Modeling Valuation Accounts

Use the Tax and Valuation Options dialog to access Shareholder Value (a Free Cash Flow method), Dividend Discount (a Free Cash Flow method) and Economic Profit options.

Entering Data for Shareholder Value Method Accounts

The Shareholder Value Method measures future free cash flows (from operations) less investments in fixed and working capital. It is not one period measure, but rather a measure of multiple year future free cash flows, discounted at the weighted average cost of capital. This approach is used by public companies to compare management's expectations to current market price of their stock and by private companies or divisions of large public companies, to obtain a proxy of the market value of their businesses.

For a more detailed explanation of these items, see Valuation Theory.

To enter data for Shareholder Value Method Accounts (SVA):

  1. Access Tax and Valuation Options.

    See About Tax and Valuation Options.

  2. In Tax and Valuation Options, select SVA tab.

  3. From the drop-down list, select either Cost of Capital or Long-Term Cost of Capital option.

    • If you select Cost of Capital from the drop-down list, and then enter the account values in the associated grid. The Cost of Capital is the weighted average costs of debt and equity. The rate should be entered as a percentage, not a decimal (5.57% is input at 5.57, not .0557). Oracle recommends that you use one rate for all periods.

    • If you select Long-Term Cost of Capital from the drop-down list, and then enter the account values in the associated grid. The Long-Term Cost of Capital is used to calculate the residual value. The rate should be entered as a percentage, not a decimal.

  4. In Method to Use, select a method.

    There are six different residual value methods:

    • Perpetuity Method

    • Growth in Perpetuity

    • Value Growth Duration

    • Price/Earnings Ratio

    • Market-to-Book Ratio

    • Liquidation Value

  5. In Residual Value Tax Rate (%), enter a rate.

    The residual value income tax rate is applied during the years following the forecast period.

  6. In Perpetuity Growth Rate (%), enter a rate.

    Enter the perpetuity growth rate when using the Growth in Perpetuity method to calculate residual value.

  7. In Value Growth Duration (years), enter the number of years.

    Enter the value growth duration when using the Value Growth Duration method to calculate residual value.

  8. From the drop-down list, select the Normalized Operating Profit Adjustment, and then enter the account values in the associated grid.

    You can use this item to change or normalize, for valuation purposes of the period–by–period values for Taxable Operating Profit that you consider to be abnormally high or low due to prevailing industry or economic conditions that you do not expect to continue.

    If you enter adjustments for periods, the amount is added to Taxable Operating Profit for each period entered and used in calculating Residual Value. While it affects the valuation, it does not change Operating Profit as it appears on the Income Statement.

    Note:

    This adjustment is only appropriate if you are using one of these residual value methods that use a perpetuity cash flow in its calculation: Perpetuity Method, Growth in Perpetuity and Value Growth Duration.

  9. From the drop-down list, select the Market-to-Book Ratio, and then enter the account values in the associated grid.

    Enter the Market-to-Book Ratio when using the Market-to-Book Ratio method to calculate Residual Value.

  10. From the drop-down list, select the Price / Earnings Ratio, and then enter the account values in the associated grid.

    Enter the Price/Earnings Ratio when using the Price/Earnings method to calculate Residual Value.

  11. From the drop-down list, select the Debt Discount / (Premium) (%), and then enter the account values in the associated grid.

    The Debt Discount/(Premium) is used in the calculation of the Market-To-Book Residual Value and Price/Earnings Residual Value. The Debt Discount/(Premium) is used to adjust the book value of Debt and/or Preferred Stock to market values.

  12. From the drop-down list, select the Normalized Earnings Adjustment, and then enter the account values in the associated grid.

    You can use this to change or normalize, for valuation purposes of the period-by-period values for Income Available for Common Shareholders that you consider to be abnormally high or low due to prevailing industry or economic conditions in that year which are not expected to continue.

    If you enter adjustments for periods, the amount is added to Income Available for Common Shareholders used in calculating the Price/Earnings Residual Value for valuation. It does not change Income Available for Common Shareholders as it appears on the Income Statement.

  13. From the drop-down list, select the Liquidation Residual Value, and then enter the account values in the associated grid.

    This item represents your estimate, in future value currency, of what the price tag of the business is in each year of the forecast period, based on your expectations of prevailing conditions in that period. You must incorporate the costs of liquidation, including such items as transaction cost and recapture tax in this value.

  14. Click OK.

Entering Data for Dividend Discount Method Accounts

The Dividend Discount Method (DDM) measures the value of a company's assets by estimating the expected future cash flows to investors, (that is, dividends) and discounting those future flows by the investors' required rate of return to determine the present value of the future cash stream.

