Output Computation System
The Output Computation System (OCS) uses information generated by ECS and RQS to perform an extensive series of output computations. The computational methods used by this system incorporate standard practices of discounted cash flow analysis and market-based valuation. These standard methods are combined with a novel approach to incorporating the enterprise probability of success, resulting in financial and investment parameters that are adjusted for enterprise risk. As featured throughout the Enterprise Analysis, the OCS produces a range of standard and novel financial metrics and advanced investment analytics.
Risk Adjustment
Enterprise parameters that are used to compute risk-adjusted output metrics (e.g., risk-adjusted IRR) are first combined with the probability of success to derive intermediate risk-adjusted parameters such as risk-adjusted free cash flow. This adjustment incorporates the probability of enterprise success and failure into risk-unadjusted free cash flow projections and thereby incorporates this probability as the statistical uncertainty inherent to the enterprise achieving projected risk-unadjusted free cash flows.
Fair Market Valuation
This computation is based on a multi-stage growth model and a market-based enterprise liquidity value. After adjustment for the probability of success, the resulting risk-adjusted free cash flows and the risk-adjusted liquidity value are discounted with the median risk-adjusted IRR of the peer group. By utilizing the peer median risk-adjusted IRR as the discount rate, this dynamic method determines the fair market valuation of an enterprise based on competitive rates of return established by independent market pricing.
Proprietary Market-Based Valuation Correlation for Transportation & Distribution Industry Sector
In calculating a market-based liquidity value for a private enterprise, Enterprise Analyzer incorporates valuation ratios from the public markets in order to establish a fair market value for an enterprise at the time of its projected liquidity event. Founded on the “law of one price,” this value is based on the revenue of the enterprise at its liquidity event and the corresponding public market "price/sales" ratio for that enterprise sector. This ratio is determined as a function of the industry sector and enterprise operating profit margin at the time of its projected liquidity event.
Every industry sector in the public markets demonstrates a unique linear relationship between enterprise operating profit margin and the valuation “price-to-sales” ratio (i.e., higher margins lead to higher valuation ratios). Based on extensive data mining and analysis of over 3,000 public companies, Enterprise Analyzer utilizes proprietary valuation regressions for each of its 34 secondary industry sectors (e.g. Transportation & Distribution Industry Sector).
This capability enables Enterprise Analyzer to value an enterprise based on its specific sector and profitability. This proprietary market valuation information is periodically updated so that “efficient market pricing” in the public markets extends to the output of Enterprise Analyzer. The Fair Market Valuation of an enterprise excludes the aggregate value of any interests in non-consolidated enterprises (presented in the enterprise balance sheet).
Risk-Adjusted Internal Rate of Return (IRR)
This computation is based on a multi-stage growth model and a market-based liquidity value. After adjustment for the probability of success, discounted risk-adjusted free cash flows and the risk-adjusted liquidity value are compared to the enterprise pre-money valuation. This net present value methodology iteratively varies the discount rate until a solution is found that equates the enterprise pre-money valuation to the sum of its risk-adjusted and discounted free cash flows and liquidity value. The resulting discount rate is an estimate of the annual risk-adjusted internal rate of return for investors in that enterprise.
Undercapitalization
Undercapitalization is an estimate of any deficiency in projected net capitalization of the enterprise as it relates to achieving positive net cash flow from operations. It is computed through a comparison of risk-adjusted free cash flows to the projected net capitalization of the enterprise within the context of achieving positive net cash flow from operations.