WACC is Not the Proper Discount Rate for Asset Cash Flows

2017 ◽  
Author(s):  
Jing Chen
Keyword(s):  
Discount Rate ◽  
Cash Flows

An Analysis of the Sources of Value Loss Following Financial Restatements

2021 ◽  
pp. 0148558X2198991
Author(s):  
Philip K. Hong ◽  
Jaywon Lee ◽  
Sang-Hyun Park ◽  
Sukesh Patro
Keyword(s):  
Stock Returns ◽  
Cash Flow ◽  
Discount Rate ◽  
Stock Price ◽  
Cash Flows ◽  
Financial Fraud ◽  
Earnings Persistence ◽  
Flow Component ◽  
Financial Restatements ◽  
Value Loss

We decompose the total value loss around firms’ announcements of financial restatements into components arising from investors’ revisions in cash flows and discount rates. First, relative to population benchmarks, restatements represent circumstances in which the cash flow component becomes more important in explaining valuations. While we find significant contributions from both sources, with the cash flow component explaining more than 33% of the variation in stock returns surrounding restatement announcements, this component explains only 13% to 22% in comparable non-restating firms. When restatements are caused by underlying financial fraud, the discount rate impact becomes more important, explaining about 88% of return variation. On the contrary, the cash flow impact is relatively larger for firms with higher earnings persistence or restatements associated with errors. Our decomposition of the value loss helps explain returns in the post-announcement period. Firms with a higher relative discount rate impact experience a significant downward stock price drift after the initial announcement-related price decline. For firms with a higher relative cash flow impact, the evidence suggests the initial impact of the restatement announcement is more complete with no subsequent drift pattern. Our findings close gaps in the evidence on financial restatements and extend the literature on the drivers of stock price movements.

The Weitzman Argument

2012 ◽  
Author(s):  
Christian Gollier
Keyword(s):  
Discount Rate ◽  
Opportunity Cost ◽  
Net Present Value ◽  
Cost Of Capital ◽  
Cash Flows ◽  
Simple Rule ◽  
Rate Of Return ◽  
Net Benefit ◽  
Investment Projects ◽  
Net Benefits

This chapter examines a model in which the exogeneous rate of return of capital is constant but random. Safe investment projects must be evaluated and implemented before this uncertainty can be fully revealed, i.e., before knowing the opportunity cost of capital. A simple rule of thumb in this context would be to compute the net present value (NPV) for each possible discount rate, and to implement the project if the expected NPV is positive. If the evaluator uses this approach, this is as if one would discount cash flows at a rate that is decreasing with maturity. This approach is implicitly based on the assumptions that the stakeholders are risk-neutral and transfer the net benefits of the project to an increase in immediate consumption. Opposite results prevail if one assumes that the net benefit is consumed at the maturity of the project.

Increasing the Efficiency of Industrial Enterprise Investment Projects through Cash Flow Management

2017 ◽  
Vol 2017 (2) ◽  
pp. 90-106
Author(s):  
Denis Shageev
Keyword(s):  
Cash Flow ◽  
Discount Rate ◽  
Cash Flows ◽  
Negative Influence ◽  
Positive Influence ◽  
Effective Management ◽  
Method Of Calculation ◽  
Investment Projects ◽  
Cash Flow Management ◽  
Actual Size

Objective and subjective factors of influence on the nominal and actual size of a cash flow of the project in the form of the scheme are opened. The analysis of method of calculation of a discount rate and award for risk is made. On analysis results, in article it was offered to exclude an indicator of an award for risk from a formula of calculation of a discount rate and to research it separately as the certain managed size influencing the nominal, but not actual size of cash flows of the project. It gave the chance to technically reduce value of a discount rate and by that to increase the NPV real value of the project. Designations of negative and positive factors project risks are entered. Availability and an opportunity positive influence of factors risks on the project is proved. The formulas of calculation of the modified cash flow, effect and effective management of cash flows of the project differing on structure, content and entering of the additional positive amendment on risk are offered. It will give the chance to reduce or eliminate negative influence of objective and subjective factors risks, and in certain cases and in addition to raise project NPV. For assessment of levels of effective management of cash flows the verbal scale is offered.

scholarly journals Actuarial valuations to monitor defined benefit pension funding

2020 ◽  
Vol 25 ◽  
Author(s):  
Christopher D. O’Brien
Keyword(s):  
Discount Rate ◽  
Current Practice ◽  
Cash Flows ◽  
Defined Benefit ◽  
Expected Return ◽  
Code Of Practice ◽  
Market Values ◽  
Using Data ◽  
Risk Free Rate ◽  
Risk Disclosures

