Corporate Valuation

Chapter 3Scenario Analysis¹

3.1 INTRODUCTION

Chapters 1 and 2 introduced the tools and essential knowledge necessary to set up a meaningful valuation approach. Metaphorically, the reader is now provided with both the ingredients and the recipe needed to make a valuation dish in a very mechanical way.

The goal of this chapter is instead a different one. It is meant to provide the reader with the level of critical thinking that is necessary when valuing.

Due to the high level of subjectivity linked to the estimation of discount rates, to the choice of the appropriate valuation procedure, as well as to cash flow forecasting, scenario analysis is a useful tool that enables the analyst as well as the company's manager to better understand the risks associated with any given valuation.

In particular, many different factors could affect the results expected by a firm on the valuation date, leading to different realized returns. For instance, there are many hypotheses made during the valuation process that might depend on the state of the economy, on the current legislative and political systems, on a particular industry's situation, as well as on the current competitive environment. It would be important to consider possible future scenarios to arrive at the best valuation given future events. It is easy enough to imagine that there could be a sudden technological breakthrough that could cannibalize the business altogether. On the other hand, due to the impossibility of considering ...