1. As we have learned so far into the course that forecasting cash flows into th
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Question
1. As we have learned so far into the course that forecasting cash flows into the foreseeable future poses a unique challenge since most enterprises are expected to stay in business for many years. As valuation experts, what we can do in order to come up with a reasonably accurate valuation of a business that is expected to continue for long time? What are the different alternative methodologies that can be applied to meet this challenge?
2.One of the bigger political "footballs" of early 2005 concerned revising Social Security. Projections abounded -- that nobody refuted -- that the system would start being in net cash outflow by 2017 (give or take a year or two) and go broke by 2042 (again, give or take a year or two).
Politics may have tabled the topic for a while, but it is useful analytically. Let me pose two questions.
First, how can we analyze the Social Security situation as a valuation problem?
Second, "Stocks are too risky for Social Security" has been one of the arguments against the proposed private accounts. Do you agree or disagree?
Explanation / Answer
1. Business valuation is a process that follows a number of key steps starting with the definition of the task at hand and leading to the business value conclusion. The five steps are:
There are many approaches to take in establishing an accurate valuation for your business. Finding the best method for your situation will provide you with the best measure of value.
Book value
Historical Earnings Method
Liquidation Value
Debt paying ability
Capitalization of earnings or cash flow
Gross income multipliers/capitalization of gross income
Dividend-paying ability
Assets and Earnings Valuation (Often Used for Gift Tax Valuation)
Future Earnings Valuation
Discounted cash flow method
Comparable sales method.
Rules of thumb/industry averages
P/E ratios
Valuing Partial Interests in Business
2. The Social Security Administration calculates a number of measures to assess the financial state of the system. This requires assigning a current value to the stream of benefit payments and payroll tax revenues that can be expected in the future. The traditional actuarial approach to making these calculations ignores risk, and assigns an expected value. Private financial markets would value these future costs and revenues differently by adjusting for uncertainty and risk.
Using this market-based approach, and applying risk adjustment empirically, we estimate an open group unfunded liability that is 30 percent lower than the SSA estimates using actuarial methods. The marketbased closed group unfunded liability is calculated to be less than half the size of the official SSA amount
Increase payroll taxes and invest the extra money in individual investment accounts, somewhat similar to existing individual retirement accounts..
They are being proposed in response to fears by Baby Boomers that there won't be enough money available for their Social Security payments when they reach retirement age.
It is a long-term worry.
Projections are that there will be enough money from Social Security taxes and interest to pay all benefits through 2019. Further taxes and trust fund reserves should pay all benefits through 2029.
The year 2030 is where the real problem starts. Then, the Social Security system won't be receiving enough money to meet all obligations.
The idea of investing some Social Security money in the stock market is being advanced as a way to increase the trust fund and postpone the problem, perhaps indefinitely.
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