Enterprise Valuation

Value evaluation has always been one of hot topics in the study of financial accounting and finance. Many economical scholars won the Nobel Prize in economics because of their contribution in the field of value evaluation, such as William Sharpe, Myron and Samuel Scholes. The combination of the financial accounting and financial concept has been a trend.It’s the first step for investors to get the success to have a reasonable assessment of "investment". It’s the cost of investment that measures the earnings, and the purpose of valuation of investment projects is to delineate a range for the cost of investment. Successful value evaluation is not only helpful for investors to get projects at lowest cost, but is conducive to protect the project’s own interests. As we all know, value evaluation had played a critical role in the famous M&A between Geely and Volvo. And it is the comprehensive value evaluation to make Yahoo have courage to refuse the proposal of Microsoft. Besides investors, it’s also important for others. For enterprise operators and managers, the reasonable evaluation of enterprise value is an effective way to improve the efficiency of management and useful for managers to make decisions. For government, it’s helpful for regulators to accurately analyze of the industry’s characteristics, in order to increase the effectiveness of industry policy and macro regulation. It’s also important for commercial bank, security company and public investors.Although it’s significant to have a accurate assessment of corporations, there are too much difficult to get it. On the one hand, information asymmetry prevent investors know the company. On the other hand, investors barely can handle the uncertainty of operation and distinguish peculiarity among corporations. Maybe the first problem can be solved by the financial statements. But the second one has been always spited investors. With the rapid developing of technology, it’s becoming more and more serious. Instead of traditional enterprises, high-tech industry has taken the first place in the capital market, for example, Microsoft corp. It is also happened to China. All of Sina, Tencent and Baidu are undergoing fast developing. The special traits of the kind of enterprise make the traditional value evaluation method face big challenges.The study of enterprise value assessment has a long history, and the Discounted Cash Flow method is one of the main methods in evaluation now. On the basis of the prediction of enterprise future cash flow, and according to certain discount rate, DCF measures the value of the enterprises.Emphasizing the potential value make the DCF conform to the requirements of the investors, who pay more attention to the growth of investment. As a result it’s popular for scholars and investors. There are many value evaluation models, all of which are on the base of the principle of the discount cash flow. Such as, FCFF model, FCFE model. Comparing with other evaluation methods, DCF actually have better effect in the evaluation of operational stability and development of mature enterprise.But the traditional discounted cash flow model is a static evaluation method. And it has two hypotheses:investment is "reversible" and corporations present a tendency of the steady growth of a single cash flow. But according to the study of Hayes and Riggs, investment is "irreversible", which means investor must pay for recovering the investment cost completely, however they have chance to avoid "irreversibility". Actually the chance is a kind of option for the investor. By now, we can find the traditional DCF can’t handle the uncertainty and ignore the value of the option, existing in operation. So scholars start to modify it, and then we have two emerging value evaluation model:EBO model and EVA model. But the new models still can’t fix the defects. It is right time that Real Option appears.Real Option is an extension and development of financial options in real investment field. It can make up the defects of DCF, because option is good at dealing with uncertainty and can measure the value of the options in the course of investment.The purpose of this paper is to explore new methods of enterprise value assessment by combining the binary tree option pricing model and the traditional discounted cash flow model on the basis of real options.This paper includes five parts:the first part is introduction, mainly introduces this paper’s research background, significance and research status of enterprise value evaluation both at home and abroad. The second part is about the theory, including the content of section2,3. Section2focuses on analyzing the principle and model of discount cash flow method and comparing their advantages and disadvantages and adaptability. Section3introduces the basic theory of real options, including the meaning and classification of real options and the deduction of the two types of real options pricing model:Black-Scholes option pricing model and binary tree option pricing model.The third part is for model designing, section4is critical part of this paper. Sales cash flow is the breakthrough point. And there are two trends about sales cash flow:up or down. Then we can build a simple multi stage two binomial tree model and we can calculate the rising multiplier and drop multiplier on every point according to the principle of binary tree option pricing.And then we can predict the future cash flow. According the principle of FCFF model, we can divide the business cycle into "forecast period" and "renewal period". During "forecast period", we can calculate the corresponding sales cash flow, according to the cost ratio and expense ratio of base period. On the other hand, we suppose the corporation reach steady state during the "renewal period". So, we can calculate the value of the enterprises in this phase by using sustainable model. Then we can discount the cash flow with the weighted average cost and define the result as unadjusted discounted corporate value. It’s easy to find that the factor of uncertainty is considered. Therefore, the evaluation result is much more reliable than the traditional single growth evaluation model’s results. In order to get more comprehensive value of the corporation, we adjust the valuation results of each point with "liquidation value". After the adjustment, therefore, the enterprise value has includes the "option" value in the process of enterprise operation.The fourth part is the empirical part, including in section5and6. I take ZhongJin Gold Corporation limited as the example to explain how to use the model designed in this paper to assess the value of the corporation. Comparing to other models, the result is effective, that means the model designed by author can be used to evaluate corporation’s value. To prove the conclusion further, I have calculated100corporations which have issue stocks publicly in Chinese stock market. According to analysis result, the unadjusted corporation value can effectively reflect the value of the sample enterprises. After considering the value of "option", the assessment can comprehensively reflect enterprise’s potential value.The fifth part is the conclusion of this paper and further research problems in this paper. I have boldly attempt to design a new model of enterprise value in the context of real option. Due to my knowledge and limited time, there are a lot of defects in the model, which I’ll continue to research them in the future.There are two creative views in this paper. First, it’s an effective way to use binary tree model to make up the defect of the traditional DCF. Second, the introduction of "liquidation value" manifested the enterprise management implied "options" in the process of operation. After adjusting, the assessment value can more fully reflect the value of corporations.The history of real option is still short and it is rarely used in the evaluation of physical. Given its superiority in dealing with ambiguity and option concept, the introduction and application of the concept of real option, is not only helpful to develop and perfect the system of value evaluation, but helpful to provide investors with a more reliable method of value evaluation.