CIIF

Working Paper WP no 449 January, 2002 Rev. February, 2007

COMPANY VA UA!ION ME!"O#S$ !"E MOS! COMMON E%%O%S IN VA UA!IONS
Pablo Fernánde

IESE Business School & University of Navarra !vda. Pear"on, 2# $ 0%0&4 'ar(elona, )pain. *el.+ ,-&4. 9& 2/& 42 00 Fa0+ ,-&4. 9& 2/& 4& 4& Ca1ino del Cerro del 2guila, & ,C3ra. de Ca"3illa, k1 /,#%0. $ 2%02& 4adrid, )pain. *el.+ ,-&4. 9# &/7 0% 09 Fa0+ ,-&4. 9# &/7 29 #& Copyrig53 6 2004 I7)7 'u"ine"" )(5ool.
IESE Business School-University of Navarra - 1

*5e CIIF, In3erna3ional Cen3er 8or Finan(ial Re"ear(5, i" an in3erdi"(iplinary (en3er 9i35 an in3erna3ional ou3look and a 8o(u" on 3ea(5ing and re"ear(5 in 8inan(e. I3 9a" (rea3ed a3 35e beginning o8 #992 3o (5annel 35e 8inan(ial re"ear(5 in3ere"3" o8 a 1ul3idi"(iplinary group o8 pro8e""or" a3 I7)7 'u"ine"" )(5ool and 5a" e"3abli"5ed i3"el8 a" a nu(leu" o8 "3udy 9i35in 35e )(5ool:" a(3ivi3ie". *en year" on, our (5ie8 ob;e(3ive" re1ain 35e "a1e+ < Find an"9er" 3o 35e =ue"3ion" 35a3 (on8ron3 35e o9ner" and 1anager" o8 8inan(e (o1panie" and 35e 8inan(ial dire(3or" o8 all kind" o8 (o1panie" in 35e per8or1an(e o8 35eir du3ie". >evelop ne9 3ool" 8or 8inan(ial 1anage1en3. )3udy in dep35 35e (5ange" 35a3 o((ur in 35e 1arke3 and 35eir e88e(3" on 35e 8inan(ial di1en"ion o8 bu"ine"" a(3ivi3y.

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!ll o8 35e"e a(3ivi3ie" are progra11ed and (arried ou3 9i35 35e "uppor3 o8 our "pon"oring (o1panie". !par3 8ro1 providing vi3al 8inan(ial a""i"3an(e, our "pon"or" al"o 5elp 3o de8ine 35e Cen3er:" re"ear(5 pro;e(3", en"uring 35eir pra(3i(al relevan(e. *5e (o1panie" in =ue"3ion, 3o 95i(5 9e rei3era3e our 35ank", are+ !ena, !.*. ?earney, Ca;a 4adrid, Funda(i@n Ra1@n !re(e", Arupo 7nde"a, Royal 'ank o8 )(o3land and Bni@n Feno"a. 533p+CC999.ie"e.eduC(ii8C

IESE Business School-University of Navarra

COMPANY VA UA!ION ME!"O#S$ !"E MOS! COMMON E%%O%S IN VA UA!IONS
Pablo Fernánde D

A'strac t
In 35i" paper, 9e de"(ribe 35e 8our 1ain group" (o1pri"ing 35e 1o"3 9idely u"ed (o1pany valua3ion 1e35od"+ balan(e "5ee3Eba"ed 1e35od", in(o1e "3a3e1en3Eba"ed 1e35od", 1i0ed 1e35od", and (a"5 8lo9 di"(oun3ingEba"ed 1e35od". *5e 1e35od" 35a3 are (on(ep3ually F(orre(3G are 35o"e ba"ed on (a"5 8lo9 di"(oun3ing. We 9ill brie8ly (o11en3 on o35er 1e35od" "in(e E even 35oug5 35ey are (on(ep3ually Fin(orre(3G E 35ey (on3inue 3o be u"ed 8re=uen3ly. We al"o pre"en3 a realEli8e e0a1ple 3o illu"3ra3e 35e valua3ion o8 a (o1pany a" 35e "u1 o8 35e value o8 di88eren3 bu"ine""e", 95i(5 i" u"ually (alled 35e break-up value. We (on(lude 35e paper 9i35 35e 1o"3 (o11on error" in valua3ion"+ a li"3 35a3 (on3ain" 35e 1o"3 (o11on error" 35a3 35e au35or 5a" de3e(3ed in 1ore 35an one 35ou"and valua3ion" 5e 5a" 5ad a((e"" 3o in 5i" (apa(i3y a" bu"ine"" (on"ul3an3 or 3ea(5er.

D Pro8e""or Finan(ial 4anage1en3, Pri(e9a3er5ou"eCooper" C5air o8 Finan(e, I7)7

J7H Cla""i8i(a3ion+ A#2, A&#, 42#

(ey)or*s+ Ialue, Pri(e, Free (a"5 8lo9, 7=ui3y (a"5 8lo9, Capi3al (a"5 8lo9, 'ook value, 4arke3 value, P7R, Aood9ill, Re=uired re3urn 3o e=ui3y, Working (api3al re=uire1en3".

IESE Business School-University of Navarra

.2002. )e(3ion 7 u"e" a realEli8e e0a1ple 3o illu"3ra3e 35e valua3ion o8 a (o1pany a" 35e "u1 o8 35e value o8 di88eren3 bu"ine""e". IESE Business School-University of Navarra .G !(ade1i( Pre"". in(o1e "3a3e1en3Eba"ed 1e35od" .. *5e reader in3ere"3ed in valua3ion u"ing op3ion" 35eory (an "ee Fernánde . *5e 1e35od" 8or valuing (o1panie" (an be (la""i8ied in "i0 group"+ BALANCE INCOME SHEET STATEMENT Book value Multiples Adjusted book PER value Sales Liquidation P/EBITDA value Othe Substantial !ultiples value MAIN VALUATION METHODS MIXED CASH FLOW (GOODWILL) DISCOUNTING Equity ca ! "lassi# "#$% $nion o% Di&i'()' Eu opean A##ountin& F*(( ca ! "#$% E'pe ts Ca+ita# ca ! Abb eviated "#$% in#o!e APV Othe s VALUE CREATION E(A E#ono!i# p o%it "ash value added ")ROI OPTIONS Bla#k and S#holes Invest!ent option E'pand the p oje#t Dela* the invest!ent Alte native uses In 35i" paper.)e(3ion &. 2002. )e(3ion % "5o9" 35e 1e35od" 1o"3 9idely u"ed by analy"3" 8or di88eren3 3ype" o8 indu"3ry. C!. 95i(5 i" u"ually (alled 35e break-up value.. ∗ !no35er ver"ion o8 35i" paper 1ay be 8ound in (5ap3er 2 o8 35e au35orJ" book FIalua3ion 4e35od" and )5are5older Ialue Crea3ion. #& and #4.)e(3ion /.)e(3ion 2. under"3anding 35e 1e(5ani"1" o8 (o1pany valua3ion i" an indi"pen"able re=ui"i3e. *5i" i" no3 only be(au"e o8 35e i1por3an(e o8 valua3ion in a(=ui"i3ion" and 1erger" bu3 al"o be(au"e 35e pro(e"" o8 valuing 35e (o1pany and i3" bu"ine"" uni3" 5elp" iden3i8y "our(e" o8 e(ono1i( value (rea3ion and de"3ru(3ion 9i35in 35e (o1pany.200#(.)e(3ion 4. 1i0ed 1e35od" # ...COMPANY VA UA!ION ME!"O#S$ ∗ !"E MOS! COMMON E%%O%S IN VA UA!IONS For anyone involved in 35e 8ield o8 (orpora3e 8inan(e. 9e 9ill brie8ly de"(ribe 35e 8our 1ain group" (o1pri"ing 35e 1o"3 9idely u"ed (o1pany valua3ion 1e35od". (5ap3er" #. )an >iego. and (a"5 8lo9 di"(oun3ingEba"ed 1e35od" . 7a(5 o8 35e"e group" i" di"(u""ed in a "epara3e "e(3ion+ balan(e "5ee3Eba"ed 1e35od" .. + *5e reader in3ere"3ed in 1e35od" ba"ed on value (rea3ion 1ea"ure" (an "ee Fernánde .

a" 35ey are able 3o (on3inue produ(ing. For 35e "eller. In (o1pany buying and "elling opera3ion"+ For 35e buyer. 35ere8ore.and are (on(ep3ually F(orre(3G. a""e""able a" a 8inan(ial a""e3. are 35o"e ba"ed on (a"5 8lo9 di"(oun3ing. *5e valua3ion o8 "everal (o1panie" i" u"ed 3o de(ide 35e "e(uri3ie" 35a3 35e por38olio "5ould (on(en3ra3e on+ 35o"e 35a3 "ee1 3o i3 3o be undervalued by 35e 1arke3. a (o1pany:" value i" di88eren3 8or di88eren3 buyer" and i3 1ay al"o be di88eren3 8or 35e buyer and 35e "eller. 95en dividing e"3a3e" be39een 5eir" or de(iding divor(e "e33le1en3". Aenerally "peaking. 1a(5inery. u"ing 35e repu3a3ion o8 35e lo(al brand. / . 35e "eller 9ill give a very 5ig5 value 3o i3" 1a3erial re"our(e". ! valua3ion 1ay be u"ed 8or a 9ide range o8 purpo"e"+ #. 95i(5 i" 35e =uan3i3y agreed be39een 35e "eller and 35e buyer in 35e "ale o8 a (o1pany. Ialua3ion" o8 li"3ed (o1panie"+ *5e valua3ion i" u"ed 3o (o1pare 35e value ob3ained 9i35 35e "5are:" pri(e on 35e "3o(k 1arke3 and 3o de(ide 95e35er 3o "ell. In 35i" (a"e. 1$ Value an* Price$ . *5e"e 1e35od" vie9 35e (o1pany a" a (a"5 8lo9 genera3or and. *5e"e are 35e 39o 8igure" 35a3 8a(e ea(5 o35er a(ro"" 35e 3able in a nego3ia3ion un3il a pri(e i" 8inally agreed on.IESE Business School-University of Navarra . 35e 8oreign buyer 9ill only value 35e brand bu3 no3 35e plan3.hat Pur-ose #oes a Valuation Serve. 35e ba"i( ai1 i" 3o de3er1ine 35e 1a0i1u1 value i3 "5ould be prepared 3o pay 8or 95a3 35e (o1pany i3 9i"5e" 3o buy i" able 3o (on3ribu3e. a" i3 5a" 1ore advan(ed a""e3" o8 i3" o9n. 95i(5 i" u"ually "o1e95ere be39een 35e 39o 2 e03re1e". Fro1 35e "eller:" vie9poin3. or di88eren3 per(ep3ion" abou3 35e indu"3ry and 35e (o1pany. 2. Fro1 35e buyer:" vie9poin3. Ko9ever. a large and 3e(5nologi(ally 5ig5ly advan(ed 8oreign (o1pany 9i"5e" 3o buy a 9ellEkno9n na3ional (o1pany in order 3o gain en3ry in3o 35e lo(al 1arke3. 8or e0a1ple. e(ono1ie" o8 "(ope. For e0a1ple. buy or 5old 35e "5are".*5e 1e35od" 35a3 are be(o1ing in(rea"ingly popular . 35e valua3ion 9ill 3ell 5i1 35e 5ig5e"3 pri(e 5e "5ould pay. Ialue "5ould no3 be (on8u"ed 9i35 pri(e. 35e valua3ion 9ill 3ell 5i1 35e lo9e"3 pri(e a3 95i(5 5e "5ould be prepared 3o "ell. *5i" di88eren(e in a "pe(i8i( (o1pany:" value 1ay be due 3o a 1ul3i3ude o8 rea"on". !rbi3ra3ion i" o83en ne(e""ary in li3iga3ion. We 9ill brie8ly (o11en3 on o35er 1e35od" "in(e E even 35oug5 35ey are (on(ep3ually Fin(orre(3G E 35ey (on3inue 3o be u"ed 8re=uen3ly. 2 *5ere i" al"o 35e 1iddle po"i3ion 35a3 (on"ider" bo35 35e buyer:" and "eller:" vie9poin3" and i" repre"en3ed by 35e 8igure o8 35e neu3ral arbi3ra3or. 35e ai1 i" 3o a"(er3ain 95a3 "5ould be 35e 1ini1u1 value a3 95i(5 i3 "5ould a((ep3 35e opera3ion. )e(3ion #2 (on3ain" 35e 1o"3 (o11on error" in valua3ion"+ a li"3 35a3 (on3ain" 35e 1o"3 (o11on error" 35a3 35e au35or 5a" de3e(3ed in 1ore 35an one 35ou"and valua3ion" 5e 5a" 5ad a((e"" 3o in 5i" (apa(i3y a" bu"ine"" (on"ul3an3 or 3ea(5er. e3(. ! (o1pany 1ay al"o 5ave di88eren3 value" 8or di88eren3 buyer" due 3o e(ono1ie" o8 "(ale.

1ilk.u"3ed book value. 5u1an re"our(e" or organi a3ional proble1". li=uida3ion value. *5e"e are 3radi3ionally u"ed 1e35od" 35a3 (on"ider 35a3 a (o1pany:" value lie" ba"i(ally in i3" balan(e "5ee3. Wi35 35i" po"i3ion. %.4 . 5e 1ay buy A7 "5are" and "5or3E"ell !1a on "5are". Publi( o88ering"+ *5e valua3ion i" u"ed 3o . )o1e o8 35e"e 1e35od" are 35e 8ollo9ing+ book value. /. Iden3i8i(a3ion o8 value driver"+ *5e valua3ion o8 a (o1pany or bu"ine"" uni3 i" 8unda1en3al 8or iden3i8ying and "3ra3i8ying 35e 1ain value driver". 4. (on3ra(3". gro9 or abandon. ad. &. )3ra3egi( planning+ *5e valua3ion o8 35e (o1pany and 35e di88eren3 bu"ine"" uni3" i" 8unda1en3al 8or de(iding 95a3 produ(3"Cbu"ine"" line"C(oun3rie"C(u"3o1er"M 3o 1ain3ain. *5ey de3er1ine 35e value 8ro1 a "3a3i( vie9poin3. 5e 9ill gain provided 35a3 A7:" "5are pri(e doe" be33er . )3ra3egi( de(i"ion" on 35e (o1pany:" (on3inued e0i"3en(e+ *5e valua3ion o8 a (o1pany or bu"ine"" uni3 i" a prior "3ep in 35e de(i"ion 3o (on3inue in 35e bu"ine"". 95i(5. - /$ Balance E2uity3 Sheet-Base* Metho*s 0Sharehol*ers1 *5e"e 1e35od" "eek 3o de3er1ine 35e (o1pany:" value by e"3i1a3ing 35e value o8 i3" a""e3". "ell.- *5e valua3ion o8 "everal (o1panie" i" al"o u"ed 3o 1ake (o1pari"on" be39een (o1panie". IESE Business School-University of Navarra . and "ub"3an3ial value. Nei35er do 35ey 3ake in3o a((oun3 o35er 8a(3or" 35a3 al"o a88e(3 35e value "u(5 a"+ 35e indu"3ry:" (urren3 "i3ua3ion. e3(. 35a3 do no3 appear in 35e a((oun3ing "3a3e1en3". L. *5e valua3ion provide" a 1ean" 8or 1ea"uring 35e i1pa(3 o8 35e (o1pany:" po""ible poli(ie" and "3ra3egie" on value (rea3ion and de"3ru(3ion.ri"e" 1ore or 8all" le"". 35ere8ore. 7.u"3i8y 35e pri(e a3 95i(5 35e "5are" are o88ered 3o 35e publi(. Co1pen"a3ion "(5e1e" ba"ed on value (rea3ion+ *5e valua3ion o8 a (o1pany or bu"ine"" uni3 i" 8unda1en3al 8or =uan3i8ying 35e value (rea3ion a33ribu3able 3o 35e e0e(u3ive" being a""e""ed. 1erge. doe" no3 3ake in3o a((oun3 35e (o1pany:" po""ible 8u3ure evolu3ion or 1oney:" 3e1porary value. i8 an inve"3or 35ink" 35a3 35e 8u3ure (our"e o8 A7:" "5are pri(e 9ill be be33er 35an 35a3 o8 !1a on. In5eri3an(e" and 9ill"+ *5e valua3ion i" u"ed 3o (o1pare 35e "5are": value 9i35 35a3 o8 35e o35er a""e3". 35an 35a3 o8 !1a on. gro9 or buy o35er (o1panie". For e0a1ple.

