Rating and ranking firms with fuzzy expert systems: the case of Camuzzi

In this paper we present a real-life application of a fuzzy expert system aimed at rating and ranking firms. Unlike standard DCF models, it integrates financial, strategic and business determinants and processes both quantitative and qualitative variables. Twenty-one value drivers are defined, concerning the target firm (strategic assets in place and expected financial performance), the acquisition (synergies, quality of management) and the sector (intensity of competition, entry barriers). Their combination via “if-then” rules leads to the definition of an output represented by a real number in the interval [0,1]. Such a number expresses the value-generating power of the target firm inclusive of synergies with the bidder (Strategic Enterprise Value). The system may be used for rating and ranking firms operating in the same sector. A regression analysis using hostile takeovers multiples may be employed to translate the score into price. The real-life case refers to Camuzzi (a natural gas distributor), acquired by Enel, the Italian ex monopolist of electric energy.Corporate finance, firm, rating, ranking, expert system, fuzzy, evaluation

Project valuation and investment decisions: CAPM versus arbitrage

This paper shows that (i) project valuation via disequilibrium NPV+CAPM contradicts valuation via arbitrage pricing, (ii) standard CAPM-minded decision makers may fail to profit from arbitrage opportunities, (iii) standard CAPM-based valuation violates value additivity. As a consequence, the standard use of CAPM for project valuation and decision making should be reconsidered.Investment, valuation, CAPM, arbitrage, disequilibrium NPV

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

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.Firm valuation, residual income, lost capital, Discount&Sum, Sum&Discount, incentive compensation

Firm Value and the mis-use of the CAPM for valuation and decision making

This paper shows that a decision maker using the CAPM for valuing firms and making decisions may contradict Modigliani and Miller’s Proposition I, if he adopts the widely-accepted disequilibrium NPV. As a consequence, CAPM-minded agents employing this NPV are open to arbitrage losses and miss arbitrage opportunities. As a result, even though the use of the disequilibrium NPV for decision-making is deductively drawn from the CAPM, its use for both valuation and decision should be rejected.Firm value, Free Cash Flow, CAPM, Modigliani and Miller’s Proposition I, Net Present Value, disequilibrium, arbitrage, decision making

Systemic Value Added, Residual Income and Decomposition of a Cash Flow Stream

The problem of decomposing a cash flow has been treated in recent years by Gronchi (1986, 1987), Peccati (1987, 1991, 1992), Stewart (1991), Pressacco and Stucchi (1997). After showing that the Economic Value Added introduced by Stewart bears a strong resemblance to (and in some conditions coincides with) the periodic Net Present (or Final) Value in Peccati's model and that Pressacco-Stucchi's model can be seen as a formal generalization of Stewart's model, this paper proposes a different decomposition model introducing the Systemic Value Added, which lends itself to a disaggregation in periodic shares whose uncompounded sum coincides with Peccati's and Pressacco-Stucchi's Net Final Value. The model proposed offers the opportunity to dwell on the notion of residual income, showing that the interpretation given by the three previous models fails to explain the correct evolution of the investor's financial system. The evaluation process is then reshaped by introducing the concept of shadow project, by means of which Peccati's and Stewart's model can be retrieved. Pressacco-Stucchi's model can also be retrieved and generalized and some of its assumptions are relaxed. The formal results in the last section provide sufficient and necessary conditions for integrating all models in the systemic framework here adopted. Finally, some hints shows that the results Pressacco and Stucchi obtain can be proved by using the systemic approach here suggested.Residual income, cash flow, Net Final Value, Systemic Value Added

Project selection and equivalent CAPM-based investment criteria

This article shows that the Capital Asset Pricing Model-based capital budgeting criteria proposed by Tuttle and Litzenberger (1968), Mossin (1969), Hamada (1969), Stapleton (1971), Rubinstein (1973), Bierman and Hass (1973) and Bogue and Roll (1974) are equivalent. They all state that a project is profitable if its internal rate of return is greater than the riskadjusted cost of capital, where the latter is given by the sum of the risk-free rate and a risk-premium which is a function of the systematic risk of the project, itself a function of the project cost.Capital budgeting, investment decisions, capital asset pricing model, equivalence

