rate” DCF approach in particular is biased against many of the kinds of decisions that corporate managers tend to view as “strategic.” Reducing the bias from valuations involves two main tasks: treating risk in a way that is consistent with observed market pricing, and accounting for the ability of companies to make decisions “dynamically” over time. The authors propose two separate tools, market-based valuation and complete decision tree analysis, for accomplishing these two improvements in valuation. The authors also suggest working with the full distribution of future cash flows, one possible realization at a time, rather than working with the aggregate measure of expected cash flow. From a technical perspective, it is necessary to work with the full distribution to value real options properly. Valuing the cash flows one realization at a time also leads to a much better understanding of the interaction between economy-level, systematic risks and local asset-level, technical risks. Just as important, the proposed approaches support an effective division of labor between local asset managers, who are better positioned to model technical considerations and other asset specifics, and the central finance staff, who can ensure the consistent treatment of economy-wide risk and to create the rules of engagement for evaluating opportunities. After presenting an overview of both the valuation and the organizational issues, the authors present a case involving a corporate investment in carbon capture and storage that illustrates both the application of the proposed methods and the various sources of bias in the typical DCF analysis. [ABSTRACT FROM AUTHOR]

The paper discusses how some of the main types of interaction between financing and value can be incorporated in the discounted cash flow model of valuation, including effects arising from taxes, transactions costs, disclosure, information asymmetry and agency problems. It explains whether a given effect should appear in a project's cash flows, in its cost of capital or as an upfront adjustment to value. Most of the effects imply that the principle of value additivity does not hold. [ABSTRACT FROM AUTHOR]

The article reports on the proper application of real options (RO) in various businesses. It briefly argues that RO is an important extension of discounted cash flow analysis, and is critical to aligning the words and the spreadsheets of financial analysts. It focuses on the minimum level of detail that will allow you to use RO to reach easy-to-communicate quantitative results.

This paper provides an empirical example of the valuation of real options in a large-scale tourism project. The main aim of this article is to elaborate the investment decision process in the evaluation of a ski centre enlargement project by employing elements of the real options methodology. Monte Carlo simulation was used to value the options as it offers the flexibility to directly simulate the uncertainty factors. Traditional discount cash flow analysis points the investment as profitable, although the real options approach proves it as not economically feasible. Copyright © 2006 John Wiley & Sons, Ltd. [ABSTRACT FROM AUTHOR]

In this article, we present the results of a series of interviews given by financial analysts specializing in the European telecommunications industry. Our objective is to gain an insight into their approaches to analysis and valuation (information sources, valuation methods, determinants of recommendations, etc.). We also consider whether analysts' approaches have changed since the "high-tech bubble". We find that today they rely much more on the discounted cash flow analysis method than at the end of the 1990s, when valuation was largely based on multiples. In line with this, analysts have changed their focus from revenue-oriented measures towards an assessment of profitability and cash flow generation. Further, analysts claim to have become more diligent and more critical in their analysis. [ABSTRACT FROM AUTHOR]

Most discussions of capital budgeting take for granted that discounted cash flow (DCF) and real options valuation (ROV) are very different methods that are meant to be applied in different circumstances. Such discussions also typically assume that DCF is “easy” and ROV is “hard”—or at least dauntingly unfamiliar—and that, mainly for this reason, managers often use DCF and rarely ROV. This paper argues that all three assumptions are wrong or at least seriously misleading. DCF and ROV both assign a present value to risky future cash flows. DCF entails discounting expected future cash flows at the expected return on an asset of comparable risk. ROV uses “risk-neutral” valuation, which means computing expected cash flows based on “risk-neutral” probabilities and discounting these flows at the risk-free rate. Using a series of single-period examples, the author demonstrates that both methods, when done correctly, should provide the same answer. Moreover, in most ROV applications—those where there is no forward price or “replicating portfolio” of traded assets—a “preliminary” DCF valuation is required to perform the risk-neutral valuation. So why use ROV at all? In cases where project risk and the discount rates are expected to change over time, the risk-neutral ROV approach will be easier to implement than DCF (since adjusting cash flow probabilities is more straightforward than adjusting discount rates). The author uses multi-period examples to illustrate further both the simplicity of ROV and the strong assumptions required for a typical DCF valuation. But the simplicity that results from discounting with risk-free rates is not the only benefit of using ROV instead of—or together with—traditional DCF. The use of formal ROV techniques may also encourage managers to think more broadly about the flexibility that is (or can be) built into future business decisions, and thus to choose from a different set of possible investments. To the extent that managers who use ROV have effectively adopted a different business model, there is a real and important difference between the two valuation techniques. Consistent with this possibility, much of the evidence from both surveys and academic studies of managerial behavior and market pricing suggests that managers and investors implicitly take account of real options when making investment decisions. [ABSTRACT FROM AUTHOR]

The idea of viewing corporate investment opportunities as “real options” has been around for over 25 years. Real options concepts and techniques now routinely appear in academic research in finance and economics, and have begun to influence scholarly work in virtually every business discipline, including strategy, organizations, management science, operations management, information systems, accounting, and marketing. Real options concepts have also made considerable headway in practice. Corporate managers are more likely to recognize options in their strategic planning process, and have become more proactive in designing flexibility into projects and contracts, frequently using real options vocabulary in their discussions. Thanks in part to the spread of real options thinking, today's strategic planners are more likely than their predecessors to recognize the “option” value of actions like the following: • dividing up large projects into a number of stages; • investing in the acquisition or production of information; • introducing “modularity” in manufacturing and design; • developing competing prototypes for new products; and • investing in overseas markets. But if real options has clearly succeeded as a way of thinking, the application of real options valuation methods has been limited to companies in relatively few industries and has thus failed to live up to expectations created in the mid- to late-1990s. Increased corporate acceptance and implementations of real options valuation techniques will require several changes coming together. On the theory side, we need more realistic models that better reflect differences between financial and real options, simple heuristic methods that can be more easily implemented (but that have been carefully benchmarked against more precise models), and better guidance on implementation issues such as the estimation of discount rates for the “optionless” underlying projects. On the practitioner side, we need user-friendly real options software, more senior-level buy-in, more deliberate diffusion of real options knowledge throughout organizations, better alignment of managerial incentives with long-term shareholder value, and better-designed contracts to correct the misalignment of incentives across the value chain. If these challenges can be met, there will continue to be a steady if gradual diffusion of real options analysis throughout organizations over the next few decades, with real options eventually becoming not only a standard part of corporate strategic planning, but also the primary valuation tool for assessing the expected shareholder effect of large capital investment projects. [ABSTRACT FROM AUTHOR]