35a3 i".. . O88i(ial 'alan(e )5ee3 . or ne3 9or35. building".!((oun3" re(eivable in(lude" 2 1illion dollar" o8 bad deb3.. 9e 9ill analy e a nu1ber o8 balan(e "5ee3 i3e1" individually in order 3o ad. LIABILITIES A##ounts pa*able Bank debt Lon&/te ! debt Sha eholde s1 equit* Total liabilities -.40 . Con3inuing 9i35 35e e0a1ple o8 *able #.#L0. i" %0 1illion dollar". 5a" a value o8 /2 1illion dollar". 2. I3 (an al"o be (al(ula3ed a" 35e di88eren(e be39een 3o3al a""e3" .e(3 3o a (er3ain degree o8 "ub. . +. +. 0. a83er di"(oun3ing ob"ole3e.&0.e(3ivi3y and di88er 8ro1 F1arke3G (ri3eria. i" 35e value o8 35e "5are5older": e=ui3y "3a3ed in 35e balan(e "5ee3 . %0 1illion dollar". 9i35 35e re"ul3 35a3 35e book value al1o"3 never 1a3(5e" 35e F1arke3G value.IESE Business School-University of Navarra . /$/$ A*6uste* Boo5 Value *5i" 1e35od "eek" 3o over(o1e 35e "5or3(o1ing" 35a3 appear 95en purely a((oun3ing (ri3eria are applied in 35e valua3ion. W5en 35e value" o8 a""e3" and liabili3ie" 1a3(5 35eir 1arke3 value. +3.#0 .land.*5e book value o8 a((oun3" payable.u"3 35e1 3o 35eir appro0i1a3e 1arke3 value./$1$ Value Boo5 ! (o1pany:" book value. i8 9e (on"ider 35a3+ . 35e "urplu" o8 35e (o1pany:" 3o3al good" and rig53" over i3" 3o3al deb3" 9i35 35ird par3ie".(api3al and re"erve". +3. 35a3 i".u"3ed ne3 9or35 i" ob3ained. !a'le 1 !l8a In(. 9or35le"" i3e1" and revaluing 35e re1aining i3e1" a3 35eir 1arke3 value.(api3al plu" re"erve". 7 . He3 u" 3ake 35e (a"e o8 a 5ypo35e3i(al (o1pany 95o"e balan(e "5ee3 i" 35a3 "5o9n in *able #. *5i" value "u88er" 8ro1 35e "5or3(o1ing o8 i3" o9n de8ini3ion (ri3erion+ a((oun3ing (ri3eria are "ub. *5e ad. ASSETS "ash A##ounts e#eivable Invento ies )i'ed assets Total assets .4illion >ollar". *5e "5are": book value . and liabili3ie" . 5ave a value o8 #/0 1illion dollar". -. 35e ad.u"3ed balan(e "5ee3 9ould be 35a3 "5o9n in *able 2. . bank deb3 and longE3er1 deb3 i" e=ual 3o 35eir 1arke3 value. 35i" i3e1 "5ould 5ave a value o8 % 1illion dollar".)3o(k. and 1a(5inery. a((ording 3o an e0per3. For e0a1ple.Fi0ed a""e3" .. +. *5i" =uan3i3y i" al"o 35e di88eren(e be39een 3o3al a""e3" and liabili3ie".

35i" 1e35od:" u"e8ulne"" i" li1i3ed 3o a 5ig5ly "pe(i8i( "i3ua3ion.!a'le / !l8a In(.4 +.8 .unu"ed land. le"" liabili3ie" .2#/. Ko9ever. *5e ad.#&/EL0.. 35e "ub"3an3ial value doe" no3 in(lude 35o"e a""e3" 35a3 are no3 u"ed 8or 35e (o1pany:" opera3ion" . 2 . /$4$ i2ui*ation Value *5i" i" 35e (o1pany:" value i8 i3 i" li=uida3ed. 35e "5are": li=uida3ion value 9ould be 7/ 1illion dollar" .Ne3 "ub"3an3ial value or (orre(3ed ne3 a""e3"+ 35i" i" 35e gro"" "ub"3an3ial value le"" liabili3ie". +0. i3 al9ay" repre"en3" 35e (o1pany:" 1ini1u1 value a" a (o1pany:" value.. *aking 35e e0a1ple given in *able 2. Nor1ally. 95en 35e (o1pany i" boug53 9i35 35e purpo"e o8 li=uida3ing i3 a3 a la3er da3e. . 5olding" in o35er (o1panie". 35a3 i".u"3ed book value e0(eed" 35e book value by // 1illion dollar". IESE Business School-University of Navarra . 4+. a" oppo"ed 3o 35eir li=uida3ion value. na1ely.4illion >ollar". 3a0 e0pen"e" and o35er 3ypi(al li=uida3ion e0pen"e".in 35e e0a1ple o8 *able 2+ #&/.redundan(y pay1en3" 3o e1ployee". 8ro1 35e ad. 4+. I3 (an al"o be de8ined a" 35e a""e3": repla(e1en3 value... a""u1ing 35e (o1pany (on3inue" 3o opera3e. a""u1ing i3 (on3inue" 3o opera3e. e3(. In 35i" (a"e. *5i" value i" (al(ula3ed by dedu(3ing 35e bu"ine"":" li=uida3ion e0pen"e" . i3" a""e3" are "old and i3" deb3" are paid o88.. 35e ad.u"3ed ne3 9or35. ASSETS "ash A##ounts e#eivable Invento ies )i'ed assets Total assets . 0. i" grea3er 35an i3" li=uida3ion value.u"3ed 'alan(e )5ee3 .Aro"" "ub"3an3ial value+ 35i" i" 35e a""e3": value a3 1arke3 pri(e .. I3 i" al"o kno9n a" ad.%0. 95i(5 9e 5ave already "een in 35e previou" "e(3ion .u"3ed book value i" #&/ 1illion dollar"+ 3o3al a""e3" . LIABILITIES A##ounts pa*able Bank debt Lon&/te ! debt "apital and ese ves Total liabilities -. +. /$7$ Value Su'stantial *5e "ub"3an3ial value repre"en3" 35e inve"31en3 35a3 1u"3 be 1ade 3o 8or1 a (o1pany 5aving iden3i(al (ondi3ion" a" 35o"e o8 35e (o1pany being valued. 9ere 3o a1oun3 3o L0 1illion dollar".u"3ed ne3 9or35. !d.in 35e e0a1ple o8 *able 2+ 2#/. i8 35e redundan(y pay1en3" and o35er e0pen"e" a""o(ia3ed 9i35 35e li=uida3ion o8 35e (o1pany !l8a In(. *5ree 3ype" o8 "ub"3an3ial value are u"ually de8ined+ .. Obviou"ly.

ra3io o8 "everal in3erna3ional "3o(k 1arke3" in )ep3e1ber #992..?< Price . Aer1an and Bni3ed )3a3e" )3o(k 41arke3" L / 4 & 2 # 0 1.4 +. . 054 +.>< 1. 95i(5 "5o9" 35e pri(eCbook value . 454 +522 +350 ..<8 1.6 +057 -5+ +537 +-5+ 057 +5+0 +. 4-5.. I3 (an be "een 35a3 35e book value. in 35e 90:". P/BV PER 0502 4456 0547 0+56 -53.PC'I. +57 45+53 054 +5+ +5. !ugu"3 2000 and February 2007. +5. 350 +50.. 450 45+ 45. +. . +573 2545.?8 1. !a'le 4 4arke3 IalueC'ook Ialue . P7R i" 35e "5are:" pri(e divided by 35e earning" per "5are..>8 1.6 425.apan S<it=e land $: $S PC'I i" 35e "5are:" pri(e . 0657 05.5. 445+ 457.in 35e e0a1ple o8 *able 2+ #7/ P 2#/ E 40. o8 >i88eren3 Na3ional )3o(k 4arke3" S(+t(42(* 566P/BV PER Di&0/P (1) .'I.>4 1.>= 1. Di&0/P (1) 457 454 45. )3anley Capi3al In3erna3ional Per"pe(3ive and Figure # "5o9" 35e evolu3ion o8 35e pri(eCbook value ra3io o8 35e 'ri3i"5..3 P/BV PER 052 4. . 457 +56 Spain "anada ) an#e 8e !an* 9on& :on& I eland Ital* .562 +354 -5+ +524 0354 +5.Redu(ed gro"" "ub"3an3ial value+ 35i" i" 35e gro"" "ub"3an3ial value redu(ed only by 35e value o8 35e (o"3E8ree deb3 .PC'I. *5e re1aining 40 1illion dollar" (orre"pond 3o a((oun3" payable.54 0524052 4544 2653 -5-. .54 4543 4050 05+ Au. +-5. 056 +5.<< 1.?4 1. *5i" (an be "een in *able &. Boo5 value Aer1any B? B) )our(e+ 4organ )3anley and >a3a"3rea1.5. /$8$ Boo5 Value an* Mar5et Value In general.== 1.?1 1. 9i:ure 1 7volu3ion o8 35e Pri(eC'ook Ialue Ra3io on 35e 'ri3i"5..57 +56 45.=4 1.65+ 054 +5-. +-5054 +25. 05. divided by i3" book value .>iv. 5a" lagged (on"iderably belo9 35e "5are": 1arke3 pri(e.P.u t -. 054 .CP. +.54 454 +6545+657 450 4254 050 +65. 35e e=ui3y:" book value 5a" li33le bearing 3o i3" 1arke3 value..<= 1.53 +545+ +5+ F(2*ua*y -.=1 1.527 65.=8 1. Aer1an and Bni3ed )3a3e" "3o(k 1arke3".547 475Di&0/P (1) +5.>1 1. >ivCP i" 35e dividend per "5are divided by 35e pri(e.52 453 +3545+-5. P7R and >ividend Qield .=< 1. )our(e+ 4organ >a3a"3rea1.5. 45.

IESE Business School-University of Navarra .@ .

9i35 a purely a((oun3ing i3e1 . o8 a "5are indi(a3e" 35e 1ul3iple o8 35e earning" per "5are 35a3 i" paid on 35e "3o(k 1arke3. In(o1e )3a3e1en3 . -. *5u".pri(e earning" ra3io. in 1e3ri( 3on" by a ra3io . *5ey "eek 3o de3er1ine 35e (o1pany:" value 35roug5 35e "i e o8 i3" earning"..< .2LC&.. *5e P7R i" 35e ben(51ark u"ed predo1inan3ly by 35e "3o(k 1arke3". +43 4$1$ Value of Earnin:s$ PE%4 !((ording 3o 35i" 1e35od. "ale" or o35er indi(a3or". I3 i" al"o (o11on 3o value (ar parking lo3" by 1ul3iplying 35e nu1ber o8 parking "pa(e" by a 1ul3iple and 3o value in"uran(e (o1panie" by 1ul3iplying annual pre1iu1" by a 1ul3iple. i3" P7R 9ill be %. & *5e P7R . *5i" (a3egory in(lude" 35e 1e35od" ba"ed on 35e P7R+ a((ording 3o 35i" 1e35od. 35e e=ui3y:" value i" ob3ained by 1ul3iplying 35e annual ne3 in(o1e by a ra3io (alled P7R .?@ Aet in#o!e 0. i3 i" a (o11on pra(3i(e 3o per8or1 =ui(k valua3ion" o8 (e1en3 (o1panie" by 1ul3iplying 35eir annual produ(3ion (apa(i3y . On o35er o((a"ion".LL . IESE Business School-University of Navarra .or "ale". 8or e0a1ple. or 35e 1ean earning" per "5are 8or 35e la"3 8e9 year". i" "5o9n in *able 4+ !a'le 7 !l8a In(. 35a3 i"+ 7=ui3y value P P7R 0 earning" *able & "5o9" 35e 1ean P7R o8 a nu1ber o8 di88eren3 na3ional "3o(k 1arke3" in )ep3e1ber #992 and !ugu"3 2000.1ul3iple. +03 +4. *5u".."5are pri(e. 35e "5are": pri(e i" a 1ul3iple o8 35e earning". 35e"e 1e35od" are ba"ed on 35e (o1pany:" in(o1e "3a3e1en3. *5e in(o1e "3a3e1en3 8or 35e (o1pany !l8a In(. i8 35e earning" per "5are in 35e la"3 year 5a" been R& and 35e "5are:" pri(e i" R2L.4illion >ollar".. Sales "ost o% sales 8ene al e'penses Inte est e'pense Ea nin&s be%o e ta' Ta' >0. 35e P7R 3ake" a" i3" re8eren(e 35e 8ore(a"3 earning" per "5are 8or 35e ne03 year. Figure 2 "5o9" 35e evolu3ion o8 35e P7R 8or 35e Aer1an.. 7ngli"5 and Bni3ed )3a3e" "3o(k 1arke3". No3e 35a3 35e P7R i" a para1e3er 35a3 rela3e" a 1arke3 i3e1 .price earnings ratio.earning".4$ IncoAe Metho*s StateAent-Base* Bnlike 35e balan(e "5ee3Eba"ed 1e35od".

