Company Valuation Under IFRS : Interpreting and Forecasting ...

Company valuation under IFRS
probability distributions for the drivers to value, and which produces a
probability distribution of resulting values for the asset or company.
4. Frequent problems
This completes our discussion of basic DCF and economic profit valuation, and
we repeat our warning from the end of the section related to forecasting. Although
we shall devote some time to discussion of issues in which the basic approach
does not work well, we shall not again reproduce an entire model and both
valuations with full explanations of how they were derived. So be sure that you
are comfortable with what we have done before moving on through this book.
We began this chapter by saying that in addition to explaining a basic model, we
would also move on to discussion of some commonly encountered problems. The
first of these, the accounting issues discussed in Chapter four, pepper the book.
The explicitly modelling issues that remain are four:
1. Varying balance sheets
2. Cyclical companies
3. ‘Asset light’ companies
4. Growth companies
They all require very different treatment, and we address them one by one below.
4.1 Changing balance sheet structures
It is not unusual to find yourself analysing a company in which the balance sheet
structure is projected to change quite dramatically. This may arise because the
company has been forecasted without any specific projections for share issues or
buy-backs, or because it is clear that the company can and should change its
balance sheet structure. In the first case, it is probably sensible to address the
problem by building share issues or buy-backs into the model, so that the balance
sheet structure remains stable. On this basis, it is not unreasonable to use a single
discount rate throughout the forecasts, as we did for Metro above.
But there are other cases where this will not do. Suppose that you are modelling
a biotechnology company, which is currently financed entirely with equity, not
least because it has unpredictable cash flows and few separable assets. The
company may fail, but if it succeeds, then it will probably become, as it matures,
a large, stable, cash generative entity, which can support a reasonable amount of
debt, and should do so to benefit from the resulting tax shelter. In this case it is
absolutely unacceptable to use a single discount rate through time. In addition, as
we discussed in Chapter two, there is also a real question as to whether its cost
of capital should not be reduced on the grounds of liquidity and general stability,
whether or not this is in accordance with the principles of the CAPM. Before we
turn to growth companies, which we shall address below, there is a simpler case
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