This study investigates the underlying theories and assumptions of two modern capital market-based valuation approaches, the Discounted-Cash-Flow (DCF) and the Economic-Value-Added (EVA) approach, which are nowadays applied principally for industrial and manufacturing firms. This general examination is then transferred into a more specific investigation exploring whether these valuation concepts can be applied to the strongly regulated and more specific field of bank valuation. A questionnaire addressing bank analysts was created to analyse this question.
The project indicates that the ideas of shareholder value which have been enforced over the last decade have implemented the need for a more shareholder-focused valuation. The application of DCF is basically attributed to this movement. It is revealed that this concept uses cash flow streams which depict a more realistic picture of an organization’s true earning power. Moreover, it employs a discount rate based on the capital market and thus reflecting the yield expectations of the investors.
EVA, on the other hand is a relatively new concept, copyrighted in 1994 by Stern Stewart. It highlights an organization’s true economic profits. The study examines its components NOPAT, Capital and Cost of Capital, establishes a relation to DCF, points out some general limitations due to the fact that it falls back on accounting figures and critically assesses its dependence on the CAPM whose inherent assumptions of efficient markets that are not transferable into reality, might affect the valuation.
The primary research undertaken finally reveals that the concepts of DCF and EVA are basically suitable to be applied to the valuation of banks. However, there are some peculiarities, primarily due to difficulties associated with the definition and measurement of debt and reinvestments which make slight adjustments in the valuation process indispensable. Nevertheless, the end result is just as effective as in other industries.
Inhaltsverzeichnis (Table of Contents)
- Introduction
- The Concept of Shareholder Value
- The Need for a Shareholder-Focused Valuation
- The Discounted-Cash-Flow (DCF) Approach
- Underlying Theories and Assumptions
- Application to Bank Valuation
- Strengths and Weaknesses
- Economic Value Added (EVA)
- The Basic Idea and its Components
- Relation to DCF
- Limitations and Critical Assessment
- Applying DCF and EVA to Bank Valuation
- Empirical Research
- Specific Considerations
- Practical Application
- Conclusion
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
The study aims to explore the applicability of two prominent capital market-based valuation approaches, Discounted Cash Flow (DCF) and Economic Value Added (EVA), in the context of bank valuation. It examines the theoretical underpinnings and practical limitations of these approaches, considering the specific characteristics of the banking industry.
- Shareholder value maximization as a key driver of valuation methodologies
- The role of cash flow analysis in capturing a company's true earning power
- The importance of incorporating market risk and investor expectations in valuation models
- The application of DCF and EVA in the context of bank-specific considerations
- Challenges associated with defining and measuring key variables for bank valuation
Zusammenfassung der Kapitel (Chapter Summaries)
- Introduction: Introduces the concept of shareholder value and its significance in modern business practices. Discusses the need for a shareholder-focused valuation approach, highlighting the limitations of traditional accounting-based valuation methods.
- The Discounted-Cash-Flow (DCF) Approach: Explores the theoretical foundations and assumptions underlying the DCF approach. Examines its practical application to bank valuation, including its strengths and weaknesses.
- Economic Value Added (EVA): Outlines the basic principles of EVA, focusing on its components and relationship to DCF. Critically assesses its limitations, including its dependence on accounting figures and assumptions of efficient markets.
- Applying DCF and EVA to Bank Valuation: Presents empirical research findings on the applicability of DCF and EVA in bank valuation. Discusses specific challenges and considerations related to the banking industry, including the definition and measurement of debt and reinvestments.
Schlüsselwörter (Keywords)
This study focuses on shareholder value, discounted cash flow (DCF), economic value added (EVA), bank valuation, capital market, risk and return, cost of capital, accounting data, market efficiency.
- Quote paper
- Dennis Schön (Author), 2003, The relevance of Discounted Cash Flow (DCF) and Economic Value Added (EVA) for the valuation of banks, Munich, GRIN Verlag, https://www.grin.com/document/27621