+/76 +/77 +/. 35e "5are": pri(e 8all" by an a1oun3 appro0i1a3ely e=ual 3o 35e rig53": value. . I8.. +/. +. Ko9ever. 95en (api3al in(rea"e" 3ake pla(e 35a3 give ri"e 3o "ub"(rip3ion rig53". > . )o1e re(o11endable 3e03" are 3o be 8ound in )oren"en and Willia1"on . / 4 O35er 8lo9" are "5are buyEba(k" and "ub"(rip3ion rig53". +/66 +/67 +/2+ +/20 +/2.0 +/. 7ngli"5 and Bni3ed )3a3e" )3o(k 4arke3" 0. !((ording 3o 35i" 1e35od.#9%L. 0. a (o1pany 8ro1 95i(5 9e e0pe(3 (on"3an3 dividend" every year. 35e relative PE% i" al"o u"ed.+ +/. / *5ere i" an enor1ou" and 5ig5ly varied li3era3ure abou3 35e i1pa(3 o8 dividend poli(ie" on e=ui3y value.?e E g. 4$/$ Value of the #ivi*en*s >ividend" are 35e par3 o8 35e earning" e88e(3ively paid ou3 3o 35e "5are5older and. nor1ally i3 redu(e" i3" gro935 be(au"e i3 di"3ribu3e" 35e 1oney 3o i3" "5are5older" in"3ead o8 plo9ing i3 ba(k in3o ne9 inve"31en3". +/26 +/27 +/7+ +/70 +/7. +/6+ +/60 +/6.9i:ure / 7volu3ion o8 35e P7R o8 35e Aer1an.. 35e dividend i" e0pe(3ed 3o gro9 inde8ini3ely a3 a (on"3an3 annual ra3e g. +. PER 8e !an* $: $S )o1e3i1e". 35e above 8or1ula be(o1e" 35e 8ollo9ing+ 7=ui3y value P >P)# C . do no3 ob3ain a gro935 in 35eir "5are pri(e a" a re"ul3. 4. . W5ere >P)# i" 35e dividend" per "5are 8or 35e ne03 year. on 35e o35er 5and.6 )our(e+ 4organ )3anley and >a3a"3rea1. in 1o"3 (a"e". and 4iller . 35i" value (an be e0pre""ed a" 8ollo9"+ 7=ui3y value P >P) C ?e W5ere+ >P) P dividend per "5are di"3ribu3ed by 35e (o1pany in 35e la"3 yearS ?e P re=uired re3urn 3o e=ui3y.a" a per(en3age o8 35eir earning". 35a3 i". 95i(5 i" "i1ply 35e (o1pany:" P7R divided by 35e (oun3ry:" P7R.#9%/.IESE Business School-University of Navarra . 71piri(al eviden(e "5o9" 35a3 35e (o1panie" 35a3 pay 1ore dividend" . 4 are 35e only regular 8lo9 re(eived by "5are5older". 4. In 35e perpe3ui3y (a"e. a "5are:" value i" 35e ne3 pre"en3 value o8 35e dividend" 35a3 9e e0pe(3 3o ob3ain 8ro1 i3. *5i" i" be(au"e 95en a (o1pany di"3ribu3e" 1ore dividend".

B0? 03B0? +4B-? 00B2? +-B0? 40B2? +4B4? +4B0? 7B. !ugu"3 2000 and February 2007. )1i35 'arney analy ed 35e rela3ion"5ip be39een 35e pri(eC"ale" ra3io and 35e re3urn on e=ui3y.in dollar". Japane"e and Bni3ed )3a3e" "3o(k 1arke3". depending on 35e 1arke3 "i3ua3ion. in 22 (oun3rie". *5e "3udy 9a" (arried ou3 in large (orpora3ion" ./T.G*$u+ 7 G*$u+ 8 G*$u+ 9 De#e!be 2-/De#e!be 27 De#e!be 27/Septe!be 76 )our(e+ )1i35 'arney.0 +/. Japan 9a" 35e (oun3ry 9i35 35e lo9e"3 dividend yield . +/76 +/77 +/.Figure & "5o9" 35e evolu3ion o8 35e dividend yield o8 35e Aer1an.(api3ali a3ion in e0(e"" o8 #/0 1illion dollar". I3 i" al"o a (o11on pra(3i(e 3o value a "o83 drink bo33ling plan3 by 1ul3iplying i3" annual "ale" in li3er" by /00 or ano35er nu1ber. 4$4$ Sales Multi-les *5i" valua3ion 1e35od.apan $SA *able & "5o9" 35e dividend yield o8 "everal in3erna3ional "3o(k 1arke3" in )ep3e1ber #992. Di&i'()' yi(#' 8e !an* . 9i:ure 4 7volu3ion o8 35e >ividend Qield o8 35e Aer1an. depending on 35e 1arke3 "i3ua3ion. +/66 +/67 +/2+ +/20 +/2. a p5ar1a(y i" o83en valued by 1ul3iplying i3" annual "ale" . In order 3o analy e 35i" 1e35od:" (on"i"3en(y. and )pain 5ad a dividend yield o8 #.. +/. by 2 or ano35er nu1ber.6 )our(e+ 4organ )3anley and >a3a"3rea1.? IESE Business School-University of Navarra . 0 4 + . Ke divided 35e (o1panie" in3o 8ive group" depending on 35eir pri(eC"ale" ra3io+ group # (on"i"3ed o8 35e (o1panie" 9i35 35e lo9e"3 ra3io.0. *5e 1ean re3urn o8 ea(5 group o8 (o1panie" i" "5o9n in 35e 8ollo9ing 3able+ !a'le 8 Rela3ion"5ip 'e39een Re3urn and 35e Pri(eC)ale" Ra3io G*$u+ 5 G*$u+ . For e0a1ple.= . +/26 +/27 +/7+ +/70 +/7. and group / (on3ained 35e (o1panie" 9i35 35e 5ig5e"3 pri(eC"ale" ra3io. (on"i"3" o8 (al(ula3ing a (o1pany:" value by 1ul3iplying i3" "ale" by a nu1ber.LT. +/6+ +/60 +/6.+ +/. Japane"e and Bni3ed )3a3e" )3o(k 4arke3" 6 (1) 3 . In 2000. 02B4? +. 95i(5 i" u"ed in "o1e indu"3rie" 9i35 a (er3ain 8re=uen(y.

. W5en I a"ked 5i1 5o9 5e 5ad arrived a3 35a3 8igure.L%. )ee Fernánde . *5e pri(eC"ale" ra3io (an be broken do9n in3o a 8ur35er 39o ra3io"+ Price..sales3 *5e 8ir"3 ra3io . 3a0e".earning"C"ale". *5e 1ul3iple" 1o"3 (o11only u"ed 3o value In3erne3 (o1panie" % Pri(eC"ub"(riber.pri(eCearning".Ialue o8 35e (o1pany C earning" be8ore in3ere"3. one o8 35e bro35er" 3old 1e 35a3 5e re(koned 35a3 35e "5are" 9ere 9or35 abou3 &0 1illion euro".. i" nor1ally kno9n a" re3urn on "ale".( 6-B.BTi ca#i . One e0a1ple o8 "u(5 ra3io" i" 35e valueCo9ner. A&(*a. In 35e ini3ial "3age" o8 a valua3ion 35a3 I 9a" (o11i""ioned 3o per8or1 by a 8a1ily bu"ine"" 35a3 9a" on "ale. L Obviou"ly. 35e e=ui3y o8 35e (o1panie" 9i35 35e lo9e"3 pri(eC"ale" ra3io in >e(e1ber #9%4 on average provided a 5ig5er re3urn 35an 35a3 o8 35e (o1panie" 9i35 a 5ig5er ra3io.B3 F*(()(t0'( +. 6 For a 1ore de3ailed di"(u""ion o8 35e 1ul3iple" 1e35od.Ialue o8 35e e=ui3y C book value. FWe are 35ree "5are5older "ibling" and I 9an3 ea(5 one o8 u" 3o ge3 #0 1illionG.IESE Business School-University of Navarra . depre(ia3ion and a1or3i a3ion . !pplying 35e 1ean ra3io ..Ialue o8 35e (o1pany C earning" be8ore in3ere"3 and 3a0e" . . a Fren(5 bank publi"5ed i3" valua3ion o8 *erra ba"ed on 35e pri(eC"ale" ra3io o8 (o1parable (o1panie"+ P i#e/Sales F*(( (*&( ++.Ialue o8 35e (o1pany C opera3ing (a"5 8lo9. 1ul3iple" o8 (o1parable (o1panie" 7 1u"3 be u"ed. during 35e period >e(e1ber %4E>e(e1ber %9..2 dollar" per "5are. 35i" (ea"ed 3o apply during 35e period >e(e1ber %9E)ep3e1ber 97+ 35ere 9a" no rela3ion"5ip be39een 35e pri(eC"ale" ra3io in >e(e1ber #9%9 and 35e re3urn on e=ui3y during 35o"e year". 4$7$ Other Multi-les In addi3ion 3o 35e P7R and 35e pri(eC"ale" ra3io.7'I*. In 4ar(5 2000. Pri(eCpage" vi"i3ed and Pri(eCin5abi3an3. in order 3o value a (o1pany u"ing 1ul3iple". 5e an"9ered.200#b. 35ey e"3i1a3ed 35e value o8 *erra:" en3ire e=ui3y 3o be #9.#0/ billion dollar" .sales B 0-rice.earnin:s3 C 0earnin:s... 3 We (ould al"o li"3 a nu1ber o8 o35er ra3io" 95i(5 9e (ould (all F"uiEgeneri"G.I3 (an be "een 8ro1 35i" 3able 35a3.7B+ I)"$ $u*c( 4+B.. % 1? .200#a. "o1e o8 35e 8re=uen3ly u"ed 1ul3iple" are+ .7'I*>!. 4$8$ Multi-les CoA-anies Use* to Value Internet are Pri(eC"ale". i" 35e P7R and 35e "e(ond . 3o *erra:" e0pe(3ed "ale" 8or 200# . .&#0 1illion dollar". Ko9ever. "ee Fernánde .74.

& 0 2L. e3(. 95ile 35e "e(ond i" (o11only u"ed 8or 35e re3ail 3rade. *5e 8ir"3 8or1ula i" 1ainly u"ed 8or indu"3rial (o1panie".. 35e"e 1e35od" "eek 3o de3er1ine 35e (o1pany:" value by e"3i1a3ing 35e (o1bined value o8 i3" a""e3" plu" a (api3al gain re"ul3ing 8ro1 35e value o8 i3" 8u3ure earning"+ 35ey "3ar3 by valuing 35e (o1pany:" a""e3" and 35en add a =uan3i3y rela3ed 9i35 8u3ure earning".11 . *5e reader (an "kip dire(3ly 3o )e(3ion /. 'a"i(ally. 9 *5e au35or 8eel" du3y bound 3o 3ell 35e reader 35a3 5e doe" no3 like 35e"e 1e35od" a3 all bu3 a" 35ey 5ave been u"ed a lo3 in 35e pa"3. 7$1$ !he EClassicF Valuation Metho* *5i" 1e35od "3a3e" 35a3 a (o1pany:" value i" e=ual 3o 35e value o8 i3" ne3 a""e3" .. 35e good9ill i" valued a" n 3i1e" 35e (o1pany:" ne3 in(o1e. brand". ! varian3 o8 35i" 1e35od (on"i"3" o8 u"ing 35e (a"5 8lo9 in"3ead o8 35e ne3 in(o1e.n 0 '. !((ording 3o 35i" 1e35od. 95i(5 o83en do no3 appear on 35e balan(e "5ee3 bu3 95i(5. a" 35ere i" no (on"en"u" regarding 35e 1e35odology u"ed 3o (al(ula3e i3. IESE Business School-University of Navarra . a""u1ing 35a3 35e good9ill i" e"3i1a3ed a3 35ree 3i1e" 35e annual earning". )o1e o8 35e 1e35od" u"ed 3o value 35e good9ill give ri"e 3o 35e variou" valua3ion pro(edure" de"(ribed in 35i" "e(3ion.u"3ed book value. a brie8 de"(rip3ion o8 "o1e o8 35e1 i" in(luded. or a" a (er3ain per(en3age o8 35e 3urnover..=uali3y o8 35e (u"3o1er por38olio. 5e "5ould no3 look 8or 1u(5 F"(ien(eG in 35e 1e35od" 35a3 8ollo9 be(au"e 35ey are very arbi3rary. and 35ey are "3ill u"ed 8ro1 3i1e 3o 3i1e. plu" 35e value o8 i3" good9ill... indu"3ry leader"5ip.. i3 9ould give a value 8or 35e (o1pany:" e=ui3y a1oun3ing 3o 2#& 1illion dollar" . 9e 9ill no3 1en3ion 35e1 again in 35e re"3 o8 35e book. W5en 35e 8ir"3 1e35od i" applied 3o 35e 5ypo35e3i(al (o1pany !l8a In(. P per(en3age W5ere+ ! P ne3 a""e3 valueS n P (oe88i(ien3 be39een #. 0 F. Ko9ever. (on3ribu3e an advan3age 9i35 re"pe(3 3o o35er (o1panie" opera3ing in 35e indu"3ry ./ and &S ' P ne3 in(o1eS o8 "ale" revenueS and F P 3urnover.7$ Doo*)ill-Base* Metho*s= Aenerally "peaking. *5e"e 1e35od" apply a 1i0ed approa(5+ on 35e one 5and. on 35e o35er 5and. good9ill i" 35e value 35a3 a (o1pany 5a" above i3" book value or above 35e ad. Aood9ill "eek" 3o repre"en3 35e value o8 35e (o1pany:" in3angible a""e3". In 3urn.#&/ . i8 5e (on3inue" 3o read 35i" "e(3ion. 35ey per8or1 a "3a3i( valua3ion o8 35e (o1pany:" a""e3" and. *5e proble1 ari"e" 95en one 3rie" 3o de3er1ine i3" value.. "3ra3egi( allian(e". 5o9ever.ne3 "ub"3an3ial value. 35ey 3ry 3o =uan3i8y 35e value 35a3 35e (o1pany 9ill genera3e in 35e 8u3ure. or I P ! . Ko9ever. 35e 8or1ula 35a3 e0pre""e" a (o1pany:" value i"+ I P ! .

