ValuationSim is a business simulation designed to be used in corporate valuation courses. It simulates a small private equity firm that acquires companies based on their valuations using assigned budgets in consecutive rounds. Students in teams of two or three individuals perform DCF based valuations using data and assumptions provided at the beginning of each round and then decide what acquisitions to make. The aim in each round is to have the lowest valuation errors and to generate the highest return from the acquired firms.
The data and the assumptions are few and simple in the first rounds. As the simulation progresses, they increase in quantity and complexity. This process allows the participants to gradually improve their valuation skills using basic techniques at the beginning and more refined techniques at the end.
There are instructions and a tutorial for each round. Once students enter their valuations for each firm and their decisions on which firms to acquire, ASDSIM processes the round and publishes a report showing valuation errors and returns for each team. A class report allows students to compare their performance to other teams generating a competitive environment that results in higher motivation to succeed while learning valuation techniques.
Students are required to use Excel in their valuation and to upload their file to the website showing their work. These files are downloadable by the instructor, but not required to evaluate team performance.
Team valuations are compared to the valuations performed by the simulator using the DCF method. Students are required to use FCFE, FCFF, and the comparables method of valuation in a sequential mode. By applying valuation models and techniques for many firms in multiple rounds, learning is reinforced. The simulation also improves students' skills in financial modeling using Excel.
A score is assigned to each team after each round based on the accuracy of their valuations and on the annual return of the acquired companies after one year, including the spread between the acquisition price and its intrinsic valuation. General feedback is given after each simulation round. At the end of the simulation a final score is assigned. The simulation is administered on www.asdsim.com.
Benefits of Using ValuationSim
Valuation of different companies for multiple rounds reinforces the learning of the following subjects:
1. Calculation of terminal value using the next year FCF and not the long term growth rate of sales (a common mistake in valuation).
2. Clearly differentiate FCFF from FCFE and know the information required to model each of them.
3. Calculation of cost of equity and WACC.
4. When to use cost of equity or WACC as the discount rate.
5. Students learn the difference between "required return", "discount rate", "cost of capital", "cost of equity" and "WACC" among other valuation terms .
6. Improvement of Excel skills.
7. Improvement of financial modeling skills.
8. Learn the impact on valuation accuracy on acquisition decisions.
9. Reflect on the decision to
acquire companies when facing similar valuations, but different risk levels.
Recommended Decision Schedule
The approach is to go from the simple (and quick) to the complex. Valuation and buy/no buy decisions are made each week with a budget of $200 million. The data provided and the complexity of doing DCF and making a buy/no buy decision increases as the simulation progresses. Decisions are made every week and they simulate one year.
Round One. FCF-Based Valuation. Students perform FCFE valuation using information consisting of given FCFs, a growth rate of these FCFs during a planning period and after, and a discount rate. Six firms need to be valued and considered for acquisition.
Round Two. Value Drivers-Based Valuation. Instead of FCFs students preform valuation based on information consisting of profit margins, assets requirements, a discount rate, and sales growth.
Round Three. Accounting-Based Valuation. Value drivers to be used in valuation need to be derived from historical income statements and balance sheets. The cost of capital is given. Valuation and buy/no buy decisions are made on four firms.
Round Four. Accounting-Based Valuation. Regression analysis is used to try to identify fixed and variable costs, and fixed and variable assets to sales. FCFE is still used, but this time the cost of capital needs to be estimated using the CAPM model. A beta for each firm is provided. The market return on which the return of each potentially acquired firm is measured, is given.
Round Five. Accounting-Based Valuation. In addition to FCFE, FCFF valuations are required. WACC needs to be estimated. No fixed and variable costs and assets need to be identified. An element of uncertainty is introduced in the form of a range of possible market returns.
Round Six. Accounting-Based Valuation. In addition to FCFE and FCFF valuation, the comparables method is required. For each firm being valued, metrics on five comparable firms is provided. The market return is still uncertain.
VALUATIONSIM has been developed by Fernando E. Arellano. He holds an MS degree in Finance and a Ph.D. in Economics from Colorado State University. He has also developed FINANSIM - A Corporate Valuation simulation, MANECSIM - A Managerial Economics Simulation and BANKMAN - A Bank management Simulation, the latter, with the late Dr. Richard D. Johnson. Dr. Arellano has taught at Colorado State University while pursuing his doctoral degree (1990-1993), Instituto Tecnologico y de Estudios Superiores de Monterrey in Mexico (1993-1996), at Universidad Peruana de Ciencias Aplicadas and Centrum - Catholic University of Peru, both in Lima Peru (1997-2000), and at University of Dallas in Dallas (2001-2020). He is currently retired, but still teaches a Valuation course online as an adjunct professor for Southeastern Oklahoma State University.