Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

CHAPTER 11

FEVA: A FINANCIAL AND ECONOMIC APPROACH TO VALUATIONa

Xavier Adserà and Pere Viñolas

Traditional valuation methods (economic value added, discounted cash flow, and Modigliani and Miller models) are mathematically equivalent and thus should provide the same result when the same inputs are used. They do not. Because these methods focus on different value drivers, we suggest an alternative valuation method that provides the adjustment necessary to produce consistent results. We also propose a new corporate valuation method (“financial and economic value added,” or FEVA) that integrates the EVA, DCF, and MM approaches and allows a detailed analysis of financial and economic corporate value drivers.

Financial analysts face a fundamental problem: When different valuation models are applied to the same company, they yield significantly different results. Because the three main families of corporate valuation models—economic value added (EVA), discounted cash flow (DCF), and Modigliani and Miller (MM)—share the same underlying assumptions, the principle of one value states that when the same inputs are used, such models should yield exactly the same result.

In this chapter, we show that all traditional valuation methods, when properly applied, are mathematically equivalent; thus, the principle of one value should apply to the last decimal. In addition, we demonstrate the adjustments required to produce consistent valuation results. Our results raise an important question: If ...