An 'Enhanced' Corporate Valuation Model: Theory and Empirical Tests

Abstract

In this paper, we develop an enhanced corporate valuation model based on the implied cost of equity capital (ICC). We argue that the enhanced approach extends the standard market multiples and discounted cash flow (DCF) approaches to corporate valuation. Specifically, it incorporates positive aspects of the market comparables and DCF approaches while mitigating the shortcomings of both. Unlike the traditional market comparables approach, the enhanced approach takes account of the full term structure of earnings forecasts. It does so by using the ICC calculated for the comparable companies as an “enhanced multiple” which translates the entire stream of cash flow forecasts into a value estimate. Unlike the DCF approach it does not require estimation of the cost of equity capital. As such, it avoids the complexity and uncertainty associated with estimating the cost of equity capital. In our empirical tests, we find the enhanced approach to be more accurate than either of the two traditional approaches.

Keywords: Valuation, DCF, Market Multiples

JEL Classification: G30, G31