Valuation of the Liability Structure by Real Options

Introduction

The traditional approaches to valuating companies are currently grouped into three categories: the patrimonial method is based on the value of company assets, the multiples method consists of determining a value using similar companies as a reference or transactions that took place in the same sector, and the method of discounted cash flows tries to consider the development potential of the company. These different methods are used by those who think the value obtained by one of them should not be the focus, but rather an approach that seeks to link them. This recommendation is justified given that the practice is not an exact science.

Nevertheless, these different approaches have specific and common limits. Indeed, the multiples method can lead the analyst to false sector-specific multiples when the company reference contains large disparities in terms of financial structure or investment policy. The DCF method depends on hypotheses, which in turn depend on the analyst’s subjectivity. In this way, each one can justify a level of provisional cash flow and weighted mean cost of capital by justifying the pertinence of the established business plan. The patrimonial approach counts on the value of assets in the current portfolio and excludes, as such, any potential for growth.

Otherwise, they have the common disadvantage of considering an accounting net debt rather than an economic net debt¹, and omitting the notion of flexibility with respect to investment decisions. ...