IESE Research Papers
No D/511:
How to value a seasonal company by discounting cash flows
Pablo Fernandez ()
Abstract: The correct way of valuing seasonal companies by cash flow
discounting is to use monthly data. It is possible to use annual data, but
it requires some adjustments. In this paper the author shows that when
using annual data in the context of the adjusted present value (APV), the
calculations of the value of the unlevered equity (Vu) and the value of the
tax shields (VTS) must be adjusted. However, the debt that has to be
substracted to calculate the equity value does not need to be adjusted. The
author derives the adjustments to be made. The errors due to using annual
data without making the adjustments are big. Adjusting the calculations
only by using average debt and average working capital requirements does
not provide a good approximation. When the inventories are a liquid
commodity such as grain or seeds, it is not correct to consider all of them
as working capital requirements. Excess inventories financed with debt are
equivalent to a set of futures contracts. The author shows that not
considering them as such leads to an undervaluation of the company. This
paper values a company in which the seasonality is due to the purchases of
raw materials: the company buys and pays for all raw materials in the month
of December. It is shown that the equity value calculated using annual data
without making the adjustments understates the true value by 45% if the
valuation is done at the end of December, and overstates the true value by
38% if the valuation is done at the end of November. The error due to
adjusting only by using average debt and average working capital
requirements ranges from -17.9% to 8.5%.
Keywords: valuation seasonal companies; seasonality; cash flow discounting; (follow links to similar papers)
JEL-Codes: G12; G31; M21; (follow links to similar papers)
27 pages, July 5, 2003
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