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

THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLES 311ation indications for all subsequent years were estimated usingthe respective method’s value formulas starting one year after theexplicit forecast period. For the DCF method, this calculation developsto the terminal value. For the EVA method this calculationdevelops the “continuing value added” after the explicit forecastperiod.Both models yield value of approximately $88 million as ofDecember 31, 2001. The comparison of the value componentsfor the two methodologies parallels observations made in Section3 about the scenario in which a company achieves more than thehurdle rate and is growing.² The EVA method recognizes value amounts in the forecastprocess faster than the DCF method. As of the end of theexplicit forecast period, through 2011, the EVA method valueestimate is $73.9 million ($42.1 million surplus plus $31.8million as the present value of future value added in years2001 through 2011). The DCF method value estimate is $54.7million representing the present value of free cash flow foryears 2002 through 2011.² The present value of the reinvestment cost (retained earnings)of $21.9 million (for all years) for DCF equals the presentvalue of the cost of growth capital for EVA. The DCF reinvestmentcost over the 10-year explicit forecast period ($18.97million) is greater than the EVA cost of growth capital duringthe same period ($10.14 million). The difference is offset inmodeled amounts for 2012 and subsequent years, $2.96 millionfor DCF and $11.79 million for EVA. 26The following diagram shows the steps in the development ofvalue presented in Exhibit 7.The recorded statutory surplus for PSIC as of December31, 2001 is $45.00 million. However, this amount exceeds the26 DCF (18:97 + 2:96) = EVA (10:14 + 11:79) = 21:93.