cashval - Cash and Non-operating Assets The operating...

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Cash and Non-operating Assets The operating income is the income from operating assets, and the cost of capital measures the cost of financing these assets. When the operating cash flows are discounted to the present, you have valued the operating assets of the firm. Firms, however, often have significant amounts of cash and marketable securities on their books, as well as holdings in other firms and non-operating assets. The value of these assets should be added to the value of the operating assets to arrive at firm value. Some analysts prefer to consider the income from cash and marketable securities in their cash flows and adjust the discount rate 1 to reflect the safety of these assets. When done right, this approach should yield the same firm value. Cash and Marketable Securities Firms often hold substantial amounts in cash and other marketable securities. When valuing firms, you should add the value of these holdings to the value of the other operating assets to arrive at the firm value. In this section, you first consider how to deal with cash and near cash investments (such as government securities) and then consider holdings of more risky marketable securities. Cash and Near-cash Investments Investments in short-term government securities or commercial paper, which can be converted into cash quickly and with very low cost, are considered near-cash investments. When valuing a firm, you add the value of cash balances and near-cash investments to the value of operating assets. There is, however, one consideration that may affect how cash is treated. If a firm needs cash for its operations – an operating cash balance – you should consider such cash part of working capital requirements rather than as a source of additional value. Any cash and near-cash investments that exceed the operating cash requirements can be then added on to the value of operating assets. How much cash does a firm need for its operations? 1 When a firm has cash and marketable securities the unlevered beta has to be adjusted downwards to reflect the safety of these assets.
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The answer depends upon both the firm, and the economy in which the firm operates. A small retail firm in an emerging market, where cash transactions are more common than credit card transactions, may require an operating cash balance that is substantial. In contrast, a manufacturing firm in a developed market may not need any operating cash. In fact, if the cash held by a firm is interest-bearing, and the interest earned on the cash reflects a fair rate of return 2 , you would not consider that cash to be part of working capital. Instead, you would add it to the value of operating assets to value the firm. Other Marketable Securities Marketable securities can include corporate bonds, with default risk embedded in them, and traded equities, which have even more risk associated with them. As the marketable securities held by a firm become more risky, the choices on how to deal with them become more complex. You have three ways of accounting for marketable
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