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Valuation: Present Values, Real Options, Bubble

Valuation: Present values, Real Options and the bubble


From June until August 2019 I have written 6 blogs on business valuation (e.g. topics: Multiples, DCF, LBO analysis, M&A analysis) and financial modelling.


These blogs are still available, you can find the links of the blogs at the very end of this blog.


In the upcoming months, I will write several blogs on the so called “Cost of Capital” that is used in business valuation.


I got inspired to do this after reading the book: “The real cost of capital: A business field guide to better financial decisions” (2004). The book is written by Tim Ogier & John Rugman & Lucinda Spicer.


I really recommend any Corporate Finance professional to read this book, since it is so practical and well-grounded in theory!


Blogs in this sequence that I have published already (with the links);


Article 1: Valuation & Betas (CAPM)


Article 2: Valuation & Equity Market Risk Premium (CAPM)


Article 3: Is the Capital Asset Pricing Model dead ? (CAPM)


Article 4: Valuation & the cost of debt (WACC)


Article 5: Valuation & Capital Structure (WACC)


Article 6: International WACC & Country Risk – Part 1


Article 7: International WACC – Part 2

In this eight one in the sequence I will talk about:

Present values, real options and the bubble.


Consultant & Trainer: Joris Kersten


I am an independent M&A consultant and Valuator from The Netherlands.


In addition, I provide training in “Financial Modelling”, “Business Valuation” and “Mergers & Acquisitions” all over the world. This at (investment) banks, corporates and universities.


Also I provide inhouse training on request and I have two open training programs in business valuation in my home country The Netherlands.


At the very end of this blog you can find all information about my open training programs.


The net present value: Introduction


Net present value (NPV) is the term given to the discounted present value of future cash flows less the value of the initial investment (so “net”).


Any investment which offers a positive (expected) NPV adds to wealth and shareholder value.


This because the risk and time-adjusted expected future financial rewards associated with the investment, outweigh the initial investment cost.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Two rules for the NPV


NPV Rule 1:

When two investments have the same NPV (of course correctly calculated), and involve the same initial outlay, then they are equally attractive.


This is regardless of the amount of systematic risk or specific risk to which they expose the investor.


Sometimes it is expected that the project with the least variable cash flows would be favored, because we assume individuals are risk averse.


However, for an equity investor the only risks that (should) count are systematic risks.


And these are reflected in the cost of equity part of the discount rate used to calculate the NPV.


This since in a portfolio the variability in returns arising from specific factors are irrelevant. I have described this before in this sequence of blogs.


Actually, when adding an investment to a portfolio it could be the case that a more variable return is actually helpful in mitigating risk. This by offsetting variations in existing investments.


NPV Rule 2:

The relevant risk that should be taken into account when calculating the NPV is the risk of the investment itself. So not the risk of the company making the investment.


An investment in a venture which has a high degree of systematic risk is always risky.


This irrespective of the company or individual which is making the investment.


Also when a company that makes the investment is able to achieve cost savings or revenue enhancements (both “synergies”), then still the risk of the target should be taken into account.


This since then these synergies should be shown in more “bullish” (higher) cash flow forecasts and not in a lower discount rate.


So a discount rate at which a company assesses an investment opportunity should be calculated specifically for that opportunity.


And this discount rate will not (necessarily) be the same as the overall cost of capital of the investor.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Drawback of the NVP approach


A drawback of the NVP approach is that it is not well suited to deal with situations in which a “follow up investment” is linked to an initial investment.


And these situations are very common in business life!


Examples include (capital) expenditures in:


Research & Development (R&D), marketing positioning, product positioning, investments in the first stage of an investment program with the possibility of expansion later on. Etcetera.


Here “real options” can provide an answer! 🙂

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Real options


Some cash flows are dependent on decisions that will only be made once various uncertainties affecting the asset value are resolved.


In these cases standard discounted cash flow (DCF) valuation is less appropriate, as mentioned!


Real option valuation provides here a basis for valuation of these opportunities (options).


This comes from the ability to make (or revise) decisions in response to changing circumstances.


So the term “real option” reflects the analogy between “financial options” and “management flexibility” to respond to events in an uncertain world.


Real option valuation is useful in looking at the value of for example start-up businesses with high, but uncertain, growth potential.


And for businesses with intangible assets such as trademarks, patents, or R&D portfolios, as well as businesses whose revenues are affected by volatile commodity prices.


So real option valuation is specifically relevant when you want to determine the value of high technology companies.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Decision three analysis


One approach for valuating real options is “decision three analysis” (DTA).


The decision analysis approach involves applying a DTA approach to calculating the NPV.


For example, an investor must choose whether or not to make the investment.


If no investment is made then the NPV is simply zero.


But if the first investment is made, then the investor faces for example a further decision on whether to take a subsequent investment or not.


And whether or not that subsequent investment should be made will depend on for example the prospects for this subsequent investment.


And this will become clear in a certain amount of years after the first investment.


Essentially DTA enables the investor to identify future actions which he or she will be able to take to minimize downside risk.


This means that real options can take into account that the subsequent investment (the second investment) will only be taken if the prospects look good.


And normal DCF cannot do this!


On the other hand, a problem with DTA is that the diagrams (decision trees) can become horrendous complicated, because in real life there are many options.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Right now I am getting my license as “Registered Valuator” (RV) in The Netherlands. I am getting the license by following the “executive master in business valuation” at TIAS Business School, a great University where I teach myself as well in Finance & Accounting.