u"ing 35e 8a(3or an.' E iI.&/2. W5ere+ ! P (orre(3ed ne3 a""e3" or ne3 "ub"3an3ial value.&/2..W C .7$/$ !he SiA-lifie* GA''reviate* Doo*)ill IncoAeG Metho* or the SiA-lifie* UEC1? Metho* !((ording 3o 35i" 1e35od. *5i" (al(ula3ed by (api3ali ing a3 (o1pound in3ere"3 .' good9ill. a (o1pany:" 3o3al value i" e=ual 3o 35e "ub"3an3ial value . o8 n annui3ie". 95i(5.9 P #7L. in 35i" (a"e. +. In 35e (a"e o8 35e (o1pany !l8a In(. a "uperpro8i3 95i(5 i" 35e pro8i3 le"" 35e 8lo9 ob3ained by inve"3ing a3 a ri"kE8ree ra3e i a (api3al e=ual 3o 35e (o1pany:" value I.&/2.a83er 3a0. 35e e=ui3y:" value 9ould be+ .# 0 &. or 35e re3urn on real e"3a3e inve"31en3" .# .#&/ . P #&/ . 35e re3urn on e=ui3ie"..&/2 . *5e di88eren(e be39een 35i" 1e35od and 35e previou" 1e35od lie" in 35e value o8 35e good9ill. In 35e (a"e o8 35e (o1pany !l8a In(.# C #.. B7C+ *5i" i" 35e a(rony1 o8 FBnion o8 7uropean !((oun3ing 70per3"G. a U"uperpro8i3U 35a3 i" e=ual 3o 35e di88eren(e be39een 35e ne3 in(o1e and 35e inve"31en3 o8 35e ne3 a""e3" F!G a3 an in3ere"3 ra3e FiG (orre"ponding 3o 35e ri"kE8ree ra3e.an . 9i35 n be39een / and % year". 35e e=ui3y:" value 9ould be+ #&/ . *5e value o8 35e good9ill i" ob3ained by (api3ali ing.' E i!. an P pre"en3 value.% 1illion dollar". ' P 2LS ! P #&/.&. He3 u" al"o a""u1e 35a3 i P #0T. 95ile in 35e "i1pli8ied 1e35od.&/2 0 2L. a (o1pany:" value i" e0pre""ed by 35e 8ollo9ing 8or1ula+ I P ! . C . an . by appli(a3ion o8 a (oe88i(ien3 an. an P &.or revalued ne3 a""e3". 95i(5 (ould be deben3ure". For 35e B7C. P 222. He3 u" a""u1e 35a3 / year" and #/T are u"ed in 35e (al(ula3ion o8 an.2L E 0. 1/ .IESE Business School-University of Navarra .&. i" (al(ula3ed 8ro1 35e value I 9e are looking 8or. giving+ I P V! .# .an .an 0 '. a3 a ra3e 3.9 1illion dollar".ian. P *5i" 8or1ula (ould be e0plained in 35e 8ollo9ing 1anner+ 35e (o1pany:" value i" 35e value o8 i3" ad. plu" 35e good9ill. i3 9a" (al(ula3ed 8ro1 35e ne3 a""e3" !. 7$4$ Union of Euro-ean Accountin: EC-erts 0UEC3 Metho* *5e (o1pany:" value a((ording 3o 35i" 1e35od i" ob3ained 8ro1 35e 8ollo9ing e=ua3ion+ I P ! .0. i P in3ere"3 ra3e ob3ained by an al3erna3ive pla(e1en3. i P #0T..4#. Wi35 35e"e a""u1p3ion". 95i(5 9ould give an P &.u"3ed ne3 9or35 plu" 35e value o8 35e good9ill.&&/2 P #LL. E i!. ' P ne3 in(o1e 8or 35e previou" year or 35a3 8ore(a"3 8or 35e (o1ing year. ' P 2LS ! P #&/. Wi35 35i" 5ypo35e"i".# 0 #&/.

*5i" 1e35od 5a" a large nu1ber o8 varian3" 35a3 are ob3ained by giving di88eren3 9eig53" 3o 35e "ub"3an3ial value and 35e earning": (api3ali a3ion value. Wi35 35e"e a""u1p3ion". *5e nu1ber o8 year" .! . !" (an be "een in 35e 8ir"3 e0pre""ion../ 1illion dollar".1 . Kere. ' P 2LS ! P #&/.i. C .. C 31 *5i" 1e35od:" 8or1ula i" 35e 8ollo9ing+ In 35i" (a"e. a (o1pany:" value i" e=ual 3o 35e ne3 a""e3" in(rea"ed by 35e re"3a3ed "uperpro8i3. In 35e (a"e o8 35e (o1pany !l8a In(./ 3o ad.' E i!. He3 u" a""u1e 35a3 31 P #/T. !((ording 3o 35i" 1e35od. 35e 8ollo9ing valua3ion 8or1ula i" u"ed+ I P ! .' E i!. ' P 2LS ! P #&/.C2..14 . *5i" "uperpro8i3 i" 35e di88eren(e be39een 35e ne3 in(o1e and 95a3 9ould be ob3ained 8ro1 pla(ing a3 35e in3ere"3 ra3e i.C2i *5e ra3e i u"ed i" nor1ally 35e in3ere"3 ra3e paid on longE3er1 *rea"ury bond". 35e value o8 35e good9ill i" e=ual 3o a (er3ain nu1ber o8 year" o8 "uperpro8i3". ri"kE8ree pla(e1en3S 35e ra3e 3 i" 35e ri"kEbearing ra3e u"ed 3o re"3a3e 35e "uperpro8i3 and i" e=ual 3o 35e ra3e i in(rea"ed by a ri"k ra3io. 35e 8or1ula i" a varian3 o8 35e B7C:" 1e35od 95en 35e nu1ber o8 year" 3end" 3o9ard" in8ini3y. i" 35e in3ere"3 ra3e 8or longE3er1 loan". In 35e (a"e o8 35e (o1pany !l8a In(. 95i(5 (an al"o be e0pre""ed a" I P ! . nor1ally u"ed range" be39een & and /.2/ and #.' E iI..1. In 35e (a"e o8 35e (o1pany !l8a In(. 35e e=ui3y:" value 9ould be 2#%. 7$<$ %is5-Bearin: an* %is5-9ree %ate Metho* *5i" 1e35od de3er1ine" a (o1pany:" value u"ing 35e 8ollo9ing e0pre""ion+ I P ! ."ub"3an3ial value. i P #0T./ 1illion dollar". 35i" 1e35od give" e=ual 9eig53 3o 35e value o8 35e ne3 a""e3" .u"3 8or 35e ri"k.7$7$ In*irect Metho* *5e 8or1ula 8or 8inding a (o1pany:" value a((ording 3o 35i" 1e35od i" 35e 8ollo9ing+ I P . *5e buyer i" prepared 3o pay 35e "eller 35e value o8 35e ne3 a""e3" plu" 1 year" o8 "uperpro8i3". and 35e value o8 35e re3urn.'C3. Wi35 35e"e a""u1p3ion". 7$8$ An:lo-SaCon Metho* or #irect I P ! . !" (an be "een.iC3. a (api3al e=ual 3o 35e value o8 35e (o1pany:" a""e3". 35e value o8 35e good9ill i" ob3ained by re"3a3ing 8or an inde8ini3e dura3ion 35e value o8 35e "uperpro8i3 ob3ained by 35e (o1pany.. *5e ra3e i i" 35e ra3e o8 an al3erna3ive. 35e e=ui3y:" value 9ould be #97.'Ci. ' P 2LS ! P #&/..# . 7$@$ Annual Profit Purchase Metho* Wi35 35i" 1e35od. *5e ra3e 31 i" 35e in3ere"3 ra3e earned on 8i0edEin(o1e "e(uri3ie" 1ul3iplied by a (oe88i(ien3 be39een #. IESE Business School-University of Navarra .! . i P #0T. and i8 1 i" / year". C 3 giving I P .. 35e e=ui3y:" value 9ould be #97.& 1illion dollar".' E i!. i P #0T. and 35e in3ere"3 ra3e . Wi35 35e"e a""u1p3ion".

Ko9ever. a "ui3able di"(oun3 ra3e i" de3er1ined 8or ea(5 3ype o8 (a"5 8lo9. >e3er1ining 35e di"(oun3 ra3e i" one o8 35e 1o"3 i1por3an3 3a"k" and 3ake" in3o a((oun3 35e ri"k. 35e 1ini1u1 di"(oun3 ra3e i" o83en "e3 by 35e in3ere"3ed par3ie" . 35e (on(ep3ual approa(5 i" "i1ilar 3o 35a3 o8 35e (a"5 budge3.# . 8or e0a1ple.. Fur35er1ore. *5en 35e re"idual value in year n i" IRn P CFn . Wi35 35e"e a""u1p3ion". 5i"3ori( vola3ili3ie"S in pra(3i(e. *5e 1i0ed 1e35od" de"(ribed previou"ly 5ave been u"ed e03en"ively in 35e pa"3.# .In 35e (a"e o8 35e (o1pany !l8a In(.# . C .. ad1ini"3ra3ive and "ale" e0pen"e". 8or ea(5 period. k P appropria3e di"(oun3 ra3e 8or 35e (a"5 8lo9": ri"k.In. no9aday". e3(. i P #0T. 17 .35e buyer" or "eller" are no3 prepared 3o inve"3 or "ell 8or le"" 35an a (er3ain re3urn..k. 8$1$ Deneral Metho* for Cash 9lo) #iscountin: *5e di88eren3 (a"5 8lo9 di"(oun3ingEba"ed 1e35od" "3ar3 9i35 35e 8ollo9ing e0pre""ion+ IP CF# CF& CFn + IR n CF2 + # . 35e (a"5 8lo9 di"(oun3ing 1e35od i" generally u"ed be(au"e i3 i" 35e only (on(ep3ually (orre(3 valua3ion 1e35od. "u(5 a". i8 3 P #/T. a" 35eir pre"en3 value de(rea"e" progre""ively 9i35 longer 3i1e 5ori on". In 35e"e 1e35od".IESE Business School-University of Navarra . (an be (al(ula3ed by di"(oun3ing 35e 8u3ure 8lo9" a83er 35a3 period. (are8ul 8ore(a"3. o8 8lo9" a83er 35a3 period.. + .g.k. In (a"5 8lo9 di"(oun3ingEba"ed valua3ion". !l35oug5 a3 8ir"3 "ig53 i3 1ay appear 35a3 35e above 8or1ula i" (on"idering a 3e1porary dura3ion o8 35e 8lo9". n 2 W5ere+ CFi P (a"5 8lo9 genera3ed by 35e (o1pany in 35e period i.. 35e e=ui3y:" value 9ould be #%/ 1illion dollar". 35i" i" no3 ne(e""arily "o a" 35e (o1pany:" re"idual value in 35e year n . Ca"5 8lo9 di"(oun3ing 1e35od" are ba"ed on 35e de3ailed. 35e (o1pany i" vie9ed a" a (a"5 8lo9 genera3or and 35e (o1pany:" value i" ob3ained by (al(ula3ing 35e"e 8lo9": pre"en3 value u"ing a "ui3able di"(oun3 ra3e.k E g. In P re"idual value o8 35e (o1pany in 35e year n. 35ey are (urren3ly u"ed in(rea"ingly le"" and i3 (an be "aid 35a3. ' P 2LS ! P #&/.. ! "i1pli8ied pro(edure 8or (on"idering an inde8ini3e dura3ion o8 8u3ure 8lo9" a83er 35e year n i" 3o a""u1e a (on"3an3 gro935 ra3e . Con"e=uen3ly. o8 ea(5 o8 35e 8inan(ial i3e1" rela3ed 9i35 35e genera3ion o8 35e (a"5 8lo9" (orre"ponding 3o 35e (o1pany:" opera3ion".# . 35e (o1pe3i3ive advan3age o8 1any bu"ine""e" 3end" 3o di"appear a83er a 8e9 year". 8$ Cash 9lo) #iscountin:-Base* Metho*s *5e"e 1e35od" "eek 3o de3er1ine 35e (o1pany:" value by e"3i1a3ing 35e (a"5 8lo9" i3 9ill genera3e in 35e 8u3ure and 35en di"(oun3ing 35e1 a3 a di"(oun3 ra3e 1a3(5ed 3o 35e 8lo9": ri"k. loan repay1en3".k .g. !l35oug5 35e 8lo9" 1ay 5ave an inde8ini3e dura3ion. + . (olle(3ion o8 "ale". per"onnel. ra9 1a3erial".k. i3 1ay be a((ep3able 3o ignore 35eir value a83er a (er3ain period. & + .

35e (o1pany:" . a1ong o35er". *5e F(o1pany:" valueG i" u"ually (on"idered 3o be 35e "u1 o8 35e value o8 35e e=ui3y plu" 35e value o8 35e 8inan(ial deb3.deb3 and e=ui3y+ > . 95en 9e 3alk abou3 35e (o1pany:" value... 35e 8ollo9ing (5ar3 "5o9" 35e di88eren3 (a"5 "3rea1" genera3ed by a (o1pany and 35e appropria3e di"(oun3 ra3e" 8or ea(5 8lo9..35e "5are". *5e e=ui3y (a"5 8lo9 0EC93 enable" 35e value o8 35e e=ui3y 3o be ob3ained.. "enior deb3. *5e "5are5older": e=ui3y or (api3al (an in(lude. "ee Fau" . "5or3 or longE3er1 deb3.8inan(ial. (onver3ible deb3. a1ong o35er". *5e di"(oun3 ra3e" 35a3 1u"3 be u"ed 8or 35e FCF and 35e 7CF are e0plained in 35e 8ollo9ing "e(3ion". +0 +- For an e0(ellen3 di"(u""ion o8 9orking (api3al re=uire1en3" . CASH FLOWS FCF0 ) ee #ash %lo< ECF0 Equit* #ash %lo< CF'0 Debt #ash %lo< APPROPRIATE DISCOUNT RATE WACC0 Cei&hted ave a&e #ost o% #apital :(0 Requi ed etu n to equit* :'0 Requi ed etu n to debt *5ere are 35ree ba"i( (a"5 8lo9"+ 35e 8ree (a"5 8lo9.WCR. (o1bined 9i35 35e value o8 35e deb3. (o11on "3o(k.. W5en 9e re8er 3o 35e (o1pany:" . 3o be ob3ained..8inan(ial. Figure 4 "5o9" in "i1pli8ied 8or1 35e di88eren(e be39een 35e (o1pany:" 8ull balan(e "5ee3 and i3" e(ono1i( balan(e "5ee3. 9e are no3 3alking abou3 i3" en3ire a""e3" bu3 abou3 3o3al a""e3" le"" "pon3aneou" 8inan(ing . (redi3or"."upplier". pre8erred "3o(k and (onver3ible pre8erred "3o(kS and 35e di88eren3 3ype" o8 deb3 (an in(lude.. In order 3o de3er1ine 35e pre"en3 1arke3 value o8 35e e0i"3ing deb3.(o"3 o8 35e deb3. 95i(5 i" 35e "u1 o8 35e in3ere"3 3o be paid on 35e deb3 plu" prin(ipal repay1en3". "ubordina3ed deb3. and 35e deb3 (a"5 8lo9. 95i(5 i" ## 95y i3" book value i" o83en 3aken a" a "u88i(ien3 appro0i1a3ion 3o 35e 1arke3 value. and i3" deb3 .18 .."5or3 and longE3er1 8inan(ial deb3.7. *o pu3 i3 ano35er 9ay. 9e 1u"3 8ir"3 de8ine 35e di88eren3 3ype" o8 (a"5 8lo9 35a3 (an be u"ed in a valua3ion. *5e (o1pany:" . 9ill al"o enable 35e (o1pany:" 3o3al value 3o be de3er1ined.."5are". e3(. *5e ea"ie"3 one 3o under"3and i" 35e deb3 (a"5 8lo9. a""e3" (on"i"3 o8 35e ne3 8i0ed #& a""e3" plu" 35e 9orking (api3al re=uire1en3".8inan(ial. ero or regular (oupon deb3. 35e deb3:" 1arke3 value "5all be e=uivalen3 3o i3" book value. In 35e re"3 o8 35e paper. *5e 8ree (a"5 8lo9 09C93 enable" 35e (o1pany:" 3o3al value . #2 ++ +4 *5i" i" only valid i8 35e re=uired re3urn 3o deb3 i" e=ual 3o 35e deb3:" (o"3. 8$/$ #eci*in: the A--ro-riate Cash 9lo) CoA-any1s EconoAic Balance Sheet for #iscountin: an* the In order 3o under"3and 95a3 are 35e ba"i( (a"5 8lo9" 35a3 (an be (on"idered in a valua3ion.'e8ore looking in 1ore de3ail a3 35e di88eren3 (a"5 8lo9 di"(oun3ingEba"ed valua3ion 1e35od".#99L. IESE Business School-University of Navarra . 9e 9ill be re8erring 3o 35e value o8 35e deb3 plu" 35e value o8 35e "5are5older": e=ui3y . 35i" 8lo9 1u"3 be di"(oun3ed a3 35e re=uired ra3e o8 re3urn 3o deb3 . a""e3". In 1any (a"e". 95i(5. liabili3ie" (on"i"3 o8 #4 35e "5are5older": e=ui3y . 8i0ed or variable in3ere"3 deb3. 35e e=ui3y (a"5 8lo9.

