Multiple Methodologies

Valuation experts typically consider alternative valuation methods, for example, a discounted cash flow (DCF) analysis and a review of comparable transactions.

When a valuation in an arbitration seeks to determine market value of an asset and the asset’s value can be observed directly in well-functioning markets under conditions similar to that which the valuation scenario calls for, those market values should be the foundation for the valuation. In such circumstances, multiple valuation methods would not improve the accuracy of the result.

In most cases, however, the market value cannot be observed directly, in which case reliable comparable transactions can be used to cross-check a DCF valuation or vice versa when each method has a roughly similar margin of error.

There may also be circumstances in which it is appropriate to combine and average estimates where they each have a similar error and the average is more reliable. For example, in estimating the Weighted Average Cost of Capital (WACC), it is common to average the estimates for several benchmark companies because each will have a similar error and the average will be more reliable than any one point estimate.

However, in valuing assets, careful consideration of each possible method may yield a preferred approach, in which case the averaging of additional methods may reduce the reliability of a valuation estimate rather than increase it. A clear warning sign is if different methods yield substantially different results. Such a result signals the need to understand and reconcile the differences, which often result from important differences in either the assets being valued or the environments in which they operate. Simply averaging disparate results masks likely problems in the analysis and does not improve the quality of the result. Indeed, in such cases, there may be no economic rationale for averaging, and focus should be given to understanding the reasons that different methods are resulting in fundamentally different results.