Improved Techniques for Valuing Large-Scale Projects

Abstract

One of the standard ways to value project finance investments is to discount equity cash flows (ECF) using a single discount rate, he project's cost of equity (KE). This approach, however, can lead to significant valuation errors when used to value complex investments. In this article, Esty illustrates problems with such an approach and then presents an improved valuation technique called Quasi-Market Valuation (QMV) which solves these problems and reduces the potential for significant errors. In addition, the author discusses two additional valuation tools-Monte Carlo simulation and real options analysis-which address deficiencies in traditional discounted cash flow (DCF) analysis. With the exception of real options analysis, these new techniques and tools are relatively simple to implement using standard spreadsheet software.