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

NOTES

1. See Bodie and Merton (1998); Damodaran (1994); Danielson (1998); Elton and Gruber (1991); Fruhan (1979); Gordon and Gordon (1997); Gordon (1962); Miller and Modigliani (1961); Peterson and Peterson (1996); Rappaport (1998); Sorensen, and Williamson (1985); Treynor (1972); and Williams (1938).

2. Although valuation models can be cast in terms of various flow variables—dividends, earnings, cash flow, etc.—I adhere in this chapter to more standard “earnings and dividends” terminology. The basic thrust of my argument can be readily extended to models based on other measures.

3. The choice of the capital Q reflects an intentional deference to Tobin’s q measure, even though his concept was much broader in scope. Moreover, because of the narrow focus on the competitive challenge, I have found it helpful to have the replacement costs serve as the numerator in our Q ratio rather than the denominator as in Tobin’s classic q measure.

4. In the more general case, strong franchise barriers could also lead to situations in which the would-be competitor’s capital expenditure would have to go far beyond simply replicating the original company’s goods-producing capacity. Such high-replacement-cost situations could lead to Q values that greatly exceed 1.

5. Q may also incorporate any general pricing divergences in the market for old versus new capital assets.

6. Even these harsh conditions would not necessarily doom the company to operational failure: The sales margin can still be positive ...