PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

276 THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLESTABLE 3Valuation Results WhenTotal Earnings Are Not Equal to Hurdle Rateand There Is No Growth10-Year Forecast Terminal In PerpetuityModel Period Value (Total)Earnings Less Than Hurdle RateDCF 70.26 23.07 93.33EVA(a) 94.98 (1.65) 93.33EVA(b) 94.98 (1.65) 93.33Earnings Greater Than Hurdle RateDCF 80.30 26.37 106.67EVA(a) 105.02 1.65 106.67EVA(b) 105.02 1.65 106.67capital. As expected, when the hurdle rate requirement exceedsearnings, the value of the company drops below the value of thestarting capital ($100 in this example). Likewise, when earningsexceed the hurdle rate, there is additional value created. In Exhibits3A, 3B, and 3C, total annual created earnings are 16% andthe cost of capital is dictated by the hurdle rate, 15%, leaving anexcess return on capital of 1% for each year in the future. Thepresent value of the 1% marginal profit in return on capital of100 is 6.67 in perpetuity. Referring to Exhibits 4A, 4B, and 4C,a 1% marginal loss in return on capital of 100 leads to a valuedecrease of 6.67.3.7. Total Earnings Not Equal to Hurdle Rate and the CompanyIs GrowingTable 4 displays the company value results for the three modelsin the scenarios in which the annual total earnings relative tocapital do not equal the hurdle rate and the company’s capital andearnings are growing by 3% per annum. Exhibits 5A, 5B, 5C,6A, 6B, and 6C show the calculations leading to these results.