Infact,theconversionofopacityintoanimplicittaxbyPrice
Waterhouserepresentsadiscountingofthecashflows.We
couldincreasethetaxrateforcomplexfirmsandestimatethe
cashflowsforthefirmwiththehighertaxrate.Thelower
expectedcashflowswillresultinlowervalue.Thisapproach
is most appropriatewhen we areunsure aboutthe current
earningsofthefirm(asstatedinitsfinancialstatements)and
feel that earnings might be overstated.
Analternativeapproachthatmaybesimpleristoreplacethe
inputsforthefirmwithmoresustainablenumbers.Thus,we
would change the operating margin of the firm from its
reported value to the industry average and change the
effectivetaxratetothemarginaltaxrate.Themanagementof
thefirmwillcomplainmightilythatwearebeingunfairin
our valuation, but the onus should be on management to
providetheinformationthatallowsustobelievethatthefirm
can sustain higher margins and lower tax rates.
Adjust the Discount
RateEarlierinthischapter,wepointedtoevidencethatmore
complexcompaniestendtohavehighercostsofdebt,equity,
andcapital.Followinguponthisevidence,wecanadjustthe
discountrate—thecostsofequityandcapital—thatweuseto
discountthecashflowsforcomplexity.Inpracticalterms,we
willincrease thecostsofequityand capitalfor firmswith
more complex financial statements, relative to firms with
moretransparentstatements.Wecanmakethisadjustmentin
four ways:
1.Estimatethehistoricalriskpremiumattachedtocomplex
firms bycomparing thereturns wewould havemadeona