Valuation of SPV with DCF method

Abstract

In the paper author have presented mainly, widely used DCF method of valuation which, fit well dynamic project valuation. Even with many assumptions in DCF model and commonly made mistakes, running project (“build and sell”) valuation is much less demanding. In the valuation we discount relatively short forecast of FCF and we are able to calculate the project price. Every valuation of the project that is being created must take under consideration uncertainty in making decisions. In case study situation, the variation of the main asset is the biggest concern. It is not common situation that evaluated company has only one main asset, so unstable in terms of value. The changing value of the plot along the time forces us to take under consideration the possibility of selling only the asset. This is recognized as real option, omitting this in valuation may be a serious mistake. Different valuations are made from different perspectives. For the bank wiling to give investment loan, the most important is the perspective of SPV and paying of the debt. Shareholders have different point of view and for them, company value is determined by the flows they will receive. In my opinion the value of the company should represent stakeholders demands. Important conclusions of this paper are as follow : Definitely company can be valued from different perspectives (different group of interest) •Value of the SPV (based on company FCF) - 5,39 mln. PLN •Value of the SPV (based on shareholders FCF) - 7,33 mln. PLN •Only one forecast of FCF is in volatile real estate business to big simplification •Constantly changing value of main asset should me taken under consideration in SPV valuation •Real options are compromise between statistics and one forecast DCF valuation •Value of the options to wait and sell asset – 6,92 mln PLN •Return based on IRR differ very much between shareholders and SPV cash flows. •ROE from static P&L analysis differ much from ROE calculated with DCF figure •Surprisingly value of the option in binominal model using simple (50%/50%) assumption is close to value of this option with 30.000 random variables (within the limit) Author wish to say that in practice much work is involved in project valuation but he would miss reality if I would make such statement. In reality still valuation based on nominal numbers is the main guideline for decision making managers. DCF valuation is commonly known but not taken much serious. The reason is the cost of capital, estimation of this figure is often to hard in practice and understanding of shareholders demand is low. This work in fact also created few figures that are much different and for average manager would be confusing. DCF valuation using even such simple model as binominal is not used in practice. Companies developing plots face serious doubts just before starting the construction. Plot with building permit is worth much more than in the beginning (even with costs of obtaining permits). Company receives an offer from aggressive market player (Spanish companies are perceived as aggressive, paying more for the plots than fair value, hoping the market to growth fast) and just by selling the plot company has demanded return on the project. What really happens is that developer turns into real estate agent. Because of that reason real options valuation may be useless in practice. Even if option to wait would be giving clear signals to wait and sell the asset, managers of the company may not decide to do so just because of the described reason. Still in practice the most important is to feel the project, to understand the project and based on outflows and inflows see the positive result ( without taking value of time into consideration ). Potential of a plot that is going to be purchased is for the managers most important, numbers either support this opinion or deny but the most important is verbal opinion.