Abstract This paper is motivated by The Pensions Regulator (TPR)’s review of its Code of Practice on funding for defined benefit schemes and aims to suggest how trustees and regulators should monitor the extent to which scheme assets are adequate to cover liabilities. It concludes that current practice is inadequate and needs to change. A review is carried out of papers on not only this subject but also (to collect ideas rather than automatically apply them to pensions solvency valuations) pensions and insurance accounting and regulation. Current practice is “scheme-specific funding” which permits discretion on choice of discount rates and other assumptions; the paper is concerned that this can lead to bias, and that trends in a scheme’s solvency can be obscured by changing assumptions. This also leads to the funding ratio communicated to scheme members having little meaning. The paper suggests that regulators should require a valuation that is based on sound principles, objective, fair, neutral, transparent and feasible. A prescribed methodology would replace discretion. It concludes that the benefits to be valued are those arising on discontinuance of the scheme, without allowing for future salary-related benefit increases, which are felt to no longer be a constructive obligation of employers. The valuation should, it is suggested, use market values of assets, which is largely current practice. Liabilities should reflect the trustees fulfilling their liabilities, rather than transferring them to an insurer (which may introduce artificialities). The discount rate should follow the “matching” approach, being a market-consistent risk-free rate: this is consistent with several papers to the profession in recent years. It avoids the problems of the “budgeting” approach, where the discount rate is based on the expected return on assets – this can be used to help set contribution levels but is not suitable for determining the value of liabilities, which depends on salary, service, longevity, etc and (very largely) not on the assets held. In principle, the liability value can be adjusted for illiquidity. Credit risk of the employer should not be allowed for. Liabilities should reflect the (probability-weighted) expected value of future cash flows and should not be increased by prudent margins or risk margins (which would lead to a non-neutral figure). Risk disclosures are needed to understand and manage risks. The resulting funding ratio is a consistent measure, to be disclosed to members, which can be used to manage the scheme, and by regulators as the basis for requiring action. Scheme-specific management using data such as the employer covenant means that immediate action to ensure 100% solvency on the proposed basis would not necessarily be appropriate. The author encourages the profession to advise TPR on the above lines.

scholarly journals Technology for Solving the Problems Related To the Implementation of the Concept of Preserving Capital in Accounting and Statistics

2019 ◽  
Vol 8 (3) ◽  
pp. 789-792 ◽  
Keyword(s):  
Discount Rate ◽  
Theory Development ◽  
Main Tool ◽  
Financial Statements ◽  
Cash Flows ◽  
Economic Life ◽  
International Standards ◽  
Special Role ◽  
Present Value ◽  
Specific Interpretation

At the present stage of economic theory development, a special role as a comprehensive indicator of the efficiency of activity is acquired by the current cost of the organization’s capital. The definition of the value of an asset was first explained by Fisher “The cost of a capital asset equals the sum of the present value of all future cash flow receipts” [17]. The concept of the current value of invested capital is the main tool for increasing the transparency of financial statements and a component of the concept of value and capital. In his work “The Nature of Capital and Income,” the American economist Fisher stated that "The theory of capital is that the value of an asset is equal to future cash receipts, reduced to present value based on the appropriate discount rate ”[1]. As for John Barr William, a well-known investor wrote in his book “The Theory of Investment Value” that “the value of any company is determined by incoming and outgoing cash flows, adjusted at a discount rate” [5]. The specific interpretation of capital by international standards largely determines the methodology for accounting for specific facts of economic life, as well as the approach to providing the financial position of an organization in its financial statements

scholarly journals The effects of interest rates on the valuation of highway infrastructure assets

2018 ◽  
Author(s):  
Carles Vergara-Alert
Keyword(s):  
Interest Rates ◽  
Cash Flow ◽  
Discount Rate ◽  
Economic Activity ◽  
Cash Flows ◽  
Rate Effect ◽  
Toll Roads ◽  
Flow Effect ◽  
Positive Correlation ◽  
Highway Infrastructure

The discounted value of cash flows of assets is negatively related to interest rates (i.e., the discount rate effect). However, economic activity is positively related to interest rates and positively related to the cash flows of assets with tariffs that can be adjusted to manage demand such as adjustable-rate toll roads, but uncorrelated to assets that do not bear demand risk such as non-toll roads (i.e., the cash flow effect). This effect arises in some types of assets from: (i) the positive correlation between economic activity and demand for the infrastructure assets; and (ii) the positive correlation between economic activity and inflation. We find that the cash flow effect dominates the discount rate effect for assets with tariffs that can be adjusted to manage demand and, therefore, the value of these assets increases in periods of economic expansion. Nevertheless, the opposite occurs for assets that do not bear demand risk.

