This thesis concentrates on the Discounted Cash Flow (DCF) analysis. More specifically, it is worked with the Weighted-average Cost of Capital (WACC) method, the Adjusted Present Value (APV) method, and the Flow-to-Equity method . In addition, the focus is on tax loss carryforwards and the problem of how to incorporate the valuation of them into a DCF framework. Generally, two approaches are accepted for valuing loss carryforwards. One can either indirectly or directly determine the value of loss carryforwards.
The thesis starts by explaining the fundamentals of business valuation and how the three DCF methods work. After that, a literature review is presented. The purpose of the literature review is to show the strategies others have developed to value loss carryforwards correctly. To show how to incorporate the valuation of loss carryforwards into a DCF framework, an example case was designed that involves two identical companies. The WACC method, the APV method, and the Flow-to-Equity method are applied and combined with the direct, as well as, the indirect method. When the results of the direct method are compared with the results of the indirect method for each one of the three DCF methods, it is concluded which of these approaches works, and gives a correct solution, and which one does not.
Table of Contents
1 Introduction
2 Valuation of loss carryforwards
2.1 Fundamentals of business valuation
2.2 Literature review
3 DCF valuation methods
3.1 The WACC method
3.2 The APV method
3.3 The Flow-to-Equity method
4 Example case
4.1 Assumptions and simplifications
4.2 The indirect method
4.2.1 The WACC method
4.2.2 The APV method
4.2.3 The Flow-to-Equity method
4.3 The direct method
4.3.1 The WACC method
4.3.2 The APV method
4.3.3 The Flow-to-Equity method
4.4 Interpretation of the results
5 Conclusion
Research Objectives and Core Themes
The primary objective of this thesis is to examine how loss carryforwards can be incorporated into business valuations using standard Discounted Cash Flow (DCF) frameworks. The research explores both direct and indirect valuation approaches to determine the impact of tax loss carryforwards on firm and equity value.
- Fundamentals of business valuation and DCF analysis
- Application of WACC, APV, and Flow-to-Equity methods
- Direct vs. indirect valuation strategies for loss carryforwards
- Comparative analysis through a simulated example case
- Handling of tax effects and path-dependency in valuation
Excerpt from the Book
2.1 Fundamentals of business valuation
The DCF analysis considers the time value of money. This concept states that money received today is worth more than money received in the future because of the opportunity cost of capital (Nurnberg, 1972, p. 655). Money received today can be invested earlier and thus a positive rate of return can be earned sooner. The discount rate used in the DCF analysis is the rate of return investors can expect from the best (meaning highest rate of return) alternative investment with similar risk characteristics (Titman and Martin, 2011, p. 98). With the DCF analysis one can compute present values of a stream of cash flows. The present value can be interpreted as the value added in the current period from the stream of cash flows earned in the future (Ross et al., 2016, p. 274). The cash flows that are discounted in a DCF valuation are after-tax cash flows. This means that the tax expense has been subtracted.
Summary of Chapters
1 Introduction: This chapter provides an overview of the thesis objectives, focusing on the intrinsic valuation of companies and the specific challenge of incorporating loss carryforwards into a DCF framework.
2 Valuation of loss carryforwards: This section reviews foundational concepts of business valuation and surveys existing literature on strategies for valuing loss carryforwards.
3 DCF valuation methods: This chapter details the three standard DCF valuation approaches: the Weighted-average Cost of Capital (WACC) method, the Adjusted Present Value (APV) method, and the Flow-to-Equity method.
4 Example case: This central chapter presents a practical example case comparing two identical companies, applying both direct and indirect methods to quantify the impact of loss carryforwards.
5 Conclusion: The final chapter summarizes the findings, confirming that while different DCF approaches lead to consistent results, they require specific adjustments to correctly account for the tax benefits of loss carryforwards.
Keywords
Business valuation, Loss carryforwards, DCF analysis, WACC method, APV method, Flow-to-Equity method, Tax savings, Interest tax shield, Corporate finance, Enterprise value, Equity value, After-tax cash flows, Valuation models.
Frequently Asked Questions
What is the primary focus of this thesis?
The thesis focuses on the technical problem of how to correctly compute and incorporate the value of tax loss carryforwards into standard DCF valuation models.
What are the core valuation methods analyzed in the study?
The study analyzes three primary DCF methods: the WACC method, the APV (Adjusted Present Value) method, and the Flow-to-Equity method.
What is the main objective of the research?
The goal is to determine how loss carryforwards impact both the enterprise value and the equity value of a firm, and which valuation approach provides the most consistent solution.
What scientific methodology is utilized?
The author utilizes a deductive approach, combining literature review with a comparative example case involving two identical companies to test the different valuation models.
What is covered in the main section of the work?
The main section establishes the theoretical DCF framework, reviews academic literature, and executes a step-by-step comparative analysis using direct and indirect valuation techniques.
Which keywords best characterize this work?
Key terms include Business Valuation, Loss Carryforwards, DCF Analysis, WACC, APV, and Interest Tax Shield.
How do the direct and indirect methods differ in this study?
The indirect method computes the firm value with and without a loss carryforward and takes the difference, while the direct method discounts the specific tax savings generated by the carryforward.
Why are assumptions and simplifications necessary in the example case?
Simplifications regarding tax laws and constant debt-to-value ratios are necessary to focus on the mathematical and conceptual core of the valuation problem without becoming overly obscured by jurisdiction-specific tax complexities.
- Citation du texte
- Ruben Kuhnle (Auteur), 2019, Valuation of loss carryforwards in the context of business valuation, Munich, GRIN Verlag, https://www.grin.com/document/512988
