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

THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLES 279TABLE 5Valuation Results WhenEarnings on Operations = 0:0%Total Earnings = 4:0% (Investment Only)and There Is No Growth10-Year Forecast Terminal In PerpetuityModel Period Value (Total)DCF 20.08 6.59 26.67EVA(a) 44.79 (18.13) 26.67EVA(b) 44.79 (18.13) 26.67That the EVA model counts the initial capital amount as valueand the DCF model does not leads to significant differences invalue contributors between the forecast period value and theterminal value. Tables 1, 2, 3, and 4 all show that the resultsfor the 10-year forecast period for the EVA model are close(and sometimes equal) to the in perpetuity time frame results.In the EVA model, therefore, excluding earnings beyond a certaintime period does not have a material effect on value. Incontrast, a significant portion of the value indicated by the DCFmodel is captured as terminal value. In these examples in whichthe total earnings of the company are set close or equal to thehurdle rate, the EVA model approaches the in perpetuity valuefaster.Table 5 shows model value results in which earnings relatedto operations are 0.0%.For a scenario in which the company’s earnings potential islow, the DCF model produces a value closer to the in perpetuityvalue in the 10-year period than the EVA model. The DCF modelis not “fooled” by the value of the stated initial capital in the shortterm. The DCF model considers only the earnings potential ofthe capital, not the capital itself. The result is further exaggeratedwhen growth is incorporated as shown in Table 6.