How to value a seasonal company’s discounting cash flows

Abstract

The correct way of valuing seasonal companies by cash flow discounting is to use monthly data. We may use annual data, but it requires some adjustments. We show that when using annual data in the context of the adjusted present value (APV), the value of the unlevered equity (Vu) and the value of the tax shields (VTS) calculations must be adjusted. However, the debt that we have to substract to calculate the equity value does not need to be adjusted. We derive the adjustments to be made. Errors due to using annual data without doing the adjustments are big. To adjust only by using average debt and average working capital requirements does not provide a good approximation. When the inventories are a liquid commodity such as grain or seeds, it is not correct to consider all of them as working capital requirements. The excess inventories financed with debt are equivalent to a set of futures contracts. We show that not considering it undervalues the company. This paper values a company in which the seasonality is due to the purchases of raw materials: the company buys and pays all raw materials in the moth of December. We show that the equity value calculated using annual data without doing the adjustments understates the true value in a 45% if the valuation is done at the end of December, and overstates the true value in a 38% if the valuation is done at the end of November. The error of adjusting only by using average debt and average working capital requirements ranges from –17.9% to 8.5%.