There aretwo ways in which we can deal with cash and
marketablesecuritiesindiscountedcashflowvaluation.One
istolumptheminwiththeoperatingassetsandvaluethefirm
(orequity)as awhole. Theotheris tovaluetheoperating
assetsandthecashandmarketablesecuritiesseparately.As
we arguein thissubsection, thelatterapproachis a much
more reliable one and less likely to result in errors.
Consolidated Valuation
Isitpossibletoconsidercashaspartofthetotalassetsofthe
firmandtovalueitonaconsolidatedbasis? Theansweris
yesanditis,in asense,whatwedowhenweforecastthe
totalnetincomeforafirmandestimatedividendsandfree
cashflowstoequityfromthoseforecasts.Thenetincomewill
then include income from investments in government
securities, corporate bonds, and equity investments.
16 Whilethisapproachhastheadvantageofsimplicityand
can be used when financial investments comprise a small
percentofthetotalassets,itbecomesmuchmoredifficultto
usewhenfinancialinvestmentsrepresentalargerproportion
of total assets for two reasons:
- Thecost of equityor capital usedto discount thecash
flowshastobeadjustedonanongoingbasisforthecash.In
specificterms,youwouldneedtouseanunleveredbetathat
representsa weightedaverageoftheunleveredbetaforthe
operating assetsofthefirmand theunleveredbeta forthe
cash and marketablesecurities. Forinstance, theunlevered
betaforasteelcompanywherecashrepresents 10 percentof
thevaluewouldbeaweightedaverageoftheunleveredbeta
forsteel companiesand thebetaofcash (which isusually
zero).Ifthe 10 percentwereinvestedinriskiersecurities,you