The Circularity Problem with Free Cash Flow

Turner, James C. G.

doi:10.5791/0882-2875-27.3.138

Cited by 1 publication

(2 citation statements)

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“…Larkin (2011) states that analysts should use the iterative method with the WACC when valuing passive investments. According to Turner (2008), the circularity problem is important, since a small error in the post-tax WACC calculation can lead to a large error in the FCFF model's valuation.…”

Section: (10)mentioning

confidence: 99%

“…Nevertheless, computing the capital structure for each company by solving the circularity problem requires some iterative calculations (Turner, 2008). Larkin (2011) details the calculations to be carried out and says that it is extremely simple to execute the iterative method in an Excel spreadsheet.…”

Section: Iterative Procedures To Determine the Capital Structurementioning

confidence: 99%

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Valuation of agrifood SMEs. Lessons to be learnt from the stock market

Vidal¹,

Ribal

2018

Span. j. agric. res.

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The European agrifood industry is mostly characterized by small and medium enterprises (SMEs); as in 2013, SMEs represented 99.13% of the total number of companies. The valuation of SMEs not listed in any stock market is a complex task since there is not enough information on comparable transactions. When applying discounted cash flow (DCF) models to value private agrifood companies, the capital structure and the cost of equity are two key parameters to be determined. The implications of these parameters in the value of the enterprise are not clear inasmuch as it is not possible to carry out a contrast due, precisely, to the lack of comparables. The main goal of this study is to determine the biases that those two parameters can introduce into the valuation process of an agrifood company. We have used the stock market as a framework wherein to apply a simple fundamental model to the companies of the European food industry in order to obtain three valuation multiples. By means of two bootstrap approaches, the bias induced in the multiples has been assessed for every year from [2002][2003][2004][2005][2006][2007][2008][2009][2010][2011][2012][2013]. Results show that the use of the return on equity as cost of equity tends to undervaluation; the use of capital asset pricing model (CAPM) tends to a slight overvaluation, whereas using the total beta induces an undervaluation bias. Moreover, the capital structure shows little influence on the valuation multiples. The conclusions drawn from this paper can be useful for managers and shareholders of privately-held agrifood companies.

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Section: (10)mentioning

confidence: 99%

Section: Iterative Procedures To Determine the Capital Structurementioning

confidence: 99%