WCR.. 9i35ou3 3aking in3o a((oun3 borro9ing .u"3ed 3o 35i" approa(5.8inan(ial deb3. on 35e o35er 5and. 35ere are no 8inan(ial e0pen"e". 35a3 i". *5e"e 39o 8ea3ure" o8 a((oun3ing di"3or3 our per(ep3ion o8 35e appropria3e approa(5 95en (al(ula3ing (a"5 8lo9". 9e "5all de3er1ine 35e (o1pany:" 8ree (a"5 8lo9. on one 5and. (o"3" and e0pen"e" u"ing ba"i(ally arbi3rary 1e(5ani"1".1. 35e (a"5 8lo9 genera3ed by opera3ion". 95i(5 1u"3 be 35e F(a"5G approa(5. 35i" 3a"k re=uire" 8ore(a"3ing (a"5 8lo9" 8ur35er a5ead in 3i1e 35an i" nor1ally done in any (a"5 budge3. a""u1ing 35a3 35ere i" no deb3 and. We 9ill no9 3ry 3o iden3i8y 35e ba"i( (o1ponen3" o8 a 8ree (a"5 8lo9 in 35e 5ypo35e3i(al e0a1ple o8 35e (o1pany XQY.2.C% Inven3orie" Ne3 Fi0ed !""e3" )5are5older"J e=ui3y WCR P Ca"5 . 35a3 i". (a"5 a(3ually re(eived or paid .. 35a3 i". !((oun3ing (anno3 give u" 35i" in8or1a3ion dire(3ly a". Ko9ever. 9e 1u"3 8ore(a"3 35e (a"5 9e 9ill re(eive and 1u"3 pay in ea(5 period. *5i" i" ba"i(ally 35e approa(5 u"ed 3o dra9 up a (a"5 budge3.9i:ure 7 Full and 7(ono1i( 'alan(e )5ee3 o8 a Co1pany 9U Assets Ca"5 !((oun3" re(eivable !((oun3" payable )5or3E3er1 8inan(ial deb3 HongE3er1 8inan(ial deb3 )5are5older"J e=ui3y Working Capi3al Re=uire1en3" . in (o1pany valua3ion.IESE Business School-University of Navarra . i" 35e opera3ing (a"5 8lo9. 95en 35e a((oun3ing i" ad. a83er 3a0. i3 allo(a3e" i3" revenue". )!. 35e "u1" o8 1oney a(3ually re(eived and paid in ea(5 period.FCF. 35ere8ore.u"3ed 3o give 35e (a"5 8lo9" 8or ea(5 period. B"ing 35i" da3a. In order 3o (al(ula3e 8u3ure 8ree (a"5 8lo9".!((oun3" Re(eivable . *able L give" 35e in(o1e "3a3e1en3 8or 35e (o1pany XQY. *5e in8or1a3ion given in 35e a((oun3ing "3a3e1en3" "5o9n in *able L 1u"3 be ad. i3 u"e" 35e a((rual approa(5 and. Ko9ever. 9e (an (al(ula3e 95a3ever (a"5 8lo9 9e are in3ere"3ed in. Ne3 Fi0ed !""e3" BA ANCE S"EE! ia'ilities ECONOMIC BA ANCE S"EE! Assets ia'ilities >eb3 . The Flow Free Cash *5e 8ree (a"5 8lo9 . 95i(5 9e kno9 by de8ini3ion 1u"3 no3 in(lude any 1@ .Inven3orie" E !((oun3" Payable 5. I3 i" 35e 1oney 35a3 9ould be available in 35e (o1pany a83er (overing 8i0ed a""e3 inve"31en3" and 9orking (api3al re=uire1en3".(olle(3ion" and pay1en3".

. / +.pay1en3" 3o 8und provider". /60B2.B. a" 35e"e "u1" 1u"3 be dedu(3ed in order 3o (al(ula3e 35e 8ree (a"5 8lo9. !a'le @ In(o1e )3a3e1en3 8or XQY 5666 Sa#( /"ost o% &oods sold /8ene al e'penses /Dep e#iation Ea*)i).4B+. /+4B+. /+0B0. ++0B3.WCR... 7+B3...6B32 2..5 +6-B2. /4. 7... IESE Business School-University of Navarra .B. +.B.. 8-06-.B. (EBIT) /Inte est e'penses Ea*)i). / 0-B..B. +. We 1u"3 al"o (on"ider 35e "u1" o8 1oney 3o be allo(a3ed 3o ne9 inve"31en3" in 8i0ed a""e3" and ne9 9orking (api3al re=uire1en3" . +6-B2.B.. / -.B2. ... 95i(5 i" ano35er (a"5 8lo9 varian3 u"ed in valua3ion" and 9ill be analy ed belo9. -.B.6B+. +5+.+B-7 / . 9e 1u"3 ignore 8inan(ing 8or 35e (o1pany:" opera3ion" and (on(en3ra3e on 35e 8inan(ial re3urn on 35e (o1pany:" a""e3" a83er 3a0. +..6B+. +0+B.B. /4. /3+B4. i8 35e (o1pany 5ad no deb3.. 2("$*( ta. /+27B. /3+B. -.B.. (EBT) /Ta' N(t i)c$4( (EAT) /Dividends R(tai)(' (a*)i).6B06 3-B42 !a'le < Free Ca"5 Flo9 o8 XQY. /6+..B.. / 4.7'I*. *able 7 "5o9" 5o9 35e 8ree (a"5 8lo9 i" ob3ained 8ro1 earning" be8ore in3ere"3 and 3a0 . 4. / . *5ere8ore....B. 8<095 In order 3o (al(ula3e 35e 8ree (a"5 8lo9.B.B. / 623B. 2("$*( i)t(*( t a)' ta.6B7. / -4B2. 35e 8ree (a"5 8lo9 9ould be iden3i(al 3o 35e e=ui3y (a"5 8lo9.1< . 2("$*( i)t(*( t a)' ta.B34 +. dividend" and in3ere"3 e0pen"e" 1u"3 no3 be in(luded in 35e 8ree (a"5 8lo9. vie9ed 8ro1 35e per"pe(3ive o8 a going (on(ern... /4... 4.6B+. / +. )! 5666 Ea*)i).+B.. /442B6. Finally.. /3.. /++B.. 3o 95i(5 9e 1u"3 add 35e depre(ia3ion 8or 35e period be(au"e i3 i" no3 a pay1en3 bu3 1erely an a((oun3ing en3ry. +54+. +-+B. +3-B2. *5e 3a0 payable on 35e 7'I* 1u"3 be (al(ula3ed dire(3lyS 35i" give" u" 35e ne3 in(o1e 9i35ou3 "ub3ra(3ing in3ere"3 pay1en3".5 +5. (EBIT) /Ta' paid on EBIT N(t i)c$4( %it!$ut '(2t DDep e#iation / In# ease in %i'ed assets / In# ease in C"R F*(( ca ! "#$% +-+B. /36B+.7 . 4..B. /.... 760<9 -. / +.B+. +-6B+... /-7B-.B.3 / 02B4. 3aking in3o a((oun3 in ea(5 period 35e inve"31en3" re=uired 8or 35e bu"ine"":" (on3inued e0i"3en(e.

K# I B # (* I3 i" i1por3an3 3o no3 (on8u"e 35e (api3al (a"5 8lo9 9i35 35e 8ree (a"5 8lo9.>. *5i" (an be repre"en3ed in 35e 8ollo9ing e0pre""ion+ EC9 B 9C9 .> ?d . 7 P 1arke3 value o8 35e e=ui3y. *5e W!CC i" (al(ula3ed by 9eig53ing 35e (o"3 o8 35e deb3 .5. The Equity Cash Flow *5e e=ui3y (a"5 8lo9 .7.> . 35e dividend" and o35er e0pe(3ed pay1en3" 3o "5are5older" 1u"3 1a3(5 35e e=ui3y (a"5 8lo9".7.a83er 3a0.e(3ion"..ACCI 95ere W!CC P 7 ?e . by 95i(5 35e in3ere"3 (orre"ponding 3o 35e e0i"3ing deb3" i" paid..2. ?e P re=uired re3urn 3o e=ui3y. Flow Capital Cash Capi3al (a"5 8lo9 .. . *5e deb3 (a"5 8lo9 i" (o1po"ed by 35e "u1 o8 in3ere"3 pay1en3" plu" prin(ipal repay1en3". 95i(5 9ill be allo(a3ed 3o paying dividend" or buying ba(k "5are". 8$4$ Calculatin: the Value of the CoA-any Usin: the 9ree Cash 9lo) In order 3o (al(ula3e 35e value o8 35e (o1pany u"ing 35i" 1e35od. and. *5i" (a"5 8lo9 a""u1e" 35e e0i"3en(e o8 a (er3ain 8inan(ing "3ru(3ure in ea(5 period.?e. 9e 1u"3 add 35e value o8 35e e0i"3ing deb3 .2.!3I . 1ade in ea(5 period 3o 35e deb3 5older" and adding 35e ne9 deb3 provided.3..Hinterest -ayAents C 01. 9e are valuing 35e (o1pany:" e=ui3y . !83er 35a3 35ere re1ain" a (er3ain "u1 95i(5 i" 35e (a"5 available 3o 35e "5are5older". ?d P (o"3 o8 35e deb3 be8ore 3a0 P re=uired re3urn 3o deb3.re"3a3ed. 3o 35e value o8 35e e=ui3y . *o 8ind 35e (o1pany:" 3o3al value . 7. i" (al(ula3ed by "ub3ra(3ing 8ro1 35e 8ree (a"5 8lo9 35e in3ere"3 and prin(ipal pay1en3" . 35e in"3all1en3" o8 35e prin(ipal are paid a3 35e (orre"ponding 1a3uri3y da3e" and 8und" 8ro1 ne9 deb3 are re(eived. u"ing 35e 9eig53ed average (o"3 o8 deb3 and e=ui3y or 9eig53ed average (o"3 o8 (api3al . In "5or3. W5en 9e re"3a3e 35e e=ui3y (a"5 8lo9. "in(e 9e are valuing 35e (o1pany a" a 95ole . i3 i" 35e (a"5 8lo9 re1aining available in 35e (o1pany a83er (overing 8i0ed a""e3 inve"31en3" and 9orking (api3al re=uire1en3" and a83er paying 35e 8inan(ial (5arge" and repaying 35e (orre"ponding par3 o8 35e deb3:" prin(ipal .7CF. 9i35 re"pe(3 3o 35e (o1pany:" 8inan(ial "3ru(3ure. i" 35e 3er1 given 3o 35e "u1 o8 35e deb3 (a"5 8lo9 plu" 35e e=ui3y (a"5 8lo9.CCF. 35ere8ore.-rinci-al re-ayAents J ne) *e't W5en 1aking pro.2.# E * . *5ere8ore+ CC9 B EC9 J #C9 B EC9 J I ... 5.?e.W!CC. and 35e (o"3 o8 35e e=ui3y . 95i(5 re8le(3" 35e e=ui3y:" ri"k.?d.in 35e even3 35a3 35ere e0i"3" deb3.> > P 1arke3 value o8 35e deb3. 35e appropria3e di"(oun3 ra3e 9ill be 35e re=uired re3urn 3o e=ui3y .deb3 plu" e=ui3y. * P 3a0 ra3e.7.+ E J # B -resent value H9C9L . *5i" i" 35e appropria3e ra3e 8or 35i" (a"e a". 35e 8ree (a"5 8lo9" are di"(oun3ed . 9e 1u"3 (on"ider 35e re=uired re3urn 3o deb3 and 35e re=uired re3urn 3o e=ui3y in 35e propor3ion 3o 95i(5 35ey 8inan(e 35e (o1pany.

IESE Business School-University of Navarra .1> .

*5i" ra3e .?e P ?u. 35e re=uired re3urn 3o e=ui3y .1= . IESE Business School-University of Navarra .2002. Con"e=uen3ly. 35e !PI (onden"e" in3o 35e 8ollo9ing 8or1ula+ # J E B NPV09C9L (u3 J value of the *e't1s taC shiel* #/ 8$8$ Calculatin: the Value of the CoA-any1s E2uity 'y #iscountin: the E2uity Cash 9lo) *5e 1arke3 value o8 35e (o1pany:" e=ui3y i" ob3ained by di"(oun3ing 35e e=ui3y (a"5 8lo9 a3 35e ra3e o8 re=uired re3urn 3o e=ui3y 8or 35e (o1pany .g.ad.g.u"3ed pre"en3 value. i3 i" po""ible 3o de3er1ine 35e (o1pany:" 3o3al value. i" kno9n a" 35e unlevered ra3e or re=uired re3urn 3o a""e3". and i3 i" 35e "pe(i8i( (on"e=uen(e o8 35e lo9er 3a0 paid by 35e (o1pany a" a (on"e=uen(e o8 35e in3ere"3 paid on 35e deb3 in ea(5 period. For a 1ore de3ailed di"(u""ion. g P (on"3an3. P0 P "5are:" (urren3 pri(e. "u"3ainable dividend gro935 ra3e. a" 35e only "our(e o8 8inan(ing being u"ed i" (api3al. 35e "5are5older" 9ould bear 35e 8inan(ial ri"k i1plied by 35e e0i"3en(e o8 deb3 and 9ould de1and a 5ig5er e=ui3y ri"k pre1iu1.. Aordon and )5apiro:" (on"3an3 gro935 valua3ion 1odel+ ?e P V>iv# C P0W . 35e (o1pany:" value i" (al(ula3ed by adding 39o value"+ on 35e one 5and.?e. *5e value o8 35e (o1pany 9i35ou3 deb3 i" ob3ained by di"(oun3ing 35e 8ree (a"5 8lo9. 95i(5 need no3 ne(e""arily be 35e in3ere"3 ra3e a3 95i(5 35e (o1pany 5a" (on3ra(3ed i3" deb3.8$7$ Calculatin: the Value of the CoA-any as the Unlevere* Value Plus the #iscounte* Value of the !aC Shiel* In 35i" 1e35od. 9e 9ill 5ave 3o di"(oun3 35e1 a3 35e ra3e (on"idered appropria3e.# . 35e value o8 35e 3a0 "5ield ob3ained by 35e 8a(3 35a3 35e (o1pany i" 8inan(ed 9i35 deb3. 1ul3iplying 35e in3ere"3 payable on 35e deb3 by 35e 3a0 ra3e. 35e value o8 35e (o1pany a""u1ing 35a3 35e (o1pany 5a" no deb3 and. +.. >iv# P dividend" 3o be re(eived in 35e 8ollo9ing period P >iv0. *5e re=uired re3urn 3o e=ui3y (an be e"3i1a3ed u"ing any o8 35e 8ollo9ing 1e35od"+ #.. On(e 9e 5ave ob3ained 35e"e 8lo9".?u. 9e 9ould 8ir"3 5ave 3o (al(ula3e 35e "aving ob3ained by 35i" 1ean" 8or ea(5 o8 35e year". !l35oug5 35e di"(oun3 ra3e 3o be u"ed in 35i" (a"e i" "o1e95a3 (on3rover"ial. (5ap3er" #9 and 2#.2004.W!CC. 35e reader (an "ee Fernánde .. on 35e o35er 5and. W5en 35i" value i" added 3o 35e 1arke3 value o8 35e deb3. *5e pre"en3 value o8 35e 3a0 "5ield ari"e" 8ro1 35e 8a(3 35a3 35e (o1pany i" being 8inan(ed 9i35 deb3. 1any au35or" "ugge"3 u"ing 35e deb3:" 1arke3 (o"3. and Fernánde .. in 35i" (a"e. i" e=uivalen3 3o 35e 9eig53ed average (o"3 o8 (api3al . *5i" 1e35od i" (alled !PI . u"ing 35e ra3e o8 re=uired re3urn 3o e=ui3y 35a3 9ould be appli(able 3o 35e (o1pany i8 i3 9ere 3o be (on"idered a" 5aving no deb3. In 35o"e (a"e" 95ere 35ere i" no deb3. In order 3o 8ind 35e pre"en3 value o8 35e 3a0 "5ield. *5e re=uired re3urn 3o a""e3" i" "1aller 35an 35e re=uired re3urn 3o e=ui3y i8 35e (o1pany 5a" deb3 in i3" (api3al "3ru(3ure a".

