Valuation of Danisco: A discounted cash flow + real option premium approach

Christopher C. Klagenberg & Niels S. Brolev

Student thesis: Master thesis


The thesis has a dualistic purpose. 1) It attempts to estimate the fair value of Danisco using the extended net present value, proposed by Stewart (1984). 2) It argues that the ENPV is a more refined valuation model for practitioners, highlighting that incorporating a real option perspective enables a more informed investment decision. An extensive academic body of research exist on real options, but it was identified that a limiting factor for its use, is the lack of practical examples. Subsequently the thesis has both a theoretical and practical scope; but with an emphasis on practicality, as the theoretical discussion revolves around solving the practical issues related to the construction of the ENPV model. Part I contains a complementary theoretical discussion, outlining the benefits of the – considered best‐practice valuation model – the discounted cash flow, and highlighted its embedded static nature and that in situations of stable competitive dynamics the model was favored compared to a real option model, due to its reliance on historic financial data. However in situations of uncertainty, defined as the continuous emergence of new information and the existence of managerial flexibility, ROA was superior. Subsequently, applying a complementary valuation model would yield a more accurate estimate for the value of Danisco. The process of identifying real options became incremental and based on a theoretical review and the case study analysis (Part II) a three‐dimensional identification model was developed, proposing to utilize the criteria of high uncertainty and high managerial flexibility as defined above, but included low correlation among option as an important factor. Using this model, the 2nd generation bio‐fuel research project with Dupont (DDCE), was identified as a sequential compound option, wherein abandonment and expansion options were present and of significant relevance for Danisco’s future. Part III comprises of the practical valuation of Danisco, where it is divided into applying DCF on its current operations and applying ROA on DDCE. This equaled a fair value of dkk 526 per share, wherein current operations accounted for dkk 512 per share and DDCE’s real option premium accounted for dkk 14 per share. Based on the estimated fair value of Danisco the recommendation to investors is “BUY”, as the share price as of 22 September 2010 was dkk 500 per share. The conclusion of the thesis is that the ENPV model is a more refined valuation model, enabling investors to distinguish between relevant real options and their counter parts, thereby overcoming the theoretical black hole that infinite real options exist within a firm setting. Two processes were identified as incremental in the efficient application of ENPV, firstly; the identification of real options and secondly; We developed a six step real option valuation model. Based on this, it can be concluded that it is a meaningful approach for practitioners to apply real options. If not contributing actual value, incorporating a real option perspective enables the identification of strategic value. In our case we can reject that DDCE is Danisco’s answer to securing the future growth. The application of the real options approach is computationally heavier than traditional models. The validity is difficult to maintain, when estimating the novel variables in ROA. Despite these complications, we found the level of information retrieved from the real options analysis is valuble.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2010
Number of pages160