Tercera etapa: Trabajo con la plataforma Khan Academy

The Physical Asset Management (PAM) as a field is far more mature than that of intangible asset management. Not only that, but the valuation methods used on physical assets have undergone many iterations and tests and are well defined for their use scenarios. It is not expected that these methods will fit information valuation perfectly however, certain aspects of the methods discussed below can be used to guide the development of this study’s method. Furthermore, physical asset valuation can help steer information valuation away from methods that have been proven not to work or require specific circumstances to be used accurately.

2.2.1

Net Present Value

The principle behind the Net Present Value (NPV) is determining the future cash flows of an asset to determine its value. Cash flows refer to the income generated by the asset, typically on a monthly or yearly basis. The NVP method starts by first estimating future cash flows and then determining a discount rate (based of inflation) for those cash flows. The NPV is widely used in industry for investment decisions as referenced by Ross (1995), where the NPV is seen as the quick deciding tool by business school graduates. How- ever, for NVP to be used, a good understanding of the future cash flows of the asset is needed.

The Net Present Value is described in Equation (2.2.1) and documented by Hartman and Schafrick (2004). In the following formula; −C0 is the initial

investment, C is the cash flow, r is the discount rate, and lastly T is the time period. NPV = −C0+ T X i+1 Ci (1 + r)i (2.2.1)

There is a flaw with the NPV in that it ignores any flexibility present in real investments, (Myers, 1984), (Pindyck, 1991). Subsequently, Wang (2010) mentions that not only does the NVP method ignore flexibility of investments but, those dynamic features themselves are difficult to impossible to estimate. Thus estimating future cash flows can be problematic and due to the Net Present Value’s reliance on cash flows, this can severely impact the accuracy

of the valuation.

Applying NPV to information valuation also has its flaws, namely; infor- mation rarely produces value in a predictable and regular basis. What is meant by this is that unlike physical assets, it is difficult to determine the future cash flows of information and intangible assets. Moreover, since part of information valuation is to determine what cash flows can be attributed to it, the use of NVP is limited to only after the valuation method has been done.

2.2.2

Decision Trees

Decision trees attempt to model the flexibilities which Net Present Value ig- nores, (Wang, 2010). In fact, the principle behind decision trees is to be able to model these flexibilities to create a more accurate representation of an asset’s value. The decision tree attempts to calculate NPV for the asset for differ- ent future outcomes by varying its discount rate, probabilities and cash flows. These options are determined by the practitioner’s knowledge of the market and asset. This then leads to a maximum and minimum NPV as opposed to the expected NPV allowing for greater strategic decisions.

However, this method is not without fault; as the investment scenario be- comes more complex, the decision tree modelling becomes more complex as well and at a faster rate (Baker and Pound, 1964). This increase in com- plexity geometrically increases the number of decisions and variables for each future outcome modelled by the decision tree (Trigeorgis, 1996). Furthermore, these variables are difficult to estimate, for instance variables such as market demand are not just high or low but are typically somewhere between. Lastly, the variable discount rate across the decision tree also poses difficulty to the practitioner (Trigeorgis, 1996).

Unfortunately, the issues with NPV and information valuation are still present with decision trees; it is difficult to determine the cash flows of infor- mation, especially the probability of them. However, decision trees still act as a useful guide for information valuation. It provides a strategy which can be applied to any single method, highlighting the fact that value isn’t constant and changes over time. Therefore, information valuation should be dynamic to a certain extent, where there is a possibility to re-evaluate the information during its lifecycle to determine its true value to an organization. This princi- ple will be incorporated in the development of the valuation method to some extent in an attempt to capture the dynamic nature of value.

2.2.3

Real Options and Lifecycle Costing

Real options modelling gives the practitioner the ability to reassign capital in future options to create a more accurate picture of future scenarios. These options could include such things as downsizing a project or conversely, ex- panding one. Wang (2010) highlights the fact that real option modelling is a multidisciplinary act. Furthermore, real option modelling layers the invest- ment options of the asset thus splitting up the risks while also producing stages where options are available. These layers or stages can be separated by various parameters associated with the asset, such as net profit or running costs. MacMillan et al. (2006) suggest that the combination of real options and NPV fixes many of its flaws in practice and thus a better valuation can be achieved. The use of NPV in real options is also detailed by Luehrman (1998) and how it affects an organization’s investment opportunity. As with the previous two methods, the use of NPV poses difficult for information valua- tion, and consequently the method cannot be used to its full extent once more. Real options also sees frequent use in lifecycle costing, where the decision to replace an asset could rely on many factors such as maintenance and oper- ational costs. Cole and Sterner (2000) detail how lifecycle costing attempts to determine the cost of an asset during distinct stages of its life. During these different stages of an asset’s life, management would then decide whether or not they should reassign investment or change how the asset is implemented. This directly affect the asset’s value to the organization. Gluch and Baumann (2004) discuss the importance of performance metrics when conducting life- cycle costing on assets. The use of performance metrics is one of the main decision tools used in real options, where the goal is to optimize the Return on Investments (ROI) of the organization. ROI is the amount of value generated for the amount of money invested in an asset or venture.

Real option’s greatest advantage can also be one of its biggest flaws; the ability to model options requires many assumptions. The difficulty of accu- rately representing the available options is also problematic. This method also requires an environment where there are options and is steered more towards long term investments, thus the asset itself needs to poses these qualities. Fur- thermore, how these options are evaluated can change the choices and the “optimal path", such as using Return on Investment. However, there are some attributes of real options that can be incorporated into information valua- tion and that is the use of performance metrics. Performance metrics help organizations evaluate whether or not an investment in an asset is a sound business decision, one of the most widely used performance metrics is ROI. Subsequently the implementation of ROI in the valuation method would be highly beneficial, especially for future development of the method.