RF P ra3e o8 re3urn 8or ri"kE8ree inve"31en3" . I3 indi(a3e" 35e "en"i3ivi3y o8 35e re3urn on a "5are 5eld in 35e (o1pany 3o 1arke3 1ove1en3".IESE Business School-University of Navarra . R4 P e0pe(3ed 1arke3 re3urn. given (er3ain value" 8or 35e e=ui3y:" be3a.#9%%.#0C200.## P 0. i3 i" e0pe(3ed 3o pay a dividend o8 #0 dollar" and 35e dividend:" e0pe(3ed annual gro935 ra3e i" ##T+ ?e P .2004b.#L P #LT 2. a" all 35e 1e35od" analy e 35e "a1e reali3y under 35e "a1e 5ypo35e"e"S 35ey di88er only in 35e (a"5 8lo9" 3aken a" 35e "3ar3ing poin3 8or 35e valua3ion.R4 E RF. i8 a "5are:" pri(e i" 200 dollar". 35e value o8 a (o1pany .C!P4. *5i" re"ul3 i" logi(al.#99L.. 8$<$ Basic Sta:es in the PerforAance of a Valuation 'y Cash 9lo) #iscountin: *5e ba"i( "3age" in per8or1ing an a((ura3e valua3ion by (a"5 8lo9 di"(oun3ing are+ #L *5e be3a 1ea"ure" 35e "y"3e1a3i( or 1arke3 ri"k o8 a "5are.For e0a1ple. 95i(5 de8ine" 35e re=uired re3urn 3o e=ui3y in 35e 8ollo9ing 3er1"+ ?e P RF . *5e (api3al a""e3 pri(ing 1odel . #7 *5e (la""i( 8inan(e 3e03book" provide a 8ull di"(u""ion o8 35e (on(ep3" analy ed 5ere.*rea"ury bond".1arke3 value o8 i3" e=ui3y plu" 1arke3 value o8 i3" deb3. /? .> CCF P . and Copeland and We"3on . di"(oun3ed a3 35e 9eig53ed average (o"3 o8 (api3al be8ore 3a0 . I8 35e (o1pany 5a" deb3.+ 7 . R4 $ RF P 1arke3 ri"k pre1iu1 or e=ui3y pre1iu1.0. For e0a1ple.Z . i" e=ual 3o 35e pre"en3 value o8 35e (api3al (a"5 8lo9" . #7 i3 i" po""ible 3o (al(ula3e 35e re=uired re3urn 3o e=ui3y.. 35e ri"kE8ree ra3e and 35e 1arke3 ri"k pre1iu1. 35u" ob3aining 35e levered be3a.. 'realey and 4yer" .7CF .> P pre"en3 value VCCFS W!CC'*W W!CC '* P 7 ?e .W!CC'*. e0plain" 3en di88eren3 1e35od" 8or Ialuing Co1panie" by Ca"5 Flo9 >i"(oun3ing and "5o9" 35a3 all 3en 1e35od" al9ay" give 35e "a1e value. *5u". 35e in(re1en3al ri"k ari"ing 8ro1 35e leverage 1u"3 be added 3o 35e in3rin"i( "y"3e1a3i( ri"k o8 35e (o1pany:" bu"ine"".CCF. . Fernánde .> ?d 7 . #L 8$@$ Calculatin: the CoA-any1s Value 'y #iscountin: the Ca-ital Cash 9lo) !((ording 3o 35i" 1odel. Z P "5are:" be3a ..>CF. *5ere are 1ore 1e35od" 8or valuing (o1panie" by di"(oun3ing 35e e0pe(3ed (a"5 8lo9".

pro8i3". CoA-ensation$ %eal o-tions$ I8 35e (o1pany 5a" real op3ion". In order 3o ob3ain a good valua3ion. *5e (a"5 8lo9 re"3a3e1en3 3e(5ni=ue i" "i1ilar in all valua3ion". *5e (o1pany:" 1anager" 1u"3 be involved in 35e analy"i" o8 35e (o1pany. Real op3ion" re=uire a 3o3ally di88eren3 ri"k 3rea31en3 8ro1 35e (a"5 8lo9 re"3a3e1en3". *5e valua3ion i" no3 a 3a"k 3o be per8or1ed "olely by 8inan(ial 1anage1en3. o8 35e indu"3ry and in 35e (a"5 8lo9 pro. i3 i" vi3al 35a3 1anager" 8ro1 o35er depar31en3" 3ake par3 in e"3i1a3ing 8u3ure (a"5 8lo9" and 35eir ri"k. (al(ula3ion o8 35e (a"5 8lo9"S b. (on"i"3en(y o8 35e (a"5 8lo9" u"ed 9i35 35e ra3e" appliedS d.ic a)' c$4+(titi&( "$*(ca t )o e#ast o% the indust *1s evolution )o e#ast o% the #o!pan*1s #o!petitive position "o!petitive position o% the !ain #o!petito s C0 C$) i t()cy $" t!( ca ! "#$% "$*(ca t )inan#ial #onsisten#* bet<een %o e#asts "o!pa ison o% %o e#asts <ith histo i# %i&u es "onsisten#* o% #ash %lo<s <ith the st ate&i# anal*sis 4$ #eterAination of the cost 0re2uire* return3 of ca-ital )o ea#h business unit and %o the #o!pan* as a <hole "ost o% the debt5 equi ed etu n to equit* and <ei&hted #ost o% #apital 7$ Net -resent value of future flo)s Aet p esent value o% the %lo<s at thei #o espondin& ateB P esent value o% the te !inal valueB (alue o% the equit*B 8$ Inter-retation of the results Ben#h!a kin& o% the value obtainedE #o!pa ison <ith si!ila #o!panies Identi%i#ation o% the value # eationB Sustainabilit* o% the value # eation >ti!e ho i=on@ Anal*sis o% the value1s sensitivit* to #han&es in the %unda!ental pa a!ete s St ate&i# and #o!petitive justi%i#ation o% the value # eation *5e (ri3i(al a"pe(3" in per8or1ing a (o1pany valua3ion are+ C%I!ICA ASPEC!S O9 A VA UA!ION #ynaAic$ !he valuation is a -rocess$ InvolveAent of the coA-any$ Multifunctional$ Strate:ic$ *5e pro(e"" 8or e"3i1a3ing e0pe(3ed ri"k" and (alibra3ing 35e ri"k o8 35e di88eren3 bu"ine""e" and bu"ine"" uni3" i" (ru(ial. 95i(5 3ran"la3e" in3o 35e di"(oun3 ra3e"S (. 1arke3 "5are. bu3 e"3i1a3ing 35e (a"5 8lo9" and (alibra3ing 35e ri"k 1u"3 3ake in3o a((oun3 ea(5 bu"ine"" uni3:" "3ra3egy. !echnically correct$ *e(5ni(al (orre(3ion re8er" ba"i(ally 3o+ a.. *5e valua3ion:" =uali3y i" in(rea"ed 95en i3 in(lude" goal" .. a 35oroug5 5i"3ori( analy"i" o8 35e 8inan(ial. . on 95i(5 35e 1anager": 8u3ure (o1pen"a3ion 9ill depend. "istoric analysis$ !l35oug5 35e value depend" on 8u3ure e0pe(3a3ion"./1 .ic a)' c$4+(titi&( a)a#y i /$ Pro6ections of future flo)s A0 Fi)a)cia# "$*(ca t In#o!e state!ents and balan#e sheets "ash %lo<s &ene ated b* the #o!pan* Invest!ents )inan#in& Te !inal value )o e#ast o% va ious s#ena ios B0 St*at(. 3rea31en3 o8 in8la3ion.e(3ion"."ale".1$ "istoric an* strate:ic analysis of the coA-any an* the in*ustry Evolution o% in#o!e state!ents and balan#e sheets Evolution o% #ash %lo<s &ene ated b* the #o!pan* Evolution o% the #o!pan*1s invest!ents Evolution o% the #o!pan*1s %inan#in& Anal*sis o% the %inan#ial health Anal*sis o% the business1s isk A0 Fi)a)cia# a)a#y i Evolution o% the indust * Evolution o% the #o!pan*1s #o!petitive position Identi%i#ation o% the value #hain "o!petitive position o% the !ain #o!petito s Identi%i#ation o% the value d ive s B0 St*at(. inve"31en3". IESE Business School-University of Navarra . "3ra3egi( and (o1pe3i3ive evolu3ion o8 35e di88eren3 bu"ine"" uni3" 5elp" a""e"" 35e 8ore(a"3": (on"i"3en(y. 35e"e 1u"3 be valued appropria3ely. gro935.. 3rea31en3 o8 35e re"idual valueS e. ade=ua3e 3rea31en3 o8 35e ri"k.

and (ar a((e""orie". edi3ed by Wiley. +2 For a 1ore de3ailed di"(u""ion o8 35i" 3ype o8 valua3ion. 35e (o1pany:" value i" (al(ula3ed a" 35e "u1 o8 35e value" o8 i3" di88eren3 #% divi"ion" or bu"ine"" uni3". *5e 8unda1en3al proble1 9i35 35e"e 1e35od" i" 35a3 "o1e are ba"ed "olely on 35e balan(e "5ee3. *5e 1o"3 "ui3able 1e35od 8or valuing a (o1pany i" 3o di"(oun3 35e e0pe(3ed 8u3ure (a"5 8lo9". !a'le > !l8a In(. 9e re(o11end C5ap3er #4 o8 35e book FIalua3ion+ 1ea"uring and 1anaging 35e value o8 (o1panie"G. <$ !he CoA-any as the SuA of the values of #ifferent #ivisions$ Brea5-u. *able % "5o9" 35e value o8 35e e=ui3y o8 35e (o1pany !l8a In(. . We 9ould all (on(ur in giving a 5ig5er value 3o 35e 8or1er (o1pany 35an 3o 35e la33er. 2000. 8or 35e e=ui3y:" o9ner". earning" and good9ill. "5ipbuilding. o35er" are ba"ed on 35e in(o1e "3a3e1en3. +60 4+0 +66 +36 +76 4+2 +76 +2. and 35e o35er in a "3abili ed "i3ua3ion 9i35 8ier(e (o1pe3i3ion.hich is the Best Metho* to Use. *5e (o1pany in =ue"3ion 5ad 35ree "epara3e divi"ion"+ 5ou"e5old produ(3". We (ould i1agine 39o (o1panie" 9i35 iden3i(al balan(e "5ee3" and in(o1e "3a3e1en3" bu3 di88eren3 pro"pe(3"+ one 9i35 5ig5 "ale". Ialue o8 35e 7=ui3y !((ording 3o >i88eren3 4e35od" . bu3 none o8 35e1 (on"ider any35ing bu3 5i"3ori( da3a. in "pi3e o8 35eir 5i"3ori( balan(e "5ee3" and in(o1e "3a3e1en3" being e=ual. by Copeland e3 al. earning" and 1argin po3en3ial.4illion >ollar".@$ .. ob3ained by di88eren3 1e35od" ba"ed on "5are5older": e=ui3y. Book value Adjusted book value Liquidation value PER "lassi# valuation !ethod Si!pli%ied $E" !ethod $E" !ethod Indi e#t !ethod Di e#t o An&lo/Sa'on !ethod Annual p o%it pu #hase !ethod Risk/bea in& and isk/% ee ate !ethod 2.8lo9". +0. *able 9 "5o9" 35e valua3ion o8 a Nor35 !1eri(an (o1pany per8or1ed in early #9%0.Value On 1any o((a"ion". a" 35e value o8 a (o1pany:" e=ui3y E a""u1ing i3 (on3inue" 3o opera3e E ari"e" 8ro1 35e (o1pany:" (apa(i3y 3o genera3e (a"5 . *5e be"3 9ay 3o e0plain 35i" 1e35od i" 9i35 an e0a1ple. 6.

