This action might not be possible to undo. Are you sure you want to continue?

Valuation methods

An overview

©2001 M. P. Narayanan

University of Michigan

FIN

Methodologies

3 Comparable multiples s P/E multiple s Market to Book multiple s Price to Revenue multiple s Enterprise value to EBIT multiple 3 Discounted Cash Flow (DCF) s NPV, IRR, or EVA based Methods

x x x

WACC method APV method CF to Equity method

©2001 M. P. Narayanan

University of Michigan

2

s Value of firm = Average Transaction P/E multiple × EPS of firm s Average Transaction multiple is the average multiple of recent transactions (IPO or takeover as the case may be) 3 If valuation is being done to estimate firm value s Value of firm = Average P/E multiple in industry × EPS of firm 3 This method can be used when s firms in the industry are profitable (have positive earnings) s firms in the industry have similar growth (more likely for “mature” industries) s firms in the industry have similar capital structure ©2001 M. Narayanan University of Michigan 3 .FIN Valuation: P/E multiple 3 If valuation is being done for an IPO or a takeover. P.

this method measures the market value of each dollar of equity invested. P. 3 Since the book value of equity is essentially the amount of equity capital invested in the firm. Narayanan University of Michigan 4 . companies which are not in technical default (negative book value of equity) ©2001 M. 3 This method can be used for s s companies in the manufacturing sector which have significant capital requirements.FIN Valuation: Price to book multiple 3 The application of this method is similar to that of the P/E multiple method.

©2001 M. 3 Value from investment activities. that is the value of the business operations (as opposed to the value of the equity). Narayanan University of Michigan 5 . or investment in stocks of other companies. is excluded. 3 The following economic value balance sheet clarifies the notion of enterprise value. 3 In calculating enterprise value.FIN Valuation: Value to EBITDA multiple 3 This multiple measures the enterprise value. only the operational value of the business is included. such as investment in treasury bills or bonds. P.

P.FIN Enterprise Value Economic Value Balance Sheet PV of future cash from business operations Cash Marketable securities $1500 $200 $150 $1850 Debt Equity $650 $1200 $1850 Enterprise Value ©2001 M. Narayanan University of Michigan 6 .

Narayanan University of Michigan 7 . P.3.8.FIN Value to EBITDA multiple: Example following data: s 3 Suppose you wish to value a target company using the Enterprise Value to EBITDA (business operations only) multiple of 5 recent transactions in this industry: 10.5. Sum of long-term and short-term debt held by target = $75 million s s s s s ©2001 M. Recent EBITDA of target company = $20 million Cash in hand of target company = $5 million Marketable securities held by target company = $45 million Interest rate received on marketable securities = 6%. 9.1. 10.2. 9. 10.

Narayanan University of Michigan 8 .98 × 17.3 = $172.65 million 3 Add cash plus marketable securities s 172.5+10. ©2001 M.65 – 75 = $147.2+10.8+9.7 million 3 EBITDA – Interest income from marketable securities s 20 – 2.06 × 45 = $2.65 + 5 + 45 = $222.3 million 3 Estimated enterprise value of the target s 9. P.65 million 3 Subtract debt to find equity value: 222.98 3 Interest income from marketable securities s 0.65 million.3)/5 = 9.7 = $17.FIN Value to EBITDA multiple: Example 3 Average (Value/ EBITDA) of recent transactions s (10.1+9.

3 Gives a measure of cash flows that can be used to support debt payments in leveraged companies.FIN Valuation: Value to EBITDA multiple accounts for different s s 3 Since this method measures enterprise value it capital structures cash and security holdings 3 By evaluating cash flows prior to discretionary capital investments. EBIT is likely to be positive. Narayanan University of Michigan 9 . ©2001 M. this method provides a better estimate of value. P. 3 Appropriate for valuing companies with large debt burden: while earnings might be negative.

in an overvalued market. Narayanan University of Michigan 10 . all of them share they do not accurately reflect the synergies that may be generated in a takeover. They assume that the firm being valued is similar to the median or average firm in the industry. they assume that the market valuations are accurate. They require that firms use uniform accounting practices. we might overvalue the firm under consideration. s s s ©2001 M.FIN Heuristic methods: drawbacks several common disadvantages: s 3 While heuristic methods are simple. For example. P.

FIN Valuation: DCF method technique we used in capital budgeting: s 3 Here we follow the discounted cash flow (DCF) Estimate expected cash flows considering the synergy in a takeover Discount it at the appropriate cost of capital s ©2001 M. P. Narayanan University of Michigan 11 .

©2001 M. Narayanan University of Michigan 12 . P.FIN DCF methods: Starting data 3 Free Cash Flow (FCF) of the firm 3 Cost of debt of firm 3 Cost of equity of firm 3 Target debt ratio (debt to total value) of the firm.

