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Executive Summary

This paper investigates the shareholders’ possibility to evaluate firm’s value. The fact, that due to the different objectives of the shareholders and the managers, the shareholder value is a suitable figure to synchronize different interests will be shown. Having shown two approaches to calculate shareholder value, these approaches will be assessed, if they provide a suitable calculation of the shareholder value. The discounted cash-flow approach (DCF), basing on prospective cash-flows, is a suitable method to determine shareholder value. The realoption approache extends the DCF-approach by the flexibility component. Regarding the occasions of evaluation, the calculating shareholder can use both approaches, but he has to be sure about the approaches’ boundaries.

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Table of Contents

  EXECUTIVE SUMMARY  2

TABLE OF  CONTENTS  3

  LIST OF FIGURES  4

1  INTRODUCTION  5

2  THE SHAREHOLDER VALUE APPROACH  6

2.1  Market value orientation  6

2.2  Shareholder Value as firms’ objective  7

3  EVALUATION OF FIRMS  8

3.1  Occasions of evaluation  8

3.2  Diversity of methods  9

4  METHODS OF EVALUATION  10

4.1  Discounted Cash-flow  10

4.1.1  Entity approach  11

4.1.2  Equity approach  12

4.2  Real options approach  12

4.2.1  Financial option price models  13

4.2.2  Flexibility  13

5  ECONOMIC ASSESSMENT  14

6  CONCLUSION  17

  BIBLIOGRAPHY  18

IT-MCHECKLISTE   22

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  List of figures  

  Figure 1 : Diversity of methods  10

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1 Introduction

Nowadays, the worldwide economic situation is characterized by globalization, mergers and acquisitions, overestimated firms’ values and strong market volatility on stock markets. ¹ Consequently, this situation led to a new discussion about effective methods of evaluations to calculate the accurate value of a firm.

Furthermore, the necessity to define effective methods of evaluations is forced by the recurrent discussion about owners’ interests or distribution of dividends by stock corporations. Methods of evaluation should be able to calculate prices that serve different issues. On the one hand, prices have to be calculated to fix sales while the owner of the firm is changing and on the other side, prices have to be evaluated in case of tax or creditable assessment. 2

Regarding the pressure of raising capital it is obvious that firms have to concentrate on the investor. In consequence, the popularity of the shareholder value approach is increasing. ³ Maximizing the equity capital is the objective of the shareholder value approach. This approach has been highly characterized by suggestions of Rappaport ⁴ and Cope-land. 5

All these methods to evaluate firms’ value have to include current and prospective economic parameters ⁶ , which have impact on the firm’s value: short product lifecycles, worldwide dynamic capital markets, planning periods with negative cash-flows, intangible assets and flexible entrepreneurial spirit. 7

The objective of this assignment is to demonstrate the impact of selected methods of evaluation to the shareholder value. The effectiveness of the methods and their expressiveness to the shareholder should be outlined, whether these methods give the shareholder the possibility to calculate a useful price.

¹ Cp. Unknown (2005): Selbst in den USA macht man sich Sorgen, p. 960 - 962.

² Cp. Drukarczyk (2001), p. 2.

³ Cp. Drukarczyk (2001), p. 1.

⁴ Cp. Rappaport (1986); Rappaport (1997). Also cp. Rappaport (2006).

⁵ The shareholder value approach is also known as „Aktionärsnutzenansatz“, „wertorientierte Strategieplanung“ or „Wertsteigerungsanalyse“. Cp. Taetzner (2000), p. 27.

⁶ Cp. Kußmaul (1999), p. 335.

⁷ According to Sullivan the „focus of this New Economy is on knowledge and relationships, with a premium awarded to firms demonstrating a capability for speed, flexibility, innovation, and the ability to connect.“ Cp. Sullivan (2000), p. IX and p. 115. Also cp. Edvinsson/ Brünig (2000); Stewart (1998).

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2 The Shareholder Value approach

2.1 Market value orientation

In general, a firm is related to different interests of different groups. The closed system of a firm is broken through by plenty of different desires and different demands by other ac-tors aside the shareholders. Beside the investing shareholders, other actors are related to the firm, who have their own preferences and try to satisfy their needs. ⁸ For example the management, suppliers, customers or employees, who have different objectives concerning the firm, may be these actors. But as these preferences differ intensively, conflicts within the decision making process of the firm may occur. So, a consolidated approach has to be chosen, that meet any expectation. 9

Beside the conflicts within the subset of stakeholders, conflicts may also occur between owner and manager. This is called principal-agent problem. The owner of the firm (principal) transfers special assignments to the manager (agent) and wants him to execute these. The specialized labour force and information provided by the agent is the advantage of the principal. Assuming that both actors are utility maximizers, “there is a good reason to believe that the agent will not always act in the best interests of the principal”. 10

As a homogenous objective is not possible to generate, the capital orientated perspective of the financial theory tries to develop an approach that fits any decision making process. 11

The advantage of cash-flow might be chosen independently disregarding the different preferences. The choice of specific investments ¹² may only be done regarding their price or rather their market value.

Now, the decisions of the management cover the expectations of the investors and shareholders. ¹³ So the conflict free market value meets the utility function of any stake-

⁸ Cp. Günther (1997), p. 42.

⁹ Cp. Schmidt/ Terberger (1999), p. 55.

¹⁰ Cp. Jensen/ Meckling (1976), p. 308.

¹¹ Cp. Schmidt/ Terberger (1999), p. 55.

¹² Ballwieser emphasizes that the returns of these investments should cover the capital costs. Cp. Ballwieser (1995), p. 121.

¹³ For a general discussion about utility maximization cp. Schmidt/ Terberger (1997), p. 44.