scholarly journals The effect of inflation on the optimum payback cut-off

1991 ◽  
Vol 22 (1/2) ◽  
pp. 22-32
Author(s):  
J. U. De Villiers
Keyword(s):  
Discount Rate ◽  
Investment Decision ◽  
Cash Flows ◽  
Payback Period ◽  
Investment Appraisal ◽  
Systematic Relationships

Despite the theoretical criticisms against it, payback is one of the most commonly used methods of investment appraisal in practice. Its ease of calculation and simplicity are seen as its most important advantages. In addition, an unsophisticated method like payback can yield the correct investment decision as long as the correct cut-off is specified. In this paper the optimum payback cut-off and how it is influenced by inflation is studied. Three different methods of calculating payback under inflation are investigated. In all of these the optimum cut-off depends upon the type of assets (current, depreciable or non-depreciable assets) as well as the life of depreciable assets employed. The study shows that the optimum nominal payback cut-off (where the payback calculation is based on inflated cash flows) decreases with increasing inflation for all asset types. The optimum real payback cut-off (based on nominal cash flows adjusted for inflation) does not change with inflation. The optimum uninflated payback cut-off (where inflation is ignored) decreases rapidly with inflation for projects employing current assets. In the paper is shown that complex but systematic relationships exist between a project's payback period and its discount rate. Despite its deficiencies, the use of the payback method is therefore not entirely irrational.

Pricing the Planet's Future

2012 ◽  
Author(s):  
Christian Gollier
Keyword(s):  
Discount Rate ◽  
Investment Project ◽  
Environmental Problems ◽  
Cash Flows ◽  
Infrastructure Investment ◽  
Dynamic Problems ◽  
Public Infrastructure ◽  
Policy Debates ◽  
Ideal Framework ◽  
Pension Benefits

Our path of economic development has generated a growing list of environmental problems including the disposal of nuclear waste, exhaustion of natural resources, loss of biodiversity, climate change, and polluted land, air, and water. All these environmental problems raise the crucial challenge of determining what we should and should not do for future generations. It is also central to other policy debates, including, for example, the appropriate level of public debt, investment in public infrastructure, investment in education, and the level of funding for pension benefits and for research and development. Today, the judge, the citizen, the politician, and the entrepreneur are concerned with the sustainability of our development. The objective of this book is to provide a simple framework to organize the debate on what we should do for the future. A key element of analysis by economists is the discount rate—the minimum rate of return required from an investment project to make it desirable to implement. The book outlines the basic theory of the discount rate and the various arguments that favor using a smaller discount rate for more distant cash flows. With principles that can be applied to many policy areas, the book offers an ideal framework for dynamic problems and decision making.

E-Capital Budgeting

2002 ◽  
pp. 182-197
Author(s):  
Parvez Ahmed
Keyword(s):  
Discount Rate ◽  
Capital Budgeting ◽  
Cash Flows ◽  
The Internet ◽  
New Era ◽  
Financial Options ◽  
New Information ◽  
Unknown Risk ◽  
The World ◽  
High Discount Rate

Over the last five years, firms with strong presence on the Internet have seen increases in the value of their firms to what some consider obscene levels. The “new era” economy has led to “irrational exuberance” in the stock market. This era of uncertainty has also unleashed numerous valuable opportunities for firms. The world in general and e-commerce ventures in particular are dominated by strategic investments with lots of uncertainty that require huge capital outlays. Moreover, these projects must have the ability to adapt to changing conditions that evolve as new information becomes available. The failure of traditional discounted cash flows (DCF), such as NPV, in valuing e-commerce projects is partially due to meager cash flows relative to required investments and high discount rate due to unknown risk in the projects. This chapter will show how techniques used in valuing financial options can be used to value project or firms under conditions of extreme uncertainty.

An Efficient Algorithm For Calculating Yields And Durations

2011 ◽  
Vol 5 (1) ◽  
pp. 45
Author(s):  
Delvin D. Hawley ◽  
Larry J. Johnson
Keyword(s):  
Discount Rate ◽  
Efficient Algorithm ◽  
Cash Flows ◽  
Computational Algorithms ◽  
Rates Of Return ◽  
Number Of Iterations

This paper presents an algorithm for the computation of yields (or internal rates of return) which offers several important advantages over traditional computational algorithms. The method described here is extremely efficient in zeroing in on the correct discount rate or yield in a remarkably small number of iterations. It is particularly useful in the calculation of internal rates of return for projects with erratic cash flows.

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