Narayanan University of Michigan 13 . P.FIN Template for Free Cash Flow Working capital Year Revenue Costs Depreciation of equipment Profit/Loss from asset sales Taxable income Tax Net oper proft after tax (NOPAT) Depreciation Profit/Loss from asset sales Operating cash flow Change in working capital Capital Expenditure Salvage of assets Free cash flow 0 1 2 “Income Statement” Noncash item Noncash item Adjustment for for non-cash Capital items ©2001 M.

FIN Template for Free Cash Flow 3 The goal of the template is to estimate cash flows. This is because. working capital. Items are entered with the appropriate sign to avoid confusion. Narayanan University of Michigan 14 . salvage. such as capital expenditures. the cost of debt. etc. 3 The “Income Statement” portion differs from the usual income statement because it ignores interest. 3 Template is made up of three parts. 3 Sign convention: Inflows are positive. is included in the cost of capital and including it in the cash flow would be double counting. P. outflows are negative. not profits. s ©2001 M. An “Income Statement” s Adjustments for non-cash items included in the “Income statement” to calculate taxes s Adjustments for Capital items. interest.

Revenue items Cost items Depreciation items Profit from asset sales 3 Adjustments for non-cash items is to simply add all non-cash items subtracted earlier (e. s s s s 3 There are four categories of items in our “Income Statement”. depreciation) and subtract all noncash items added earlier (e. P. Narayanan .g. Plant. and Equipment (PP&E)) Working capital University of Michigan 15 ©2001 M. or Property. gain from salvage). the last one is likely to be less frequent.g. 3 There are two type of capital items s s Fixed capital (also called Capital Expenditure (Cap-Ex).FIN Template for Free Cash Flow While the first three items occur most of the time.

Salvage the market value property plant and equipment Recover the working capital left in the project (assume full recovery) ©2001 M. P. Narayanan University of Michigan 16 .FIN Template for Free Cash Flow s s 3 It is important to recover both at the end of a finite-lived project.

Costs .Change in working capital . Narayanan University of Michigan 17 .Profit from asset sales Free cash flow = Operating cash flow .Opportunity cost of land + Salvage of land Adjustment of noncash items: Add the noncash items you sub tracted earlier and sub tract the noncash items you added earlier.Capital Expenditure + Salvage of equipment . P.FIN Template for Free Cash Flow Taxab le income = Revenue .Depreciation + Profit from asset sales NOPAT = Taxab le income . ©2001 M.Tax Operating cash flow = NOPAT + Depreciation .

Narayanan University of Michigan 18 . calculate a “Terminal Value”. 3 Since a company is assumed to have infinite life: s s Estimate FCF on a yearly basis for about 5 − 10 years. After that. which is the ongoing value of the firm. or some such multiple ©2001 M. 3 Terminal value is calculated one of two ways: s Estimate a long-term growth and use the constant growth perpetuity model.FIN Estimating Horizon 3 For a finite stream. it is usually either the life of the product or the life of the equipment used to manufacture it. P. s Use a Enterprise value to EBIT multiple.

Narayanan University of Michigan 19 . s Use Gordon-growth model and find expected re.FIN Costs of debt and equity 3 Cost of debt can be approximated by the yield to maturity of the debt. ©2001 M. P. this is the required re. check the bond rating of the company and find the YTM of similar rated bonds. 3 If it is not directly available. Under the assumption that market is efficient. 3 Cost of equity s CAPM x Find β e and calculate required re.

FIN Model of a Firm Value from Operations Value from investments Value generated Enterprise value FIRM DEBT and other liabilities ©2001 M. Narayanan Equal if debt is fairly priced Value to Equity EQUITY University of Michigan 20 . P.

P.Value of debt and other liabilities ©2001 M. Narayanan University of Michigan 21 .FIN 3 Value of equity Value of equity = Enterprise value + Value of cash and investments .

- More on Valuating
- Valuation Methods
- Cash Flow Analysis and Value Added Measures
- 1977
- BASEL 3
- FINAL PDF
- Moody's Ratio definitions.pdf
- Valuation
- 2009 Valuation Handbook a UBS Guide
- Capital Adequacy Final
- Ä¦¸ù¹«Ë¾µÄ¹«Ë¾¹ÀÖµÅàÑµ×ÊÁÏ(Ó¢ÎÄ)
- UT Dallas Syllabus for ba3341.001 06s taught by Mark Laplante (mjl024000)
- Valuation
- Case
- 58638_1980-1984
- Final Review Session SPR12Rป
- 12243_1980-1984
- How to calculate the IRR – a manual
- Final Project Report
- Interview Questions
- CAPITAL Sructure
- 100 Questions in Finance - SSRN-Id1117917
- Capital Structure
- 45037_1980-1984
- 45154_1980-1984
- Discounted Cash Flow Valuation Method
- Valuation Slides (1)
- BER_OSR_111813_6751
- Finance Project
- Crean Bros., Inc. v. Commissioner of Internal Revenue, 195 F.2d 257, 3rd Cir. (1952)

Are you sure?

This action might not be possible to undo. Are you sure you want to continue?

We've moved you to where you read on your other device.

Get the full title to continue

Get the full title to continue reading from where you left off, or restart the preview.

scribd