The relevance of Discounted Cash Flow (DCF) and Economic Value Added (EVA) for the valuation of banks

Table of Contents

Introduction

CHAPTER 1 RESEARCH METHODOLOGY

1.1 Investigation techniques

1.2 Definition of sample

1.3 Questionnaire design

1.4 Limitations

CHAPTER 2 THE DISCOUNTED CASH FLOW (DCF) APPROACH

2.1 The Shareholder Value Concept

2.2 Calculating Cash Flows

2.2.1 The Direct Cash Flow Calculation

2.2.2 The Indirect Cash Flow Calculation

2.3 Cash Flow versus Free Cash Flow

2.4 Fundamentals of DCF valuation

2.5 Techniques of DCF

2.5.1 The Entity Model

2.5.2 The Equity Model

2.6 The Price of Risk – Estimating appropriate Discount Rates

2.6.1 The Determination of the Cost of Equity

2.6.1.1 The Capital Asset Pricing Model (CAPM)

2.6.1.2 The Arbitrage Pricing Model (APM)

2.6.2 The Determination of the Cost of Debt

2.6.3 Combination of CoE & CoD using the WACC Approach

CHAPTER 3 THE ECONOMIC VALUE ADDED (EVA) CONCEPT

3.1 Background and relevance of EVA

3.2 Calculation of EVA

3.2.1 Special requirements in calculating NOPAT and Capital

3.2.2 Example of EVA calculation

3.3 EVA and Market Value Added (MVA) – The Link to DCF

3.4 Imperfections of the EVA concept

3.4.1 General Limitations of EVA

3.4.2 Efficient Market Hypothesis (EMH) and the CAPM

CHAPTER 4 FINDINGS AND ANALYSIS

4.1 Important aspects of bank valuation

4.2 Questionnaire review and presentation of findings

4.3 Analysis in relation to existing theory on DCF and EVA

4.3.1 Dividend Discount Model (DDM)

4.3.2 Valuation of Deutsche Bank with DDM

4.3.3 EVA & Bank Valuation

4.4 Summary

CHAPTER 5 CONCLUSION

Objectives & Core Topics

This study evaluates the applicability of Discounted Cash Flow (DCF) and Economic Value Added (EVA) as capital market-based valuation models within the banking sector, specifically addressing the challenges of adapting these traditional industrial methods to the highly regulated banking environment.

• Theoretical examination of DCF and EVA valuation frameworks.
• Analysis of the relationship between capital market expectations and company valuation.
• Empirical investigation into the valuation practices of bank analysts.
• Assessment of the challenges in applying non-financial valuation tools to banks.
• Discussion of necessary adjustments (e.g., Dividend Discount Model) for bank valuation.

Excerpt from the Book

Summary of Chapters

Introduction: Provides the rationale for modern company valuation and introduces the study's focus on DCF and EVA methodologies.

CHAPTER 1 RESEARCH METHODOLOGY: Outlines the two-stage research process, combining a literature review of secondary data with primary data collected via a questionnaire to a bank analyst.

CHAPTER 2 THE DISCOUNTED CASH FLOW (DCF) APPROACH: Details the theoretical foundations of the DCF model, including shareholder value, cash flow calculations, and the estimation of discount rates.

CHAPTER 3 THE ECONOMIC VALUE ADDED (EVA) CONCEPT: Explores the EVA approach as a single-period residual income metric and its theoretical links to DCF and shareholder wealth maximization.

CHAPTER 4 FINDINGS AND ANALYSIS: Discusses the practical application of DCF and EVA in bank valuation, focusing on the Dividend Discount Model and bank-specific adjustments.

CHAPTER 5 CONCLUSION: Synthesizes findings, concluding that while adaptations are necessary due to banking sector peculiarities, both DCF and EVA remain effective valuation tools.

Keywords

Shareholder-value, Discounted-cash-flow, Economic-value-added, Bank-valuation, NOPAT, CAPM, WACC, Cost-of-equity, Free-cash-flow, Market-value-added, Dividend-discount-model

Frequently Asked Questions

What is the core purpose of this study?

The study aims to investigate whether modern capital market-based valuation models, specifically DCF and EVA, are transferable and applicable to the banking industry, which is characterized by unique regulatory and structural requirements.

What are the central thematic fields covered?

The research covers corporate finance theory, company valuation techniques, the evolution of the shareholder value concept, and the practical challenges faced by analysts in the financial services sector.

What is the primary research question?

The research explores if valuation approaches designed for industrial companies can effectively be applied to banks, and what specific modifications, such as the Dividend Discount Model, are required to generate reliable valuations.

Which scientific methods are utilized?

The work employs a dual methodology: a comprehensive secondary literature review of financial theories and a primary investigation using a questionnaire addressed to a bank analyst, complemented by a simplified valuation case study of Deutsche Bank.

What does the main body focus on?

The main body provides an in-depth review of DCF and EVA formulas and theories, followed by an analysis of the questionnaire results to assess the feasibility of these models in real-world bank valuation practice.

Which keywords define this work?

Key terms include Shareholder-value, DCF, EVA, Bank-valuation, CAPM, WACC, NOPAT, Free-cash-flow, Market-value-added, and Dividend-discount-model.

Why is the Entity approach often neglected in bank valuation according to this text?

Due to the difficulty in defining and separating debt from equity in banks—where deposits act as "raw material"—the Entity approach is often considered less suitable than equity-focused models like the Dividend Discount Model.

What makes bank valuation conceptually more difficult than industrial valuation?

The primary difficulties lie in the heavy regulation of banks (e.g., capital adequacy requirements), the challenge of classifying "raw material" (deposits) as debt or capital, and the necessity of capturing different risk profiles across various banking business units.