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How to value a seasonal company by discounting cash flows

Author

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  • Fernandez, Pablo

    (IESE Business School)

Abstract

The correct way of valuing seasonal companies by cash flow discounting is to use monthly data. It is possible to use annual data, but it requires some adjustments. In this paper the author shows that when using annual data in the context of the adjusted present value (APV), the calculations of the value of the unlevered equity (Vu) and the value of the tax shields (VTS) must be adjusted. However, the debt that has to be substracted to calculate the equity value does not need to be adjusted. The author derives the adjustments to be made. The errors due to using annual data without making the adjustments are big. Adjusting the calculations only by using average debt and average working capital requirements does not provide a good approximation. When the inventories are a liquid commodity such as grain or seeds, it is not correct to consider all of them as working capital requirements. Excess inventories financed with debt are equivalent to a set of futures contracts. The author shows that not considering them as such leads to an undervaluation of the company. This paper values a company in which the seasonality is due to the purchases of raw materials: the company buys and pays for all raw materials in the month of December. It is shown that the equity value calculated using annual data without making the adjustments understates the true value by 45% if the valuation is done at the end of December, and overstates the true value by 38% if the valuation is done at the end of November. The error due to adjusting only by using average debt and average working capital requirements ranges from -17.9% to 8.5%.

Suggested Citation

  • Fernandez, Pablo, 2003. "How to value a seasonal company by discounting cash flows," IESE Research Papers D/511, IESE Business School.
    • Handle: RePEc:ebg:iesewp:d-0511
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    File URL: http://www.iese.edu/research/pdfs/DI-0511-E.pdf
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    References listed on IDEAS

    as
    1. Fernandez, Pablo, 2004. "The value of tax shields is NOT equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 73(1), pages 145-165, July.
    2. Fernandez, Pablo, 2004. "Shareholder value creation of microsoft and GE," IESE Research Papers D/564, IESE Business School.
    3. Fernandez, Pablo, 2002. "Valuation Methods and Shareholder Value Creation," Elsevier Monographs, Elsevier, edition 1, number 9780122538414.
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    Cited by:

    1. Pablo Fernández & Andrada Bilan, 2013. "110 Common Errors in Company Valuations," International Journal of Economics & Business Administration (IJEBA), International Journal of Economics & Business Administration (IJEBA), vol. 0(1), pages 33-78.
    2. Fernandez, Pablo, 2004. "Most common errors in company valuation," IESE Research Papers D/565, IESE Business School.
    3. Nangia, Vinay Kumar & Agrawal, Rajat & Reddy, K. Srinivasa, 2011. "Business Valuation: Modelling Forecasting Hurdle Rate," MPRA Paper 60420, University Library of Munich, Germany, revised 2011.
    4. Fernandez, Pablo, 2003. "75 common and uncommon errors in company valuation," IESE Research Papers Db/515, IESE Business School.
    5. Fernandez, Pablo, 2004. "80 common and uncommon errors in company valuation," IESE Research Papers D/550, IESE Business School.

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    More about this item

    Keywords

    valuation seasonal companies; seasonality; cash flow discounting;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics

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