// .IESE Business School-University of Navarra .

i3 (al(ula3ed 35e value o8 ea(5 divi"ion.e(3ed ea(5 divi"ion:" ne3 in(o1e and 35en allo(a3ed a . and (on"e=uen3ly. 95i(5 1ay in3rodu(e un(er3ain3ie". *5e gro935 o8 u3ili3y (o1panie" i" u"ually 8airly "3able. 3 PER %o ea#h business >!ini!u! and !a'i!u!@ 7 +. (alue o% equit* >!illion dolla s@ -0..6B423B.# 1illion dollar" in (a"5. 35e (on(lu"ion rea(5ed i" 35a3 ea(5 "5are i" 9or35 be39een &/ and &9 dollar"./ 1illion dollar". LessE non/%unded eti e!ent pensions at *ea /end 0-B. 35e value o8 35e earning" genera3ed by 35e (o1pany.B-67B4 7907 7607 (alue pe sha e >based on +454. 66B.L 1illion dollar" o8 8inan(ial deb3. 35i" =uan3i3y 5ad 3o be "ub3ra(3ed 8ro1 35e (o1pany:" value. i3 i" "i1pler 3o e03rapola3e 35eir opera3ing "3a3e1en3 and 35en di"(oun3 35e (a"5 8lo9". !a'le = Ialua3ion o8 a Co1pany a" 35e )u1 o8 35e Ialue o8 i3" >ivi"ion" Individual Ialua3ion o8 7a(5 'u"ine"" B"ing 35e P7R Cri3erion 9ousehold "a TOTAL >Million dolla s@ p odu#ts Shipbuildin& a##esso ies "OMPAAF E'pe#ted net -=0< 5808 90= 8=0= !ini!u! !a'i!u! !ini!u! !a'i!u! !ini!u! !a'i!u! !ini!u! !a'i!u! in#o!e .1a0i1u1 and 1ini1u1. *5ere8ore. B"ing a "i1ple 1ul3ipli(a3ion . le"" #0 1illion dolar" 8or opera3ion" and le"" #/.be39een &%7 and 4&L 1illion dollar". We 1u"3 no9 add 3o 35i" 8igure 35e (o1pany:" (a"5 "urplu". Ko9ever. !83er per8or1ing 35e"e opera3ion". *5e (o1pany:" value i" "i1ply 35e "u1 o8 35e 35ree divi"ion": value". 9ould "erve a" a ba"i" 8or a""e""ing 35e o88er.+5. *able 9 "5o9" 35a3 35e inve"31en3 bank valued 35e (o1pany:" e=ui3y be39een 4&0 and 479 1illion dollar" . i3 pro.. 95i(5 35e inve"31en3 bank e"3i1a3ed a3 77. . 0-B. P7R 3o ea(5 one. >$ Valuation Metho*s Use* #e-en*in: on the Nature of the CoA-any Kolding (o1panie" are ba"i(ally valued by 35eir li=uida3ion value. 95i(5 i" very (lo"e 3o 35e o88er 1ade o8 &% dollar" per "5are. sha es@ DCa"5 "urplu"+ #0&.2B. We (an (all 35i" value . Fir"3 o8 all. 35e ra3e" (5arged 8or 35eir "ervi(e" are u"ually inde0ed 3o 35e CPI. 95i(5 i" in(luded in *able 9. 30B2 026B-03B4 PlusE esti!ated net #ash su plus at *ea /endG 66B. 23B. In developed (oun3rie". 'u3 le3 u" "ee 5o9 i3 arrived a3 35a3 value. or 35ey are (al(ula3ed in a((ordan(e 9i35 a legal 8ra1e9ork.i3 9a" "5or3 by &4.earning" 0 P7R. 35e (o1pany:" pen"ion plan 9a" no3 8ully 8unded . be39een &/ and &9 dollar" per "5are. +. In 35e"e (a"e".. 95i(5 i" (orre(3ed 3o 3ake in3o a((oun3 3a0e" payable and 1anagerial =uali3y.or. 3o pu3 i3 ano35er 9ay. par3i(ular a33en3ion 1u"3 be paid 3o regula3ory (5ange". *5i" valua3ion../ 1illion dollar". ++ (alue >!illion dolla s@ 4.! 8inan(ial group laun(5ed a 3akeover bid on 35i" (o1pany a3 &% dollar" per "5are and a 9ellE kno9n inve"31en3 bank 9a" (o11i""ioned 3o value 35e (o1pany. 64B..

IESE Business School-University of Navarra ./4 .

In 35e (a"e o8 bank". Ko9ever. *5e"e i""ue" are di"(u""ed in grea3er de3ail in Fernánde .u"3ing ba"i(ally 8or bad deb3".*$%t! Risk/% ee Ma ket inte est isk ate p e!iu ! Bu*e / ta &et Risk pe #eived b* the !a ket )inan#ial isk Ma*>(t c$44u)icati$) . pri(eC"ale".. 9e (an divide in3o opera3ing ri"k and 8inan(ial ri"k.. and on 35e e=ui3y:" ri"k 95i(5.8inan(ial 1argin le"" (o11i""ion" le"" opera3ing e0pen"e". In 35e"e (a"e". Ialua3ion" "u(5 a" 35e P7R are u"ed. 35e re=uired re3urn 3o e=ui3y depend" on a variable over 95i(5 35e (o1pany 5a" no (on3rol. (5ap3er" & and 4.+(ctati$) $" "utu*( ca ! "#$% "o!petitive advanta&e pe iod A#tual businessB Ba ie s to Ae< businesses / p odu#ts Re&ulato * envi on!ent R(qui*(' *(tu*) t$ (quity "ont ol o% ope ations Mana&e PeopleB "o po ate sB #ultu e /7 ."5are5older": e=ui3y ad. 35e 1o"3 (o11only u"ed valua3ion" E apar3 8ro1 re"3a3ed (a"5 8lo9" E are 35o"e ba"ed on 8inan(ial ra3io" .2002... =$ (ey 9actors Affectin: Value+ Dro)thM Interest %ates %eturnM %is5 an* *5e e=ui3y:" value depend" on e0pe(3ed 8u3ure 8lo9" and 35e re=uired re3urn 3o e=ui3y.u"3ed 8or provi"ion "urplu"e"Cde8i(i3". in 3urn. !a'le 1? Fa(3or" In8luen(ing 35e "rivers. *5eir indu"3ry por38olio i" al"o analy ed. ad.P7R. and (api3al gain" or lo""e" on a""e3" "u(5 a" 35e indu"3ry por38olio. Indu"3rial and (o11er(ial (o1panie". 35e gro935 o8 8u3ure 8lo9" depend" on 35e re3urn on inve"31en3" and 35e (o1pany:" gro935. In 3urn. pri(eC(a"5 8lo9.IESE Business School-University of Navarra Risk !ana&e!ent Assets in pla#e P o%it !a &in Real options Te#hnolo&* Ope atin& isk Indust *5 #ount ies5 la<s Expected *(tu*) on invest!ent Expected #o!pan* . 35e ri"kE8ree in3ere"3 ra3e. or 35e ne3 9or35 1e35od . 35e 8o(u" o8 a33en3ion i" 35e opera3ing pro8i3 . 7=ui3y:" Ialue !alue VA UE O9 ENUI!Y Adquisitions / disposals st u#tu Indust e *B "o!petitive E.

*5i" i" 35e "oE(alled 8unda1en3al value. "u(5 a" ?eyne": Uani1al "piri3"U. In o35er 9ord". 'y vir3ue o8 35e la33er "olu3ion. opera3ing ri"k and 8inan(ial ri"k. bur"3 and vani"5. inve"3or" 95o e0pe(3 3o 8ind in +7 *5e (o11uni(a3ion 9i35 35e 1arke3 8a(3or no3 only re8er" 3o (o11uni(a3ion and 3ran"paren(y 9i35 35e 1arke3" in 35e "3ri(3 "en"e bu3 al"o 3o (o11uni(a3ion 9i35+ analy"3". and i3 (an be ob3ained 8ro1 35e "a1e e=ua3ion 35a3 give" 35e 8or1ula nor1ally u"ed by 35e 8unda1en3ali"3". *5u". 35e"e 8a(3or" are "3ill very general.. ra3ing (o1panie".value #rivers. "5are pri(e 8or1a3ion doe" no3 8ollo9 any ra3ional valua3ion rule bu3 ra35er depend" on 35e "3a3e" o8 eup5oria. 95i(5 a3 any given 3i1e 1ay+ a. !no35er group o8 35eorie" i" ba"ed on p"y(5ologi(al or "o(iologi(al be5avior". e1ployee". a "5are:" pri(e (an be grea3er 35an i3" 8unda1en3al value ./8 .. i8 a bubble develop" "i1ul3aneou"ly. *5e 4I* pro8e""or Olivier 'lan(5ard developed 35e algebrai( e0pre""ion o8 35e "pe(ula3ive bubble. *5e ad. di"3ribu3ion (5annel". I3 i" 35e"e p"y(5ologi(al p5eno1ena 35a3 give 5ope 3o 35e (5ar3i"3"+ i8 1ood" do no3 (5ange 3oo o83en and inve"3or" value e=ui3y 3aking in3o a((oun3 35e "5are pri(e": pa"3 evolu3ion. #9 *5e"e 8a(3or" (an be "ubdivided in 3urn in3o re3urn on 35e inve"31en3.+ . board o8 dire(3or". "upplier". 8inan(ial in"3i3u3ion". . IESE Business School-University of Navarra . regula3ory agen(ie". 1arke3 ri"k pre1iu1. predo1ina3ing a3 any given 3i1e in 35e 8inan(ial (o11uni3y and in "o(ie3y in general. pe""i1i"1. a "5are:" pri(e i" e=ual 3o 35e ne3 pre"en3 value o8 all 35e e0pe(3ed 8u3ure dividend".*able #0 "5o9" 35a3 35e e=ui3y:" value depend" on 35ree pri1ary 8a(3or" . one o8 95i(5 i" 35e 8unda1en3al "olu3ion and ano35er i" 35e 8unda1en3al "olu3ion 9i35 a "pe(ula3ive bubble 3a(ked on3o i3. one (an e0pe(3 35a3 "u((e""ive "5are pri(e" 9ill be (orrela3ed or 9ill repea3 in "i1ilar (y(le".e(3ive 8unda1en3al re8er" 3o 35e para1e3er" 35a3 in8luen(e 35e "5are pri(e+ in3ere"3 ra3e". I3 i" very i1por3an3 35a3 a (o1pany iden3i8y 35e 8unda1en3al para1e3er" 35a3 5ave 1o"3 in8luen(e on 35e value o8 i3" "5are" and on value (rea3ion. Obviou"ly. (o1pany gro935. or b. inve"31en3:" ri"k. (u"3o1er". 95i(5 "eek 3o a((oun3 8or 35e be5avior and evolu3ion o8 "5are pri(e". *5e "pe(ula3ive bubble 35eory (an be derived 8ro1 8unda1en3al analy"i" and o((upie" a 1iddle ground be39een 35e above 39o 35eorie". and "5are5older". *5i" pro(e"" (an (on3inue "o long a" 35ere are inve"3or" 95o 3ru"3 35a3 35e "pe(ula3ive bubble 9ill (on3inue 3o gro9. !((ording 3o 35e"e 35eorie". (on3inue 3o gro9.. ri"kE 8ree in3ere"3 ra3e. i8 5e 5ope" 35a3 35e bubble 9ill (on3inue gro9ing. *o avoid 3iring our"elve" 9i35 e=ua3ion". ea(5 8a(3or:" i1por3an(e 9ill vary 8or 35e di88eren3 bu"ine"" uni3". I3 "i1ply 1ake" u"e o8 35e 8a(3 35a3 35e e=ua3ion 5a" "everal "olu3ion". 35e "5are pri(e re8le(3" (urren3 earning" genera3ion plu" gro935 e0pe(3a3ion".70pe(3a3ion" o8 8u3ure 8lo9".Re=uired re3urn 3o e=ui3y.Co11uni(a3ion 9i35 35e 1arke3. gro935 e0pe(3a3ion". 9e (an i1agine 35e bubble a" an e=ui3y overvalua3ion+ an inve"3or 9ill pay 3oday 8or a "5are a =uan3i3y 35a3 i" grea3er 35an i3" 8unda1en3al value i8 5e 5ope" 3o "ell i3 3o1orro9 8or a 5ig5er pri(e. 35a3 i". par3ner (o1panie".. . Ko9ever. 11$ S-eculative Bu''les on the Stoc5 Mar5et *5e advo(a3e" o8 8unda1en3al analy"i" argue 35a3 "5are pri(e" re8le(3 8u3ure e0pe(3a3ion" upda3ed by ra3ional inve"3or". 35a3 i".Ne3 Pre"en3 Ialue o8 all 8u3ure dividend".

%00 2. In o35er 9ord". 35e bur"3ing o8 a bubble 35a3 5ad been gro9ing over 35e previou" 1on35" (au"ed 35e "3o(k 1arke3 (ra"5. )5iller in3ervie9ed #000 in"3i3u3ional and priva3e inve"3or".000 2.200 &."5are. bu3 3ru"3ed 35a3 35ey 9ould be able 3o "ell be8ore 35e bubble bur"3. ! re(en3 "3udy per8or1ed by 35e Qale pro8e""or )5iller provide" 8ur35er eviden(e in "uppor3 o8 35i" 35eory.35e 8u3ure o35er 3ru"3ing inve"3or" 3o 95o1 35ey (an "ell 35e bubble .L00 &. 8or a pri(e 35a3 i" grea3er 35an 35e pri(e 35ey 5ave paid. i3 "ee1" 35a3 1ore 35an 90T o8 35e in"3i3u3ional inve"3or" 9ere a9are 35a3 a "pe(ula3ive bubble 9a" being 8or1ed E 35e "3o(k 9a" being "old 8or 1ore 35an i3" 8unda1en3al value E.L00 2. 1ore 35an L0T "3a3ed 35a3 35ey al"o believed 35a3 35e "3o(k" 9ere overvalued. Ko9ever.400 I'7X &/ &. in 35e evolu3ion o8 "5are pri(e".400 2. *5i" 35eory i" a33ra(3ive be(au"e i3 enable" 8unda1en3al 35eory 3o be "yn35e"i ed 9i35 35e e0i"3en(e o8 ano1alou" be5avior" . 35e 1o"3 "urpri"ing 8inding i" 35a3 1ore 35an 90T o8 35e in"3i3u3ional inve"3or" 95o did no3 "ell "aid 35a3 35ey 3oo believed 35a3 35e 1arke3 9a" overvalued.200 2. 'ubble" 3end 3o gro9 during period" o8 eup5oria. !((ording 3o 35i" e0plana3ion.000 0#E%7 0&E%7 0/E%7 07E%7 09E%7 ##E%7 0#E%% 0&E%% 0/E%% 07E%% 09E%% ##E%% /@ . 9i:ure 8 *5e #929 !1eri(an )3o(k 4arke3 Cri"i" &00 2/0 200 #/0 #00 /0 0 #E2L #E27 #E2% #E29 #E&0 #E&# #E&2 #E&& #E&4 #E&/ #E&L #E&7 9i:ure @ *5e )pani"5 )3o(k 4arke3 Cri"i" o8 O(3ober #9%7 &. bu3 5oped 35a3 35ey 9ould be able 3o "ell be8ore 35e inevi3able do9n3urn. Ko9ever. 95en i3 "ee1" 35a3 35e 1arke3:" only po""ible 3rend i" up9ard". !1ong 35e priva3e inve"3or" 95o did no3 "ell be8ore #9 O(3ober. *5e inve"3or" 95o "old be8ore 35e 'la(k 4onday "aid 35a3 35ey "old be(au"e 35ey 35oug53 35a3 35e "3o(k" 9ere already overvalued. 4any analy"3" 5ave u"ed 35i" 35eory 3o a((oun3 8or 35e 3re1endou" drop in "5are pri(e" on 35e Ne9 Qork "3o(k 1arke3 and on 35e o35er 9orld 1arke3" on #9 O(3ober #9%7.8or 35e 8unda1en3ali"3".IESE Business School-University of Navarra . 35ere (o1e" a day 95en 35ere are no 1ore 3ru"3ing inve"3or" le83 and 35e bubble bur"3" and vani"5e"+ "5are" re3urn 3o 35eir 8unda1en3al value.

