Finance and Accounting - Essay Example

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This essay explores strategic option valuation which is an alternative valuation method that takes advantages of certain trends, factors and opportunities of the external environment in evaluation of options. Brokers often take advantage of the anticipated bully market…
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Finance and Accounting
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Finance and accounting [Insert al affiliation Explain the use of strategic option in valuation. Explain how strategic options are often abused in valuation.
Strategic option valuation is an alternative valuation method that takes advantages of certain trends, factors and opportunities of the external environment in evaluation of options. Brokers often take advantage of the anticipated bully market at an expense of other stake holders in the exchange market. For instance if the there the brokers anticipate a fall in price, they tend to sell their securities at higher price than the anticipated price fall while when they anticipate an increase in the price of the securities, they buy at low and sell at a future date at a higher price.
2. Explain the APV approach and how it is used in enterprise valuation.
Adjusted present value approach is a capital budgeting technique that is used to value a firm that borrows debt. The technique starts with computing the value of the firm without the debt. Secondly, the technique values the firm with debt then considers the effect of the debt value both cost of borrowing and benefits. The method assumes the ultimate benefit of borrowing is tax benefit and the disadvantage being the borrowing cost.
The technique has three steps:
Value of unlevered firm is the first step which involves valuation of the firm without a debt by discounting the future cash flows at unlevered cost of equity.
Value of unlevered firm =
where FCFF is the current after tax operating cash flow to the firm and ke being the cost of equity and g is the growth rate anticipated.
Unlevered beta =
B levered =beta for unlevered firm
B current is the equity beta that is current
T is the tax rate
D/E is the debt to equity ratio.
Expected tax benefit from borrowing
This is the second step and involves computation of expected benefit from debt
Expected tax benefit from borrowing =
Expected bankruptcy costs and net effect
This is the last step and involves calculating the effect of a given level of debt on risk of default and consequently on bankruptcy costs anticipated.
= (probability of bankruptcy) (PV of bankruptcy cost)
The present value of expected bankruptcy cost = α EF where α is default probability on additional debt and EF is the present value of bankruptcy cost
3. Explain how derivative securities are used to find certainty equivalent cash flows. How would you use these cash flows in valuation?
Derivative securities are financial instruments that have their value from the underlying assets. Such derivatives have different degrees of risks and therefore the certainty equivalent of cash flows can be computed by use simple multiple and based model where the cost of capital is used in finding both the current uncertain values of future uncertain cash flows.
4. Compare and contrast relative valuation techniques with discounted cash flow valuation.
Both techniques are used in evaluation and estimation of the firms/company’s value. Additionally, both techniques use cash flows from the assets in their respective evaluations to find out the intrinsic value of the firm. Conversely, in discounted cash flow valuation, the purpose is to discover the value of assets, given their respective cash flows, growth rates and risk distinctiveness. In relative valuation, the purpose is to value assets, based upon how comparable assets are presently priced in the market.
5. Identify the issues that make private equity more difficult to value as compared to public firms.
Private equity has been facing difficulties in valuing the private equity value as there have been different definitions of the fair value and inadequate/limited guidance in application of generally accepted accounting principles. Additionally, issues like financial crisis compel problems in valuation of private equity as the markets become unsteady hence triggering liquidity and placing stress on particular assets. Ineffective policies and procedures used by managers regarding valuation of private equity bring about another problem in valuation. Read More
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