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Investment and Company Valuation

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Valuation of Network Effects in Software Markets

Part of the book series: Contributions to Management Science ((MANAGEMENT SC.))

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Abstract

The most relevant concepts of the valuation literature are reviewed in this first chapter of the theoretical framework. First, the background of the relevant conventional valuation approaches is depicted, before the more innovative Real Options Valuation approach and the underlying Option Pricing Theory are summarized. The insights in this chapter provide the financial background for the subsequent design of a framework for valuations in software markets.

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Notes

  1. 1.

    The value of an asset is frequently defined as the sum of the subjective utility provided to its owner (Moxter 1991). While the neoclassical theory assumes that the price and the value of an asset are identical, more recent research on behavioral finance indicates that the two can differ (Shleifer 2000). In this context it is also important to note that motivations to conduct valuations are diverse and influence the outcome (Kühnemann 1985; Born 1995; Koller et al. 2005). Analogous to assets, the value of a company is defined as the total utility of a portfolio of investment projects. The company is interpreted as a set of temporary production functions (Busse von Colbe and Coenenberg 1992). Please note that the primary focus of the subsequent investigations is on asset valuation of customer networks in the context of company valuation as defined in Sect. 1.3. Hence, the terms customer network-centric valuation of companies operating in software markets and valuation are used interchangeably.

  2. 2.

    Risk is the possibility of an either favorable or unfavorable deviation from an expected value that is quantified by probabilities (Mikus 2001).

  3. 3.

    The opportunity costs of capital are the sum of interest for equity and debt financing. The most influential cost of capital concepts are the CAPM and the APM (Sharpe 1964; Lintner 1965; Mossin 1966; Ross 1977). While the original model was published as Arbitrage Pricing Theory with a focus on securities, in the following the broader term Arbitrage Pricing Model is used which also comprises publications on the pricing of derivatives. Please consider (Ross et al. 1996) for further information.

  4. 4.

    Please consider (Brealey and Myers 1996) for further details on DCF models.

  5. 5.

    Please confer Sect. 3.3.

  6. 6.

    Please confer Sect. 2.3.3 for a typology of real options.

  7. 7.

    Please confer (Wilmott et al. 1995) for an extensive overview on option pricing theory.

  8. 8.

    More generally, the option embeds the right to purchase or to sell an underlying at a predetermined exercise price on (European) or before (American) a predetermined date. Values of options can stem from two different sources, the intrinsic value, which is equal to the price differential between the underlying and the exercise price, and from the time value until expiration (Myers 1977).

  9. 9.

    Please confer (Hull 1989; Trigeorgis 1996; Neftci 1996) for further information.

  10. 10.

    The portfolio is also called tracking portfolio (Amram and Kulatilaka 2000).

  11. 11.

    Please note that the value of a real option is zero once it is exercised, but it can not have a negative value as it is a right and not a binding obligation (Hommel and Müller 1999).

  12. 12.

    Please note the interdependency of multiple real options.

  13. 13.

    Please confer Sect. 2.3.3.

  14. 14.

    Please confer Chap. 4 for further reference.

  15. 15.

    Please confer the sensitivity analysis in Sect. 8.5 for details on possibilities to account for such interdependencies.

  16. 16.

    Please confer Chap. 3.

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  1. Azaleenweg 114, 60433, Frankfurt, Germany

    Dr. Andreas Kemper

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Kemper, A. (2010). Investment and Company Valuation. In: Valuation of Network Effects in Software Markets. Contributions to Management Science. Physica-Verlag HD. https://doi.org/10.1007/978-3-7908-2367-7_2

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