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Valuation of firms with multiple business units


Dierkes, Stefan; Schäfer, Ulrich (2021). Valuation of firms with multiple business units. Journal of Business Economics / Zeitschrift für Betriebswirtschaft, 91(4):401-432.

Abstract

Corporate valuation often relies on the assumption of a constant and homogenous growth rate. However, large firms frequently (re)balance their activities by diverting cash flows from some business units to fund investments in other units. We develop a value driver model of terminal value for a firm with two units. The model relaxes common assumptions and allows for cross-unit differences in the return on invested capital. We consider intra-unit and cross-unit investments and show their implications for firm value and the long-term development of key accounting variables. Our results help characterize business unit strategies that can be reconciled with popular firm strategies such as the constant payout and constant growth strategies. We find that popular valuation methods that assume both constant payout ratios and constant growth rates (e.g., Gordon and Shapiro, Manage Sci 3:102–110, 1956) constitute a restrictive special case of our model and should only be applied to firms with homogenous business units. We use a simulation analysis to compare our results with alternative valuation models and to illustrate the economic relevance of our findings. The simulation shows that an accurate depiction of business unit strategy is particularly useful if firms plan large-scale cross-unit investments into business units with high returns and if the cost of capital is low.

Abstract

Corporate valuation often relies on the assumption of a constant and homogenous growth rate. However, large firms frequently (re)balance their activities by diverting cash flows from some business units to fund investments in other units. We develop a value driver model of terminal value for a firm with two units. The model relaxes common assumptions and allows for cross-unit differences in the return on invested capital. We consider intra-unit and cross-unit investments and show their implications for firm value and the long-term development of key accounting variables. Our results help characterize business unit strategies that can be reconciled with popular firm strategies such as the constant payout and constant growth strategies. We find that popular valuation methods that assume both constant payout ratios and constant growth rates (e.g., Gordon and Shapiro, Manage Sci 3:102–110, 1956) constitute a restrictive special case of our model and should only be applied to firms with homogenous business units. We use a simulation analysis to compare our results with alternative valuation models and to illustrate the economic relevance of our findings. The simulation shows that an accurate depiction of business unit strategy is particularly useful if firms plan large-scale cross-unit investments into business units with high returns and if the cost of capital is low.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Business Administration
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Social Sciences & Humanities > Business and International Management
Social Sciences & Humanities > Economics and Econometrics
Uncontrolled Keywords:General Medicine
Scope:Discipline-based scholarship (basic research)
Language:English
Date:1 May 2021
Deposited On:13 Aug 2021 15:03
Last Modified:14 Jun 2024 03:41
Publisher:Springer
ISSN:0044-2372
OA Status:Hybrid
Publisher DOI:https://doi.org/10.1007/s11573-020-01010-z
Other Identification Number:merlin-id:21382
  • Content: Published Version
  • Language: English
  • Licence: Creative Commons: Attribution 4.0 International (CC BY 4.0)