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Abstract
Purpose - This paper sets out to look at "calculation of worth" as it relates to valuations.
Design/methodology/approach - A number of pricing models and valuation methods are analysed. Forecasting is also considered.
Findings - It is possible to adapt the discounted cash flow (DCF) method to incorporate subjective predicted growth rates. In the case of a rack-rented freehold, the DCF method produces the same value as the traditional method.
Originality/value - This paper looks at "testing the assumptions".
Keywords Discounted cash flow, Accounting valuations
Paper type Research paper
Introduction
In the first article in this series, it was shown that a valuation is an estimate of price in the market. It is the expert opinion of what the valuer considers that the subject property will sell for in the open market today. The article went on to consider the investment method, implicit and explicit, as an appropriate model for the valuation of (in our example) a rack-rented office building in the UK. That valuation is repeated in Table I.
In the case of a rack rented freehold, the discounted cash flow (DCF) method produces the same value as the traditional method. As a pricing model, either can be used, however the advantage of the DCF model is that it makes the assumptions underpinning the valuation explicit. This may not be important if the only reason for the analysis is to estimate price, but an investor should always be asking a supplementary question to "what is the price?" They should also be asking the question "is it worth buying it at that price?"
Calculation of worth
This paper looks at "testing the assumptions". The valuation is a single figure based upon predetermined input information. In this case, the valuer has determined the appropriate all risk yield, the equated yield, the implied rental/capital growth and so on. They are "best estimates" but they may not truly reflect what a particular investor may think will happen in the future. A calculation of worth is a separate analysis that tests the assumptions underpinning the valuation. If the investor believes that the market is underestimating (say) the expected growth of rental in the market, then the calculation of worth analysis can change the growth input to...