See Valuation Theory.

Entering Data for Dividend Discount Method Accounts:

  1. Access Tax and Valuation Options.

    See About Tax and Valuation Options.

  2. In Tax and Valuation Options, select the DDM tab.

  3. From the drop-down list, select either Cost of Capital or Long-Term Cost of Capital option.

    • If you select Cost of Capital from the drop-down list, and then enter the account values in the associated grid. The Cost of Capital is the weighted average costs of debt and equity. The rate should be entered as a percentage, not a decimal (5.57% is input at 5.57, not .0557). Oracle recommends that you use one rate for all periods.

    • If you select Long-Term Cost of Capital from the drop-down list, and then enter the account values in the associated grid. The Long-Term Cost of Capital is used to calculate the residual value. The rate should be entered as a percentage, not a decimal.

  4. In Method to Use, select an option from the drop-down list.

    When performing a valuation using the Free Cash Flow method, you can select from six different residual value methods:

    • Perpetuity Method

    • Growth in Perpetuity

    • Value Growth Duration

    • Price/Earnings Ratio

    • Market-to-Book Ratio

    • Liquidation Value

  5. In Long-Term Return on Book Equity (%), enter a value.

    Enter the Long-Term Return on Book Equity which is used to compute the Perpetuity Affordable Dividend.

  6. In Target Leverage Ratio (%), enter a value.

    Enter the Target Leverage Ratio (%) when using the Perpetuity, Growth in Perpetuity or Value Growth Duration methods to calculate residual value.

  7. In Perpetuity Growth Rate (%), enter a value.

    Enter the Perpetuity Growth Rate (%) when using the Growth in Perpetuity Method to calculate residual value.

  8. In Value Growth Duration (years), enter a value.

    Enter the Value Growth Duration (years) when using the Value Growth Duration Method to calculate residual value.

  9. From the drop-down list, select the Market-to-Book Equity Ratio, and then enter the account values in the associated grid.

    Enter the Market-to-Book Ratio which is used in the calculation of Market-to-Book Equity Residual Value.

  10. From the drop-down list, select the Price / Earnings Equity Ratio, and then enter the account values in the associated grid.

    Enter the Price/Earnings Equity Ratio which is used in the calculation of Price/Earnings Equity Residual Value.

  11. From the drop-down list, select the Normalized Earnings Adjustment, and then enter the account values in the associated grid.

    You can use this item to change or normalize, for valuation purposes of the period-by-period values for Income Available for Common Shareholders that you consider to be abnormally high or low due to prevailing industry or economic conditions in that year which are not expected to continue.

    If you enter adjustments for periods, the amount is added to Income Available for Common Shareholders used in calculating the Price/Earnings Equity Residual Value for valuation. It will not change Income Available for Common Shareholders as it appears on the Income Statement.

  12. From the drop-down list, select the Equity Liquidation Value, and then enter the account values in the associated grid.

    This item represents your estimate, in future value currency, of what the price tag of the business is in each year of the forecast period, based on your expectations of prevailing conditions in that period. You must incorporate the costs of liquidation, including such items as transaction cost and recapture tax in this value.

  13. Click OK.

Entering Data for Economic Profit Method Accounts

The Economic Profit (EP) method assumes that a company's value equals the amount of invested capital plus a premium equal to the present value of the economic profit in each forecast year. Economic Profit equals the spread between the rate of return on invested capital and the rate of return on required capital, multiplied by the invested capital.

See Valuation Theory.

Entering Data for Economic Profit Method Accounts:

  1. Access Tax and Valuation Options.

    See About Tax and Valuation Options.

  2. In Tax and Valuation Options, select EP tab.

  3. From the drop-down list, select either Economic Profit or Long Term Required Return option.

    • If you select the Economic Profit from the drop-down list, and then enter the account values in the associated grid. The Economic Profit is the discount rate used to determine the discount factor which is used to calculate the present value of economic profit. The rate should be entered as a percentage, not as a decimal.

    • If you select the Long Term Required Return from the drop-down list, and then enter the account values in the associated grid. The Long Term Required Return is the rate used to discount the residual value of the economic profit. The rate should be entered as a percentage, not as a decimal.

  4. In Residual Value Tax Rate (%), enter a value.

    Enter the Residual Value Tax Rate which is applied during the years following the forecast period.

  5. In Residual NOPAT Adjustment, enter a value.

    Enter adjustments to NOPAT for the residual period.

  6. From the drop-down list, select the Economic Profit Adjustment to NOPAT, and then enter the account values in the associated grid.

    Enter adjustments to NOPAT.

  7. From the drop-down list, select the Economic Profit Adjustment to Assets, and then enter the account values in the associated grid.

