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A Sum&Discount Method for Appraising Firms: An Illustrative Example
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A Sum&Discount Method for Appraising Firms: An Illustrative Example

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  • Carlo Alberto Magni

Abstract

This paper presents a new way of valuing firms and measuring residual income. The method, originally introduced in Magni (2000a, 2000b, 2000c, 2001), is here renamed lost-capital paradigm. In order to enhance comprehension the presentation relies on a very simple numerical example which shows that the new paradigm of residual income enjoys a property of abnormal earnings aggregation, according to which the NPV (and therefore the market value) of the firm does not change if each residual income changes, as long as the (uncapitalized) sum of all residual incomes do not change. While radically different from the standard residual income, the difference between the two notions is equal to the interest accrued on the past cumulated standard residual incomes, which has interesting implications for incentive compensation.

Suggested Citation

  • Carlo Alberto Magni, 2007. "A Sum&Discount Method for Appraising Firms: An Illustrative Example," Department of Economics 572, University of Modena and Reggio E., Faculty of Economics "Marco Biagi".
    • Handle: RePEc:mod:depeco:572
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    References listed on IDEAS

    as
    1. Magni, Carlo Alberto, 2000. "Decomposition of a Certain Cash Flow Stream: Differential Systemic Value and Net Final Value," MPRA Paper 7308, University Library of Munich, Germany.
    2. Carlo Alberto Magni, 2009. "Opportunity Cost, Excess Profit, and Counterfactual Conditionals," Frontiers in Finance and Economics, SKEMA Business School, vol. 6(1), pages 118-154, April.
    3. Magni, Carlo Alberto, 2000. "Systemic Value Added, Residual Income and Decomposition of a Cash Flow Stream," MPRA Paper 5900, University Library of Munich, Germany.
    4. Magni, Carlo Alberto, 2004. "Modelling excess profit," Economic Modelling, Elsevier, vol. 21(3), pages 595-617, May.
    5. Carlo Alberto Magni, 2003. "Decomposition of Net Final Values: Systemic Value Added and Residual Income," Bulletin of Economic Research, Wiley Blackwell, vol. 55(2), pages 149-176, April.
    6. Magni, Carlo Alberto, 2001. "Valore Aggiunto Sistemico: un'alternativa all'EVA quale indice di sovraprofitto periodale," MPRA Paper 7525, University Library of Munich, Germany.
    7. Magni, Carlo Alberto, 2005. "On decomposing net final values: EVA, SVA, and shadow project," MPRA Paper 12357, University Library of Munich, Germany.
    8. Magni, Carlo Alberto, 2007. "Measuring performance and valuing firms: In search of the lost capital," MPRA Paper 5850, University Library of Munich, Germany.
    9. Carlo Alberto Magni, 2006. "Zelig and the Art of Measuring Excess Profit," Frontiers in Finance and Economics, SKEMA Business School, vol. 3(1), pages 103-129, June.
    10. Carlo Magni, 2005. "On Decomposing Net Final Values: Eva, Sva and Shadow Project," Theory and Decision, Springer, vol. 59(1), pages 51-95, August.
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    Citations

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    Cited by:

    1. Magni, Carlo Alberto, 2009. "Splitting up value: A critical review of residual income theories," European Journal of Operational Research, Elsevier, vol. 198(1), pages 1-22, October.

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    1. Magni, Carlo Alberto, 2009. "Splitting up value: A critical review of residual income theories," European Journal of Operational Research, Elsevier, vol. 198(1), pages 1-22, October.
    2. Magni, Carlo Alberto, 2010. "Residual income and value creation: An investigation into the lost-capital paradigm," European Journal of Operational Research, Elsevier, vol. 201(2), pages 505-519, March.
    3. Carlo Alberto Magni, 2009. "Opportunity Cost, Excess Profit, and Counterfactual Conditionals," Frontiers in Finance and Economics, SKEMA Business School, vol. 6(1), pages 118-154, April.
    4. Carlo Alberto Magni, 2006. "Zelig and the Art of Measuring Excess Profit," Frontiers in Finance and Economics, SKEMA Business School, vol. 3(1), pages 103-129, June.
    5. Roberto Ghiselli Ricci & Carlo Alberto Magni, 2014. "Axiomatization of residual income and generation of financial securities," Quantitative Finance, Taylor & Francis Journals, vol. 14(7), pages 1257-1271, July.
    6. Magni, Carlo Alberto, 2016. "Capital depreciation and the underdetermination of rate of return: A unifying perspective," Journal of Mathematical Economics, Elsevier, vol. 67(C), pages 54-79.
    7. Magni, Carlo Alberto, 2005. "Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I," MPRA Paper 7359, University Library of Munich, Germany, revised 27 Feb 2008.
    8. Magni, Carlo Alberto, 2007. "Measuring performance and valuing firms: In search of the lost capital," MPRA Paper 5850, University Library of Munich, Germany.
    9. Carlo Magni, 2005. "On Decomposing Net Final Values: Eva, Sva and Shadow Project," Theory and Decision, Springer, vol. 59(1), pages 51-95, August.
    10. Magni, Carlo Alberto, 2001. "Valore Aggiunto Sistemico: un'alternativa all'EVA quale indice di sovraprofitto periodale," MPRA Paper 7525, University Library of Munich, Germany.
    11. Magni, Carlo Alberto, 2004. "Rating and ranking firms with fuzzy expert systems: the case of Camuzzi," MPRA Paper 5889, University Library of Munich, Germany.
    12. Magni, Carlo Alberto, 2004. "Modelling excess profit," Economic Modelling, Elsevier, vol. 21(3), pages 595-617, May.
    13. Carlo Alberto Magni, 2009. "Accounting and economic measures: an integrated theory of capital budgeting," Proyecciones Financieras y Valoración 5983, Master Consultores.
    14. Magni, Carlo Alberto, 2005. "On decomposing net final values: EVA, SVA, and shadow project," MPRA Paper 12357, University Library of Munich, Germany.
    15. Magni, Carlo Alberto, 2000. "Systemic Value Added, Residual Income and Decomposition of a Cash Flow Stream," MPRA Paper 5900, University Library of Munich, Germany.

    More about this item

    Keywords

    Firm valuation; residual income; lost capital; Discount&Sum; Sum&Discount; incentive compensation;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M2 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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