A significant component of this program is “real options”, so in the upcoming months I will share a lot more info on real options in valuations. Including in depth calculations in excel. Stay tuned!


The valuation of “Dot.coms”


The high market capitalisations of internet companies, and the wild fluctuations in share prices, have been sources of bewilderment to many equity analysts and valuation experts.


This partly came from the fact that these internet companies could not be valued with standard stock market valuation techniques.


The standard techniques are based on:

· Price/ earnings multiples;

· Revenue multiples;

· Book value of assets;

· Reliable estimates of future growth, etc.


But these internet companies had virtually no tangible assets, often negative earnings, and future growth prospects were highly uncertain.

Equity analysts still had to come with valuation metrics and with breaking down the traditional methods they came up with rules of thumb, like for example:

· Market capitalisation per user;

· Revenue per subscriber;

· Market capitalisation per monthly page view, etc.


However there was little science behind these measures.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


Dot.coms and real options


Investments in internet companies were actually investments in options.


The crazy market capitalisations of the internet companies have indicated that the market believed the internet could be the “next big thing”.


Maybe similar to the development of electricity, the telephone and the computer, concerning impact on the daily lives of people.


Essentially investors who bought these shares have bought options to be well-placed to capitalize on these business opportunities that might emerge in the future.


And whether they would really become successful would depend on factors like for example:


Worldwide growth in the use of internet, customer loyalty, and the ease at which competitors can replicate their products and services.


Issues that we can simulate with options.

(Tim Ogier, John Rugman, Lucinda Spicer, 2004)


As mentioned, right now I am studying “real options” extensively in order to get my license as “Registered Valuator” (RV).


In the upcoming months I will share in depth examples (cases) of real option valuations including excel models. This since I believe it is a really interesting, and practical, valuation methods that should be used more often. Stay tuned!


My next blog, next week, will be on a more straight forward topic:


Using the cost of capital (WACC) in different methods for business valuation.

And when you have any questions in the meantime do not hesitate to contact me on:

(it can take a while before I response, since I am always busy, but in the end I will respond)


Sources used for this blog


·The real cost of capital: A business field guide to better financial decisions (2004). Prentice Hall Financial Times/ Pearson Education. Tim Ogier & John Rugman & Lucinda Spicer. 9780273688747.

This book is fantastic and very practical, just a pleasure to read for every investment professional. Highly recommended! 😊


Training Calendar on Business Valuation of Joris Kersten:


In case you like additional in class training:

In my home country The Netherlands, and abroad, I provide open training programs in “Business Valuation” and “Financial Modelling”.

The next sessions are given below:


1. Business Valuation & Deal Structuring (6 day training): 18, 19, 20, 21 and 23, 24 March 2020 @ Uden in the South of The Netherlands;


2. Financial Modelling in Excel (4 day training): 20, 21, 22, 23 April 2020 @ Uden in the South of The Netherlands;


3. Financial Modelling in Excel (5 day training): 2, 3, 4, 5, 6 February 2020 @ Riyadh in Saudi Arabia.


All info on these open training sessions can be found on:


And 130 references on my training sessions can be found on:


Trainer & Consultant: J.J.P. (Joris) Kersten, MSc BSc RAB


– 130 recommendations on his training can be found on:
– His full profile can be found on:


J.J.P. (Joris) Kersten MSc BSc RAB (1980) is owner of “Kersten Corporate Finance” in The Netherlands, under which he works as an independent consultant in Mergers & Acquisitions (M&A’s) of medium sized companies.


Joris performs business valuations, prepares pitch books, searches and selects candidate buyers and/ or sellers, organises financing for takeovers and negotiates M&A transactions in a LOI and later in a share purchase agreement (in cooperation with (tax) lawyers).


Moreover, Joris is associated to ‘AMT Training London’ for which he provides training as a trainer and assistant-trainer in Corporate Finance/ Financial Modelling at leading investment banks in New York, London and Hong Kong.


And Joris is associated to the ‘Leoron Institute Dubai’ for which he provides finance training at leading investment banks and institutions in the Arab States of the Gulf.


In addition, Joris provides lecturing in Corporate Finance & Accounting at leading Universities like: Nyenrode University Breukelen, TIAS Business School Utrecht, the Maastricht School of Management (MSM), the Luxembourg School of Business and SP Jain School of Global Management in Sydney.


Moreover, he provides lecturing at partner Universities of MSM in: Peru, Surinam and Mongolia. And at partner Universities of SP Jain in Dubai, Mumbai and Singapore.


Joris graduated in MSc Strategic Management and BSc Business Studies, both from Tilburg University. In addition, he is (cum laude) graduated as “Registered Advisor Business Acquisitions” (RAB), a 1-year study in the legal and tax aspects of M&A’s. And Joris obtained a degree in “didactic skills” (Basic Qualification Education) in order to lecture at Universities.


Currently Joris is doing the “Executive Master of Business Valuation” to obtain his title as “Registered Valuator” (RV) given out by the “Netherlands Institute for Registered Valuators” (NIRV). This title will enable Joris to give out business valuation judgements in for example court cases.


J.J.P. (Joris) Kersten, MSc BSc RAB. Email: Phone: +31 6 8364 0527


Earlier blogs on “Business valuation to Enterprise Value”


From June until August I have written the following blogs on valuation:


1) LBO Analysis:


2) M&A Analysis:


3) Discounted Cash Flow Valuation:


4) Valuation Multiples 1 – Comparable Companies Analysis:


5) Excel Shortcuts & Business Valuation:


6) Valuation Multiples 2 – Precedent Transaction Analysis:



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