    Enter the Asset Adjustment which is used to adjust Book Value.

  8. From the drop-down list, select the Economic Profit Adjustment to Liabilities, and then enter the account values in the associated grid.

    Enter the Liabilities Adjustment which is used to adjust Book Value.

  9. Click OK.

Entering Data for Other Valuation Accounts

On the Other Valuations tab, select to have your cash flows discounted at mid-period or end-of-period. Mid-period discounting assumes that cash flows arrive (on average) at the mid-point of a period; end-of-period discounting assumes that the cash flows all arrive at the end of a period. You can enter some other adjustments to each of the three valuation methods used in Strategic Modeling.

See Valuation Theory.

Entering Data for Other Valuation Accounts:

  1. Access Tax and Valuation Options.

    See About Tax and Valuation Options.

  2. In Tax and Valuation Options, select Other Valuation tab.

  3. In Current Stock Price, enter a value.

    Enter the stock price as of the last day in history. This value can be compared to the Shareholder Value per Share, Equity Value Per Share and Economic Profit Shareholder Value per Share to see if the market seems to be undervaluing or overvaluing the stock.

    Note:

    Enter the current stock price for the company you are modeling to use for comparison to the Shareholder Value per Share on the valuation reports. This amount appears at the bottom of the reports with the Shareholder Value per share. The Premium/Discount Over/Under Market (%) account calculates and display the percent that the Shareholder Value per Share is over or under the current stock price.

  4. In Market Value of Debt, enter a value.

    Enter the Market Value of Debt which is calculated using the yield to maturity of all debt instruments in a company’s debt portfolio. The Market Value of Debt must be deducted from Corporate Value or Economic Profit Corporate Value to arrive at Shareholder Value or Economic Profit Shareholder Value.

  5. In Underfunded Pension Liabilities, enter a value.

    Enter Underfunded Pension Liabilities which must be deducted from Corporate Value or Economic Profit Corporate Value to arrive at Shareholder Value or Economic Profit Shareholder Value.

  6. In Market Value of Other Obligations, enter a value.

    Enter the Market Value of Other Obligations which represents the market value of other obligations not included in Market Value of Debt or Underfunded Pension Liabilities. Market Value of Other Obligations must be deducted from Corporate Value or Economic Profit Corporate Value to arrive at Shareholder Value or Economic Profit Shareholder Value.

  7. In Investments in Stocks and Bonds, enter a value.

    Enter the Investments in Stocks and Bonds which represents the market value of the company’s current portfolio of long-term investments in stocks and bonds. Investments in Stocks and Bonds are included in Corporate Value.

  8. In Cost/Equity Adjustment, enter a value.

    Enter the adjustment to be added to Corporate Value for an investment using the Cost or Equity method of consolidation. This adjustment should be the ownership % * Shareholder Value of the investment.

    This adjustment calculates if the investment is consolidated into the current Strategic Modeling file using the Cost or Equity method of consolidation.

  9. In Minority Interest Adjustment, enter a value.

    Enter the adjustment to be subtracted from Shareholder Value for an investment using the Minority Interest method of consolidation. This adjustment should be the ownership % * Shareholder Value of the investment.

    This adjustment is automatically calculated if the investment is consolidated into the current Strategic Modeling file using the Minority Interest Method of consolidation.

  10. In Market Value of Other Liabilities, enter a value.

    Enter the Market Value of Other Liabilities - DDM which is deducted from the Estimated Equity Value.

  11. In Market Value of Other Assets, enter a value.

    Enter the Market Value of Other Assets - DDM which is added to the Estimated Equity Value.

  12. In Cost/Equity Adjustment, enter a value.

    Enter the adjustment to be added to Economic Profit Corporate Value for an investment using the Cost or Equity method of consolidation. This adjustment should be the ownership % * Economic Profit Shareholder Value of the investment.

    This adjustment is automatically calculated if the investment is consolidated into the current Strategic Modeling file using the Cost or Equity method of consolidation.

  13. In Minority Interest Adjustment, enter a value.

    Enter the adjustment to be subtracted from Economic Profit Shareholder Value for an investment using the Minority Interest method of consolidation. This adjustment should be the ownership % * Economic Profit Shareholder Value of the investment.

    This adjustment is automatically calculated if the investment is consolidated into the current Strategic Modeling file using the Minority Interest Method of consolidation.

  14. Select a Calculate Discount Factor as option.

    • End-of Period Select the End-of-Period Discount Factor if discounting is to be done at the end of a period.

    • Mid-Period Select the Mid-Period Discount Factor if discounting is to be done at the mid-point of a period.

  15. Click OK.