Research On The Application Of Monte Carlo Simulation In The Income Method

Income approach is the most accurate and scientific method of asset valuation, but theapplication of income approach in the practice involves the valuations of three mainparameters these are the amount of revenue, the discount rate and the income period. Sincethe objects being evaluated situates in a constantly changing market, they suffer influencenot only from macroeconomic factors in the external but also from internal micro factors.This leads to the uncertainty of the parameters in the evaluation process when applying theincome approach. The influence of the uncertainty can be described by probability theoryand mathematical statistics theory and the random variable of the parameters can be drawnfrom historical data. The traditional method is based on complete information assumption,ignoring the uncertainties in the assessment of the income approach, and the result foundedin the assessment is usually the point estimate. No matter in theoretical circles or practicecircles, more and more experts and evaluation practitioners questioned the rationality ofthe results of the point estimate.This paper regards the uncertainty of the income approach in the assessment of assetsas a breakthrough, and combines with the income approach to enterprise valuation, usesthe discounted free cash flow model (DCF model) to analyze the existing problems. Firstly,we analyze the traditional income approach in enterprise valuation and the discounted freecash flow model, introducing the method for determining the amount of revenue, thediscount rate and the income period. Secondly, we analyze the uncertainties assetsassessment and sources of uncertainties, constructing a DCF model containing theseuncertainties based on probability theory and mathematical statistics, then we discussed therandom distribution of the parameters using available data and expert opinions, we alsostudies how to handle the correlation of different parameters, and bring out the thought oftaking nonrecurring events into account.Finally, we combine income approach in enterprise valuation, the features of DCF,and points and steps of Monte Carlo simulation; we built the income approach assessmentprocess based on Monte Carlo simulation and discuss the important steps in detail. Finallywe give a practical case, using both traditional enterprise evaluation method and theenterprise value evaluation method based on the Monte Carlo simulation. Throughcomparing the results of the two assessment methods, we consider that the interval estimation from the second method is more objective, reliable and accurate, and providemore useful reference for the users of the assessment results to make effective decisions.