Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

CHAPTER 10

VALUE ENHANCEMENT AND CASH-DRIVEN VALUATION MODELSa

Aswath Damodaran

Because the “new” value enhancement tools, such as EVA, are simply derivatives of the traditional discounted cash flow model, they offer no truly new advances. When used for valuation, these value enhancement methods also present the same core challenges of estimation as DCF analysis, such as cash flows, growth rates, and risk premiums. The key to effective valuation remains unchanged: choosing the right methods for estimating critical variables and understanding the real nature of value creation.

In the past 10 years, value enhancement has become the mantra of consultants and investment banks, who recognize that this concept is a cash cow. As a result, various new measures for value enhancement, such as economic value added (EVA), have come into existence.

This chapter attempts to put the concept of value enhancement in perspective by providing an appreciation of the underlying principles of cash-driven valuation models. The first section examines the basic aspects of the discounted cash flow (DCF) model and reconsiders some of the fundamental estimation issues that typically cause problems in this type of analysis. The second section analyzes the limited number of ways in which companies can truly create value and explains how investors can distinguish between value-neutral actions and value-enhancing actions. The third section directly evaluates the most prominent value enhancement concept, EVA, ...