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

THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLES 277TABLE 4Valuation Results WhenTotal Earnings Are Not Equal to Hurdle Rate andEarnings and Capital Are Growing @ 3% Per Annum10-Year Forecast Terminal In PerpetuityModel Period Value (Total)Earnings Less Than Hurdle RateDCF 61.22 30.45 91.67EVA(a) 94.43 (2.76) 91.67EVA(b) 94.43 (2.76) 91.67Earnings Greater Than Hurdle RateDCF 72.35 35.99 108.33EVA(a) 105.57 2.76 108.33EVA(b) 105.57 2.76 108.33The impact of growth on the company’s value is to increasethe portion of value contributed in the future. If the company’searnings are not achieving the hurdle rate, growing the businessfurther lowers value. When earnings exceed the hurdle rate,growth produces increased value.The DCF model results show that capital growth, necessaryto support business and earnings growth, reduces free cash flowin the short term in return for an increase in future earnings.Looking at the Earnings Greater Than Hurdle Rate scenario, the10-year forecast period value with no growth is 80.30, droppingto 72.35 with 3% annual growth. However, the comparable terminalvalues increase from 26.37 to 35.99, yielding an in perpetuitygain in total value of 1.66 with growth (108.33 with 3% growthversus 106.67 with 0% growth). In the early projection years,the reinvestment earnings to grow the capital (thereby reducingfree cash flows) exceed the marginal increase in earnings on theadditional capital. This reverses itself in later projection years,resulting in higher terminal values.