Valuation of firms with multiple business units
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Valuation of firms with multiple business units Stefan Dierkes1 · Ulrich Schäfer2
© The Author(s) 2020
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. Keywords Terminal value · Business unit organization · Intra-firm heterogeneity · Value driver analysis
Electronic supplementary material The online version of this article (https://doi.org/10.1007/s1157 3-020-01010-z) contains supplementary material, which is available to authorized users. * Ulrich Schäfer [email protected] 1
Chair of Finance and Accounting, Georg August University, Platz der Göttinger Sieben 3, 37073 Göttingen, Germany
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Department of Business Administration, University of Zurich, Plattenstrasse 14, 8032 Zürich, Switzerland
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S. Dierkes, U. Schäfer
1 Introduction Value-based management aims to identify strategies that maximize shareholder value (Rappaport 1997; Ittner and Larcker 2001; Young and O’Byrne 2001). Strategic decisions typically affect firm profitability over the long term. Therefore, valuation models should account for cash flows over a long time horizon and ideally be based on a going-concern premise. The literature provides various terminal value models that determine the value of cash flows in such a going-concern scenario. Many approaches are based on the value driver model by Gordon and Shapiro (1956) and develop valuation formulas under the premise that a firm’s free cash flow grows at a constant nominal rate.1 Yet, this assumption is inapt to describe firms with multiple business units where strategies define the product-market mix and specify the development of the portfolio of business units. In multi-business organizations, the valuation outcome shou
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