A Sum&Discount method for appraising firms:An illustrative example

Magni, Carlo Alberto (2007): A Sum&Discount method for appraising firms:An illustrative example.

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Firm valuation, residual income, lost capital, Discount&Sum, Sum&Discount, incentive compensation
• Subjects: G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M41 - Accounting; G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting ; Fixed Investment and Inventory Studies ; Capacity; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M40 - General; G - Financial Economics > G3 - Corporate Finance and Governance > G30 - General; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M2 - Business Economics > M21 - Business Economics

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