Rational Pricing of Internet Companies Revisited

Abstract

Abstract In this article we expand and improve the Internet company valuation model of Schwartz and Moon (2000) in numerous ways. By using techniques from real options theory and modern capital budgeting, the earlier paper demonstrated that uncertainty about key variables plays a major role in the valuation of high growth Internet companies. Presently, we make the model more realistic by providing for stochastic costs and future financing, and also by including capital expenditures and depreciation in the analysis. Perhaps more importantly, we offer insights into the practical implementation the model. An important challenge to implementing the original model was estimating the various parameters of the model. Here, we improve the procedure by setting the speed of adjustment parameters equal to one another, by tying the implied half‐life of the revenue growth process to analyst forecasts, and by inferring the risk‐adjustment parameter from the observed beta of the company's stock price. We illustrate these extensions in a valuation of the company eBay.