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a. Discounted Cash-Flow
The income approach employed by Mr. Fuller was the
discounted cash-flow method (DCF). A DCF analysis attempts to
measure value by forecasting a firm's ability to generate cash
and discounting the flows to present value using the firm’s cost
of capital. There are three components to the DCF analysis: (1)
The cash-flow projections over the forecasted period; (2) the
terminal value; and (3) the appropriate discount rate. Using
DCF, a firm's value is calculated as the discounted present value
of the forecasted cash-flow from operations plus the discounted
present value of the terminal value. See Brealey & Myers,
Principles of Corporate Finance 30, 64, G4 (4th ed. 1991).
Before performing his DCF analysis, Mr. Fuller reduced the
operating assets shown on Peoples' balance sheet in order to
project Peoples' free cash-flow from operations (FCF). Mr.
Fuller made these adjustments because he considered Peoples to be
overcapitalized, as measured by its ratio of book equity to
assets. With total equity of $19,918,000 and total assets of
$90,689,000 on the reporting date, Peoples had a book equity-to-
assets ratio of 22 percent.15 In comparison, according to Mr.
15 The pro forma balance sheet prepared by Mr. Fuller as of
May 20, 1993, showed total equity of $20,772,000 and total
assets of $94,948,000, resulting in a similar book equity-
to-assets ratio.
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