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1.5 Risk in contextToday world is in a social and political uncertainty. Globalisation is a major factorin business. The business environment is no longer limited to the country whereit operates. Competition for today’s businesses can come from all the countriesaround the globe. Today’s management teams in order to work efficiently andeffectively to cope up with the dynamic change environment need to better,faster, leaner and quicker on their feet than ever before.The pace of technological change suggests that this is likely to continue wellbeyond the near future and it is clear that standing still is not an option. Onlythose organisations that adapt well will prosper; change management becomesboth a business necessity and an art. The true measure of a business success isthe rate at which it can improve its range of products, services and the way itproduces and delivers them.The reason why risk is so difficult to determine is the varied and uncertain extentto which business players’ act to influence the outcome. Risk may be defined asuncertainty about a possible future change, either beneficial or adverse. It ishowever different to uncertainty since it can be predicted on a mathematicalbasis whereas uncertainty cannot.The term risk management is applied in a number of diverse disciplines. Toomany social analysts, politicians and academics it is the management ofenvironmental and nuclear risks, those technology generated macro risks thatappear to threaten our existence.To bankers and financial officers it is the sophisticated use of such techniques ascurrency hedging and interest rate swaps. To insured buyers and sellers it iscoordination of insurable risks and the reduction of insurance costs. To hospitaladministers it may mean quality assurance. To safety professionals it is reducingaccidents and injuries.

Risk management is a discipline for living with the possibility that future even tomay cause adverse effects. Risk management means a course of action plannedto reduce the risk of an event occurring and minimizing or containing theconsequential effects should that event occur. In order to achieve this, a riskmanagement policy should be put in place.Risk management involves the identification, measurement and economic controlof risks and developing strategies to manage the risk that threaten the assetsand earnings of the institution. The management of any loss-producing event,which occurs pre-emergency, emergency handling and recovery, is contingencyplanning, whereas the process of restoring operations and minimising the lossassociated with an occurrence is disaster recovery.In ideal risk management, a prioritisation process is followed whereby the riskswith the greatest loss and the greatest probability of occurring are handled first,and risks with lower probability of occurrence and lower loss are handled later. Inpractice, the process can be very difficult when balancing between risks.Risk management also faces a difficulty in allocating resources properly. This isthe idea of opportunity cost. Resources spent on risk management could beinstead spent on activities that are more profitable. Again, ideal risk managementspends the least amount of resources in the process while reducing the effects ofrisks as much as possible.Learn from your mistakes is an admonition for losers. Successful people learnfrom others’ mistakes and thereby avoid their own. As business becomeincreasingly complex, it is becoming more difficult for CEOs to know whatproblems might lie in wait. Therefore, they need someone systematically to lookfor potential problems to design safeguards in order to minimise potentialdamage. In any event, risk management is becoming increasingly important.

Risk management is seen as the answer for developing the business ability toanticipate the unexpected. Businesses can identify and analyse the risk and thencan use their core competences to manage them. Businesses can turnaroundplenty of threats into opportunities if they really assess the risks better than theirrivals do.Risk management should not be looked at another task for today’s businessplayers to fit into an already overcrowded business schedule. Businesses have toadapt ways of prioritising the schedule, deploying people and capital moreproductively. The important issue is to focus on the uncertainties of future and tobe able to identify and handle them. Risk management can help to ensure thatthey reach the successful goal eventually.1.6 Valuation of a businessA business valuation is the process of determining the intrinsic value of commonstock. The valuation process includes understanding the business, analysing theindustry, determining a methodology and generating a report.In a globalise dynamic business world, valuation is gaining momentum inemerging markets for mergers, acquisitions, joint ventures, restructuring and thebasic task of running businesses to create value. Yet valuation is much moredifficult in these environments because buyers and sellers face greater risks andobstacles than they do in developed countries.In 1997, the risks and obstacles had been so serious in the emerging markets ofEast Asia. This Asian financial crisis weakened a mass of companies and banksand led to a surge in merger and acquisition activity, giving valuation practitionersa good chance to test their skills. The findings of valuation of companies inemerging markets clearly suggest that market prices for equities do not take intoaccount the commonly expected country risk premium. If these premiums wereincluded in the cost of capital, the valuation would be 50 to 90 percent lower than

