Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

Dealing with Marketable Securities in Valuation

Marketable securities can include corporate bonds, with
default risk embedded in them,and traded equities, which
haveevenmoreriskassociatedwiththem.Asthemarketable
securitiesheldbyafirmbecomemorerisky,thechoiceson
howtodealwiththembecomemorecomplex.Wehavethree
ways of valuing marketable securities.

1. The simplest and most direct approach is to obtain or
   estimate the current market value of these marketable
   securitiesandaddthevaluetothevalueofoperatingassets.
   For firms valued on a going-concern basis, with a large
   numberofholdingsofmarketablesecurities,thismaybethe
   only practical option.


2. The second approach is to estimate the current market
   valueofthemarketablesecurities andnetouttheeffect of
   capitalgainstaxesthatmaybedue ifthosesecuritieswere
   soldtoday. Thisis thebest wayof estimatingvalue when
   valuing a firm on a liquidation basis.

3.Thethirdandmostdifficultwayofincorporatingthevalue
ofmarketablesecuritiesintofirmvalueistovaluethefirms
thatissued thesesecuritiesand estimatethesecurity value.
Thisapproachtendstoworkbestforfirmsthathaverelatively
few, but large, holdings in other publicly traded firms.

ILLUSTRATION 10.5: Microsoft’s Cash and Marketable
Securities

Between 1991 and2000,Microsoftaccumulatedalargecash
balanceasaconsequenceofholdingbackonfreecashflows