Sanity Checks to Keep it Real and Defensible (Part II of II) This is the second QuickRead article on interest rate volatility and modeling, read Part I here. As valuation professionals, we know that we need to develop and test the interest rate assumption. Valuation professionals also need to understand the impact that an interest rate used will have on the cash flows and value of the firm, and ensure that the rate is real and defensible. Monte Carlo modeling allows us to test the underlying assumptions. Time to put it all together. This is the second QuickRead article on…
-
-
A Case Study In articles published in The Value Examiner, “A Hybrid Approach to Estimating Company Specific Risk,” and “A Hybrid Approach to Determining Company Specific Risk: Using Monte Carlo Simulation,” the author explains the theoretical basis for using a company specific risk premium in the build-up method and presents a methodology for developing the company specific risk premium. Then he shows how to incorporate Monte Carlo simulation into the model. The model is a variation of David Wood’s MUM for allocating personal and business goodwill and the risk rate component model. The following article is a review of some…
-
Time to Revisit this Tool If you think Monte Carlo simulations are too complex to use in business valuation, you are not alone. There are three main reasons valuators shy away from using Monte Carlo analysis: 1) they do not totally understand it, 2) it involves statistical analysis and most would prefer not to relive their college statistics class, and 3) it is difficult to explain, especially to a jury. A recent survey by Business Valuation Resources (BVR), which was ongoing as of the date this article was written, indicates 51 percent of the respondents (82 respondents to date) use…
-
In Related-Party Cost Sharing Arrangements (Part II of II) This two-part paper demonstrates how the discount rate associated with the investment in intangibles developed under a cost sharing arrangement can be calculated using an analytical framework that explicitly considers variability of outcomes in profitability of the intangibles to be developed. Such framework is the probability-weighted scenario analysis. The method of calculating discount rates using the scenario analysis can be applied to compute the PCT payment under both the “income method” and the “residual profit split method” described in the U.S. transfer pricing regulations. The same method also allows to calculate…
-
In Related-Party Cost Sharing Arrangements (Part I of II) This two-part paper demonstrates how the discount rate associated with the investment in intangibles developed under a cost sharing arrangement can be calculated using an analytical framework that explicitly considers variability of outcomes in profitability of the intangibles to be developed. Such framework is the probability-weighted scenario analysis. The method of calculating discount rates using the scenario analysis can be applied to compute the PCT payment under both the “income method” and the “residual profit split method” described in the U.S. transfer pricing regulations. The same method also allows to calculate…
-
The Use of Common Sense and Experience The acceptance of tools such as Monte Carlo simulation and Option Pricing models has changed our ability to value options, warrants, and derivative instruments. The list goes on and on. However, as many of us are fond of saying, valuation is as much an art as it is a science. Many of our tools address the science, not so many of them address the art. In my opinion, one of the most underutilized tools that addresses the art side, may in fact be our own common sense. “Common sense is not so common.”-Voltaire…
-
Odds as a Financial Ratio in Business Valuation Theory Every business transaction involves a bet of sort. This is also evidenced in the price of put and call options. Can we draw some insight from sports betting to help us calculate the value of a business? Perhaps. Odds in sports betting is a common expression communicating the change and return of winning a bet. Odds as a ratio in business valuation theory is presented in this article. Using odds as a ratio in business valuation helps expressing the probability of a forecasted free cash flow. This might start further discussions…
-
Accepting and Rejecting Data from Public Company Data Valuation analysts who, for whatever reason, eschew the publicly traded guideline company method but who would like to use option models for various aspects of the valuation assignment, face a conundrum. All option models require, as an input, a volatility factor in percentage format. Since the only place to derive such a volatility factor (usually defined as the standard deviation of total returns) is from public company data, how do you reject public company data on the one hand over here but use it on the other hand over there? Using non-public…
-
Part II of II This is a two-part article. In this second part, the authors discuss valuation and the approaches used to value contingent assets and liabilities. Read Part I here.
-
Part I of II This is a two-part article. A variety of methods may be appropriate, depending on the context, to value contingent or disputed assets or claims in solvency opinions. These include probability discount, hindsight, and traditional valuation of future earnings. Other possibilities are the cost of insurance or Monte Carlo simulation. The authors discuss the cases and the uses and limitations of the various methods.
-
About the Use of Monte Carlo Simulation QuickRead’s Technical Editor, Roberto Castro, explains that Monte Carlo is another tool valuation and litigation support professionals should embrace since courts have signaled its approval.
-
Businesses Where Real Estate is Integral to Operations What is the best approach to use to value a business where real estate is indispensable to operations? In this article, Dr. Brous discusses the use of the option to abandon.