An alternative approach to firms’ evaluation: expert systems and fuzzy logic

Discounted Cash Flow techniques are the generally accepted methods for valuing firms. Such methods do not provide explicit acknowledgment of the value determinants and overlook their interrelations. This paper proposes a different method of firm valuation based on fuzzy logic and expert systems. It does represent a conceptual transposition of Discounted Cash Flow techniques but, unlike the latter, it takes explicit account of quantitative and qualitative variables and their mutual integration. Financial, strategic and business aspects are considered by focusing on twenty-nine value drivers that are combined together via “if-then” rules. The output of the system is a real number in the interval [0,1], which represents the value-creation power of the firm. To corroborate the model a sensitivity analysis is conducted. The system may be used for rating and ranking firms as well as for assessing the impact of managers’ decisions on value creation and as a tool of corporate governance.Firms’ evaluation, fuzzy logic, expert system, rating, acquisition, sensitivity analysis

Correct or incorrect application of CAPM? Correct or incorrect decisions with CAPM?

This paper focuses on inconsistencies arising from the use of NPV and CAPM for capital budgeting. It shows that (i) CAPM capital budgeting decision-making based on disequilibrium NPV is deductively inferred by the Capital Asset Pricing Model, (ii) the use of the disequilibrium NPV is widespread in finance both as a decision rule and as a valuation tool, (iii) the disequilibrium NPV does not guarantee additivity nor consistency with arbitrage pricing, so that it is unreliable for valuation, (iv) Magni’s (2002, 2007a, forthcoming) criticism of the NPV criterion refers to the disequilibrium NPV, and De Reyck’s (2005) project valuation method, on the basis of which Magni’s criticism to NPV is objected, leaves decision makers open to arbitrage losses and incorrect decisions.Corporate finance; investment analysis; Net Present Value; Capital Asset Pricing Model; disequilibrium; decision; valuation; nonadditivity; arbitrage

Rating and ranking firms with fuzzy expert systems: the case of Camuzzi

In this paper we present a real-life application of a fuzzy expert system aimed at rating and ranking firms. Unlike standard DCF models, it integrates financial, strategic and business determinants and processes both quantitative and qualitative variables. Twenty-one value drivers are defined, concerning the target firm (strategic assets in place and expected financial performance), the acquisition (synergies, quality of management) and the sector (intensity of competition, entry barriers). Their combination via “if-then” rules leads to the definition of an output represented by a real number in the interval [0,1]. Such a number expresses the valuegenerating power of the target firm inclusive of synergies with the bidder (Strategic Enterprise Value). The system may be used for rating and ranking firms operating in the same sector. A regression analysis using hostile takeovers multiples may be employed to translate the score into price. The real-life case refers to Camuzzi (a natural gas distributor), acquired by Enel, the Italian ex monopolist of electric energy.Corporate finance, firm, rating, ranking, expert system, fuzzy logic, evaluation

On decomposing net final values: EVA, SVA, and shadow project

A residual-income model, named Systemic Value Added (SVA), is proposed for decision-making purposes, based on a systemic approach introduced in Magni (2000, 2003, 2004). The model translates the notion of residual income (excess profit) giving formal expression to a counterfactual alternative available to the decision maker. Relations with other residual income models are studied, among which Stewart's Economic Value Added. The index here introduced differs from EVA in that it rests on a different interpretation of the notion of excess profit and is formally connected with the EVA model by means of a shadow project. The SVA is formally and conceptually threefold, in that it is economic, financial, accounting-flavoured. Some results are offered, providing su±cient and necessary conditions for decomposing Net Final Values. Relations between a project's SVA and its shadow project's EVA are shown, all results of Pressacco and Stucchi (1997) are proved by making use of the systemic approach and the shadow counterparts of those results are also shown.Excess profit, residual icome, net final value, decomposition, EVA, SVA, systemic, shadow project