the market values. (Asian Development Outlook 2000, Asian Development Bankand Oxford University Press, p. 32)In order for the stock market to function, a belief in valuation techniques ofindividual firms is necessary. Without a valuation model to estimate value,investors would not be able to arrive at conclusions on what price to buy or sellan asset. When inspecting different analysts’ results of specific businessvaluation, the value often differs.1.7 Problem discussion1.7.1 Why do these valuations differ?This is because different valuation techniques used by different analysts and theinputs plugged into the valuation techniques differ between the analysts. Sincethe analysts have diverse views of the future of the business, their forecasts willdiffer, hence the recommended values differ.1.7.2 How does one know which of these values is the mostaccurate?It is not possible to determine the correct value because of risks anduncertainties involved in carrying out businesses. Therefore, a present needs toimprove the tools used by analysts in valuing their businesses.In order to understand valuation, two main concepts of value must beunderstood.First, the commonly accepted theoretical principle to value anyfinancial asset is the discounted cash flow (DCF) methodology. An asset is worththe amount of all future cash flows to the owner of this asset discounted at anopportunity rate that reflects the risk of the investment. This fundamentalprinciple does not change and is valid through time and geography. A valuationmodel that best converts this theoretical principle into practice should be themost useful.

Based on the first concept, the second concept states that valuation is aninherently forward looking in a business. Valuation requires an estimate of thepresent value of all expected future cash flows to shareholders. In other words, itinvolves looking into an uncertain future and making an educated guess aboutthe many factors determining future cash flows. Since the future is uncertain,intrinsic value estimates will always be subjective and imprecise. Better modelsand superior estimation techniques may reduce the degree of inaccuracy, but novaluation technique can be expected to deliver a single correct intrinsic valuemeasure.These main concepts illustrate that there are few things more complex than thevaluation of businesses. Thousands of variables affect the future cash flows of acompany and thus the value of a business. Most variables are known, but veryfew are understood; they are independent and related, they are measurable, butnot necessarily quantitative and they affect business values alone and incombination.A continuous need is to improve the tools used by analysts when valuing firms.This dissertation aims to contribute to the continuous process. There are severalopinions on what creates value in a business. Therefore, there are differentapproaches to estimate the value of a firm. It is a huge task to do research on allapproaches. In this dissertation, a brief discussion was made on selected corevalue techniques and the focus is on discounted cash flow (DCF) value modelapproach.Discounted cash flow (DCF) method is the mostly used fundamental method inbusiness valuation (Perrakis, 1999), consequently the basic problem that thisstudy is faced with is; how can improvements to the discounted cash flow (DCF)model, as it is used to value firms, be achieved?

In order to show how analysts can improve the way they apply the discountedcash flow (DCF) model and how they report their results, thorough understandingof the discounted cash flow (DCF) model and the context in which it is used isnecessary. In order to achieve this, analyst has to ask the question; what are theweaknesses and limitations of the discounted cash flow (DCF) model. Thediscounted cash flow (DCF) method is used as a management tool in decisionmaking of the businesses.The discounted cash flow (DCF) model depends on two inputs; the numerator,which is an estimated future cash flow and the denominator i.e. discount rate(weighted average cost of capital). The output of the model is dependent onthese two inputs. How to calculate the denominator are the major concern ofsome scientific reports (Bohlin, 1995) as well as the topic of large discussions infinancial text. (Copeland, 2001, Perrakis, 1991 and Ross, 1991)To summarise the problem discussion; the thesis is conducted in order to findreasons behind problem areas in the discounted cash flow (DCF) approach tofirm valuation, as well as how improvements can be made to these areas.This will be accomplished by conducting,1) A literature study of related academic theories, mathematical models ingeneral, the discounted cash flow (DCF) model in particular, forecastingmodels of revenue, risks, uncertainties involved, cost of capital, discountrate to be used on the free cash flows in order to project the presentvalues.2) Questionnaire survey and personal interviews of 63 organisations1.8 PurposeThe purpose of this study is to analyse the theories and examine the approachesof business valuation models. Identifying the key inputs used in the valuationmodels, and then to find out the methods of forecasting these inputs with greater

degree of accuracy. This will be accomplished by a literature study and asubsequent questionnaire survey.The purpose of the literature study is to analyse the use of the discounted cashflow method as it is used in firm valuation. The aim is to probe into theweaknesses of the method and the reasons behind the problem areas. Further,the study will be conducted to find reasons and arguments to solutions of theseproblemsThe purpose of the subsequent questionnaire survey is to prove whether the nullhypothesis is true or false and to expose important implications of empiricalweaknesses and limitations of the discounted cash flow (DCF) model.The null hypothesis H0 states that the different techniques of valuation ofbusinesses will produce the same results.The alternate hypothesis H1 assumes that different techniques of valuation ofbusine

flow (DCF) analysis is applied to investment project appraisal and corporate valuation. By combining assessments of both opportunity cost and risk, a discount rate is calculated for the analysis of present value of anticipated future cash flows. Free cash flow is the remaining amount of operating cash flow for the shareholders,