An important part of economic value involves the consideration of the risks associated with corporate decision-making targeting the creation of value. In this sense, going too far is just as bad as coming up short.

Where are the risks in our valuation model that uses cash flows discounted at WACC?

In FCFs, one must consider the main operating risks inherent to the different business policies of the company involving sales, personnel, logistics, production, overheads, collection, investment, etc. Once these risks have been identified and their importance quantified, they are normally included in the valuation model through sensitivity analyses or probability simulations.

WACC includes financial risk stemming from the gearing ratio implied by the capital structure; risks perceived by shareholders, which form part of the cost of equity (market-risk premium and systematic operating and financial risks of the company); and risks perceived by financial entities that are included in the cost of debt.

Table 7 summarizes these risks.

Table 7

ECONOMIC VALUECOMPONENTSASSOCIATED RISKS

IN FCFOPERATING RISKS:

OPERATING FCFIN OPERATING ACCOUNT COMPONENTS

FCF FROM WORKING CAPITALIN WORKING CAPITAL COMPONENTS

FCF FROM INVESTMENT IN FIXED ASSETSIN INVESTMENT COMPONENTS

IN WACCCOST OF DEBTRISKS PERCEIVED BY FINANCIAL ENTITIES

COST OF EQUITY:EQUITY BETASYSTEMATIC OPERATING AND FINANCIAL RISKS PERCEIVED BY SHAREHOLDERS

CAPITAL STRUCTUREFINANCIAL RISKS

There is a high probability of duplicating or omitting relevant risks when said risks are not adequately identified and their correct inclusion in the model is not verified.