Equity valuation, production, and financial planning: A stochastic programming approach

Most of the operations management literature assumes that a firm can always finance production decisions at an optimal level or borrow at a constant interest rate; however, operational decisions are constrained by limited capital and often critically depend on external financing. This paper proposes an integrated corporate planning model, which extends the forecasting-based discount dividend pricing method into an optimization-based valuation framework to make production and financial decisions simultaneously for a firm facing marker uncertainty. We also develop an efficient algorithm to solve the resulting integer stochastic programming model with nonlinear constraints. Compared with traditional valuation and planning models, our method yields higher equity valuations, indicating that valuation without considering contingent decisions is inherently inaccurate. (C) 2006 Wiley Periodicals, Inc.