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

QUESTION AND ANSWER SESSION

Question: Can you elaborate on valuing a controlling interest versus a minority interest?

Parrino: In valuing a controlling interest, you must account for the incremental value of control. The magnitude of the adjustment depends on the situation. It reflects the fact that control of a firm affords the controlling shareholder the right to set the strategic direction of the firm, hire and fire managers, buy or sell assets, set financial policies, and so on. A noncontrolling shareholder does not have the ability to do these things. The incremental value of control is specific to the party gaining control and varies with how the business is run and how it is financed. Keep in mind that the price actually paid when one business buys a controlling interest in another business reflects some general benefits of control as well as benefits and synergies that are expected to be realized from the pairing of the two specific businesses involved in the transaction. It is not always easy to isolate the effect of the control premium on the value of a business from the effects of other factors, such as synergies.

If you are valuing a controlling interest, your cash flow forecast and discount rate may be very different from the case where you are valuing a minority interest. Additionally, there will be implications for how you can use, for example, a guideline comparables analysis.

Question: In a free cash flow analysis, should you adjust for off-balance-sheet items—especially, ...