2.2.4

Appraisals

Another option is to determine an asset’s value through appraisals that are linked to the current fair market value for the asset. Appraisals are often used during life cycle costing, as noted by Taylor (1981), to determine the best use of an organization’s resources. Appraisals are also widely used in different in- dustries such as for forest assets (Xiang-bin, 2007) and even intangible assets (Foster et al., 2003). However, organizations face certain difficultly when there is no current market for the asset or if the market is too small. It often requires a third party to perform the appraisal to avoid bias when used for financial stating such as for balance sheets.

Foster et al. (2003) notes that the need for the appraisal of intangible assets is linked to recently issued accounting standards. This need highlights one of the greatest benefits of appraisals; that it is a true representation of an assets value. The value received from appraisals directly relates to what others are willing to pay for the asset. Insurance claims often rely on appraisals to deter- mine payouts. Thus when its possible, appraisals give a very practical value to an asset that an organization can then use to make strategic decisions with. Appraisals are not without flaw though as they do not capture the internal value of an asset, that is the value it generates for an organization. Every organization implements and uses assets differently, consequently the assets being used are linked to different cash flows. This results in an asset that could have a substantially lower appraisal value than its internal value. Due to the unique nature of information, any applicable method would have to be able to capture this internal value of an asset.

Clayton et al. (2001) describes another issue with appraisals, the fact that the accuracy of the appraisal is directly linked to which third party does it. An appraisal can be less or more than what the market actually thinks its value is, therefore, special care needs to be taken in who conducts the appraisals. The issue of inaccurate appraisals is echoed by Frentz (2011) who goes on to discuss how the appraisal is linked to the true reporting of certain aspects of the asset being assessed. Subsequently this opens up the method to a certain level of subjectivity, especially by the person conducting the appraisal.

Appraisals are often difficult to do with intangible assets and even more so for information. Without an adequate market to refer to and clear understand- ing of how value is generated by the asset, it is difficult to provide the asset with an accurate value. There are not many lessons that can be learnt from appraisals for information valuation besides the need for a clear definition of an asset’s attributes. Anything that is therefore linked to information’s value should be detailed and considered while using the valuation method.

2.2.5

Liquidation Value

The liquidation value of an asset is the value that an organization can obtain from selling it. This value is often determined at the time the asset is being sold, often favouring the shortest route to the sale of the asset. It is most frequently used during the settling of debt as noted by Galai et al. (2007) and Allen and Gale (2000). This method is highly dependent on the current demand of the asset and consequently there is a high variance in the result. Moraux (2002) describes how companies can make use of this ever changing liquidation value to get the most out of their assets, a technique often used in the banking industry. As with appraisals, the liquidation value does not capture its value to the organization and is often well below. Moraux (2002) details the method in which companies can sell their assets at the point when they will get the most value for it. This point is where the internal value is falling behind that of the liquidation value. Therefore, there is a big discon- nect between the value of an asset to the organization and the value they are able to liquidate it at the present moment in time. There is also the issue of current markets, without a market that is willing to buy the asset, there can be no liquidation value and its contingent on the asset being able to be sold at that price.

The reoccurring problem with these valuation methods thus presents it- self once more; the inability to capture the internal value for an asset, in this case information. This problem once again indicates that the liquidation value is a poor match for use for valuing information. There is also no transfer- able methodology or strategy from the liquidation value that can be used for information valuation.

2.2.6

Replacement Costs

An internal approach to valuation is determining the replacement cost of the asset. For instance, if an asset were to disappear or break down, what costs would the organization incur to replace it. This method requires the replace- ment cost to be calculated at the time of replacement, thus the prices may increase or decrease depending when the calculation is done. The calculated cost is inconsistent and acts as a minimum value of an asset to an organiza- tion. It should also be noted that the replacement cost does not have to be for the same asset but one that performs the same task/function. Sullivan et al. (2002) note that replacement cost is a valuable tool that can be used to help mitigate maintenance and life cycle costs, this view is also shared by Beichelt (2001). This is because replacement cost works on a function basis and is an internal metric, therefore cheaper but functionally equal assets could be used instead of more expensive ones. Replacement cost thus act as a useful measure of value to an organization but not to a market. Another consideration, as

noted by Cheevaprawatdomrong and Smith (2003), is that the replacement of an asset is often linked with a certain performance increase especially when it involves technology. Therefore, the replacement cost as a valuation method can often be inaccurate, since an organization would be valuing the new im- proved asset and not the replaced one.

The replacement cost of an asset is typically higher than that of its liqui- dation value. This is often because the replacement cost, as previously men- tioned, is for a new and/or improved asset while the liquidation value is that of a second hand asset being sold. Whittington (2008) compares the current value of an asset with its current replacement costs, which is identical to the comparison between liquidation value and replacement costs. He described how these two values differ and how the gap between the two increases over time. This is because as replacement costs increase overtime (due to inflation), the liquidation value of an asset decreases. The once again highlights the dy- namic nature of replacement costs, resulting in them often changing.

As was the case with appraisals, there is little that replacement costs can do for the valuation of information. There are cases where an organization can value an intangible asset by how much it costs them to replace it, but this approach is flawed. The main reason being that it is flawed is that there is often no replacement that can be bought or used for the analysis. Note that the replacement cost differs from the cost approach dealt with in section 2.3.2.1.