For 35i". and Polaroid:" 8ro1 90 3o #L.3o R/0. In 35e ele(3roni( (o1panie": bubble.5ere 1any (5ar3i"3" (an be in(luded. *5e "3ory i" al9ay" 35e "a1e+ pri(e" 3e1porarily ro(ke3 up9ard" and 35en re3urn 3o Fnor1alG level". "o 8ar. and 5ou"e5old na1e (o1panie" 35roug5ou3 35e 70:". 35e 3ulip": pri(e re3urned 3o nor1al level" and 1any people 9ere ruined. *5i" 1ean" being able 3o "epara3e 35e "5are pri(e in3o 39o (o1ponen3" .in #9L# 3o R&00 in #9L2S and *e0a" In"3ru1en3": "5are pri(e 8ell 8ro1 R200. i" 35a3 i3 provide" an ingeniou" e0plana3ion 3o a((oun3 8or even3" a po"3eriori bu3 i3 i" no3 very u"e8ul 8or providing 8ore(a"3" abou3 35e (our"e 35a3 "5are pri(e" 9ill 8ollo9 in 35e 8u3ure. 1/$ Most Valuations CoAAon Errors in *5e 8ollo9ing li"3 (on3ain" 35e 1o"3 (o11on error" 35a3 35e au35or 5a" de3e(3ed in 35e 1ore 35an one 35ou"and valua3ion" 5e 5a" 5ad a((e"" 3o in 5i" (apa(i3y a" bu"ine"" (on"ul3an3 or pro8e""or ./< . 95o appeal 3o e"o3eri( 3enden(ie" and 35e 8ooli"5ne"" or ra"5ne"" o8 o35er inve"3or".. 200L. *5e proble1 9i35 35i" 35eory.u"3 one year.u"3 a 8e9 e0a1ple". !n unu"ual "3rain o8 3ulip" began 3o be(o1e in(rea"ingly "oug53 a83er and i3" pri(e ro"e (on3inuou"ly. all 35e bubble" 5ave even3ually bur"3. 3o give . 1any (o1panie": "5are" in #9L2 9ere 9or35 le"" 35an 20T 95a3 35ey 9ere 9or35 in #9L#. *5ere 5ave al"o been 1any "pe(ula3ive bubble" in 35e real e"3a3e bu"ine"". In 35e pro(e"".. )pe(ula3ive bubble" (an al"o develop ou3"ide o8 35e "3o(k 1arke3."ee Fernánde and Carabia". We (an 8ind re(en3 e0a1ple" in )pain in #974 and in 35e B)!+ ele(3roni( and 5ig5E3e(5 (o1panie" in #9L2. In 35e end. 1any inve"3or" 95o 3ru"3 35a3 35e pri(e 9ill (on3inue 3o ri"e lo"e a lo3 o8 1oney. )ony:" 8ro1 92 3o #7. W5a3 35e 35eory doe" re1ind u" i" 35a3 35e bubble (an bur"3 a3 any 3i1e. 9e 9ould need 3o kno9 5o9 3o de3e(3 35e bubble and predi(3 i3" 8u3ure (our"e. *5e only "ure re(ipe 3o avoid being 3rapped in a "pe(ula3ive bubble i" 3o no3 en3er i3+ 3o never buy 95a3 "ee1" 3o be e0pen"ive.+ IESE Business School-University of Navarra . Ugood (on(ep3U (o1panie" in #970. Ki"3ory "5o9" 35a3.*5i" bur"3ing o8 a "pe(ula3ive bubble i" no3 a ne9 p5eno1enon in 5i"3ory. a" 9i35 1any o8 35e e(ono1i( in3erpre3a3ion".35e 8unda1en3al value and 35e bubble. 7ven larger 9a" 35e bubble 35a3 gre9 in #970 around 35e Ugood (on(ep3U (o1panie"+ "everal o8 35e1 lo"3 99T o8 35eir value in 35e "pa(e o8 .. One o83enE=uo3ed e0a1ple i" 35 35a3 o8 35e >u3(5 3ulip" in 35e #7 Cen3ury. even i8 advi"ed 3o do "o by (er3ain Ue0per3"U. Kou"e5old na1e (o1panie" al"o "u88ered "evere drop" in 35eir "5are pri(e" during 35e 70:"+ 4(>onaldJ" P7R 8ell 8ro1 %& 3o 9. I'4:" "5are pri(e 8ell 8ro1 RL00. and kno9ing 35e nu1ber o8 inve"3or" 95o 3ru"3 35a3 35e bubble 9ill (on3inue 3o gro9 .

B "aluing all the different businesses of a diversified company using the same W !! #same leverage and same $e%. using the beta of the acquiring company. 4B Odd o ad/ho# %o !ulaeB )B C on& t eat!ent o% #ount * isk +B 'ot considering the country risk.!onsidering the increase in the company(s cash position or financial investments as an equity cash flow.B "onside in& net in#o!e as a #ash %lo<B 3B "onside in& net in#o!e plus dep e#iation as a #ash %lo<B BB E o s <hen valuin& seasonal #o!panies +B Wrong treatment of seasonal working capital requirements. t!( (. 2B "al#ulatin& the CA"" assu!in& a #e tain #apital st u#tu e and dedu#tin& the outstandin& debt % o! the ente p ise valueB 7B "al#ulatin& the CA"" usin& book values o% debt and equit*B +. 0B $sin& dis#ount ates lo<e than the isk/% ee ateB -B $sin& the statuto * ta' ate5 instead o% the e%%e#tive ta' ate o% the leve ed #o!pan*B . 0B C on& t eat!ent o% seasonal debtB "B E o s due to not p oje#tin& the balan#e sheets +B )orgetting balance sheet accounts that affect the cash flows.!he Aost coAAon errors are in italic 50 E**$* i) t!( 'i c$u)t *at( ca#cu#ati$) a)' c$)c(*)i).B A &uin& that the best esti!ation o% the beta o% a #o!pan* % o! an e!e &in& !a ket is the beta o% the #o!pan* <ith espe#t to the SHP . t!( c$4+a)y? *i >i)( AB C on& isk/% ee ate used %o the valuation +B $sin& the histo i#al ave a&e o% the isk/% ee ateB 4B $sin& the sho t/te ! 8ove n!ent ateB 0B C on& #al#ulation o% the eal isk/% ee ateB BB C on& beta used %o the valuation +. 4B $sin& the histo i#al beta o% the #o!pan* <hen the esult &oes a&ainst #o!!on senseB 0B Assu!in& that the beta #al#ulated % o! histo i#al data #aptu es the #ount * iskB -B Using the wrong formulae for levering and unlevering the beta. 4B The equi ed !a ket isk p e!iu! is equal to =e oB 0B Assu!e that the equi ed !a ket isk p e!iu! is the e'pe#ted isk p e!iu!B DB C on& #al#ulation o% CA"" +B C on& de%inition o% CA""B 4B The debt to equity ratio used to calculate the W !! is different from the debt to equity ratio resulting from the valuation. 4B "onside in& an asset evaluation as a #ash %lo<B 0B Inte est e'penses not equal to D :dB DB Exaggerated optimism when forecasting cash flows /> .B "al#ulatin& the CA"" usin& st an&e %o !ulaeB EB C on& #al#ulation o% the value o% ta' shields +B &iscounting the tax shield using the cost of debt or the required return to unlevered equity. $* "$*(ca ti). when the result goes against common sense. . 0B Errors in the calculation of the taxes that affect the )!). Using the historical industry beta. 3B "onside in& that CA"" / >+/T@ is a easonable etu n %o the #o!pan*1s stakeholde sB 6B Using the wrong formula for the W !! when the value of debt is not equal to its book value. arguing that it is diversifiable. -B Expected Equity !ash )lows are not equal to expected dividends plus other payments to shareholders #share repurchases*% . 4B Wrong treatment of stocks that are cash equivalent. "B C on& !a ket isk p e!iu! used %o the valuation +B The required market risk premium is equal to the historical equity premium... or the average of the betas of similar companies.. 4B Assu!in& that a disaste in an e!e &in& !a ket <ill in# ease the beta o% the #ount *1s #o!panies #al#ulated <ith espe#t to the SHP ..B 3B When valuing an acquisition.IESE Business School-University of Navarra .+(ct(' ca ! "#$% AB C on& de%inition o% the #ash %lo<s +B )o &ettin& the in# ease in Co kin& "apital Requi e!ents <hen #al#ulatin& #ash %lo<sB 4.B 0B Assu!in& that an a& ee!ent <ith a &ove n!ent a&en#* eli!inates #ount * iskB -B Assu!in& that the beta p ovided b* Ma ket 8uide <ith the Bloo!be & adjust!ent in#o po ates the illiquidit* isk and the s!all #ap p e!iu!B .B Odd #al#ulations o% the #ount * isk p e!iu!B 8B In#ludin& an illiquidit*5 s!all/#ap5 o spe#i%i# p e!iu! <hen it is not app op iate +B In#ludin& an odd s!all/#ap p e!iu!B 4B In#ludin& an odd illiquidit* p e!iu!B 0B In#ludin& a s!all/#ap p e!iu! equal %o all #o!paniesB -0 E**$* %!() ca#cu#ati).

Aot usin& the #o e#t %o !ulae <hen the value o% debt is not equal to its book valueB +ncluding the value of real options that have no economic meaning. +. t!( &a#uati$) AB !onfusing "alue with /rice..versa. that are inconsistent with the economic environment. the industry outlook. "B Involvin& onl* the %inan#e depa t!ent in valuin& a ta &et #o!pan*B +B 4B 0B -B . 4B Using real cash flows and nominal discount rates. DB Othe #on#eptual e o s Aot #onside in& #ash %lo<s esultin& % o! %utu e invest!entsB "onside in& that a #han&e in e#ono!i# #onditions invalidates si&ned #ont a#tsB !onsidering that the value of debt is equal to its book value when they are different. BB Asse tin& that Lthe valuation is a s#ienti%i# %a#t5 not an opinionMB "B A valuation is valid %o eve *bod*B DB company has the same value for all buyers. +0B "onside in& that the ROA is the etu n o% the debt and equit*holde sB +-B $sin& di%%e ent and in#onsistent dis#ount ates %o #ash %lo<s o% di%%e ent *ea s o %o di%%e ent #o!ponents o% the % ee #ash %lo<B +.? a t and .B In !atu e #o!panies5 assu!in& p oje#ted #ash %lo<s that a e !u#h hi&he than histo i#al #ash %lo<s <ithout an* &ood easonB ++B ssumptions about future sales. 0B The % ee #ash %lo< and the equit* #ash %lo< do not satis%* E") I )") D JD K Int >+/T@B BB E o s <hen usin& !ultiples +B Using the average of multiples extracted from transactions executed over a very long period of time.a)i@ati$)a# (**$* AB Makin& a valuation <ithout #he#kin& the %o e#asts !ade b* the #lientB BB !ommissioning a valuation from an investment bank without having any involvement in it. 4B Using the average of transactions multiples that have a wide scatterB 0B $sin& !ultiples in a <a* that is di%%e ent to thei de%initionB -B $sin& a !ultiple % o! an e't ao dina * t ansa#tionB .B 3B 6B 2B IESE Business School-University of Navarra ./= . +4B !onsidering that the -..? s#ien#eMB <0 O*. EB "on%usin& st ate&i# value %o a bu*e <ith %ai !a ket valueB )B !onsidering that the goodwill includes the brand value and the intellectual capitalB 8B )o &ettin& that a valuation is #ontin&ent on a set o% e'pe#tations about #ash %lo<s that <ill be &ene ated and about thei iskinessB 9B A%%i !in& that Na valuation is the sta tin& point o% a ne&otiationMB IB A%%i !in& that Na valuation is . etc.B Appl*in& a dis#ount <hen valuin& dive si%ied #o!paniesB 4+B C on& a bit a&e a &u!entsB 44B Addin& a #ont ol p e!iu! <hen it is not app op iateB 90 E**$* %!() i)t(*+*(ti). margins.B $sin& past !a ket etu ns as a p o'* %o equi ed etu n to equit*B +3B Addin& the liquidation value and the p esent value o% #ash %lo<sB +6B $sin& ad ho# %o !ulas to value intan&iblesB +2B A &uin& that di%%e ent dis#ounted #ash %lo< !ethods p ovide di%%e ent valuationsB +7B C on& notion o% the !eanin& o% the e%%i#ient !a ketsB 4.E is the return to the shareholders. or vice. BB The debt to equit* atio used to #al#ulate the CA"" to dis#ount the pe petuit* is di%%e ent % o! the debt to equit* atio esultin& % o! the valuationB "B $sin& ad ho# %o !ulas that have no e#ono!i# !eanin&B DB Using arithmetic averages instead of geometric averages to assess growth. )o &ettin& to in#lude the value o% non/ope atin& assetsB In#onsisten#ies bet<een dis#ount ates and e'pe#ted in%lationB (aluin& a holdin& #o!pan* assu!in& pe !anent losses ><ithout ta' savin&s@ in so!e #o!panies and pe !anent p o%its in othe sB 7B Wrong concept of the optimal capital structure.B $sin& ad ho# valuation !ultiples that #on%li#t <ith #o!!on senseB 3B $sin& !ultiples <ithout usin& #o!!on senseB "B Ti!e in#onsisten#ies +B Assu!in& that the equit* value <ill be #onstant %o the ne't %ive *ea sB 4B The equity value or the enterprise value does not satisfy the time consistency formulae. EB "al#ulatin& the esidual value usin& the < on& %o !ulaB )B Assu!e that a pe petuit* sta ts a *ea be%o e it eall* sta tsB 80 I)c$) i t()ci( a)' c$)c(+tua# (**$* AB "on#eptual e o s about the % ee #ash %lo< and the equit* #ash %lo< +B !onsidering the cash in the company as an equity cash flow when the company has no plans to distribute it. or competitive analysis.70 E**$* i) t!( ca#cu#ati$) $" t!( *( i'ua# &a#u( AB +nconsistent cash flow used to calculate perpetuity.

. Ko9 do analy"3" (on(lu"ion"[. 4(Ara9E Kill. )oren"en.%eferences 'realey.. /9.G L35 edi3ion. 7di(ione" Folio. FIaluing real op3ion"+ 8re=uen3ly 1ade error". ?oller and J. FPrin(iple" o8 Corpora3e Finan(e.2002.. K. FIalua3ion 4e35od" and )5are5older Ialue Crea3ion$G !(ade1i( Pre"".. and >. 4? .2004b.. 4a""a(5u"e33". 7&C#.G ))RN Working Paper n. 4.G Financial )nalysts %ournal. Ne9 Qork. F*5e Ialue o8 *a0 )5ield" i" NO* 7=ual 3o 35e Pre"en3 Ialue o8 *a0 )5ield". 274%//. rea(5 35eir Fernánde . Fau".. pp. ))RN Working Paper n. FIalua3ion+ 4ea"uring and 4anaging 35e Ialue o8 Co1panie"G.. FIalua3ion u"ing 1ul3iple".. Fernánde .. 2L/L0%.!.G 'iblio3e(a I7)7 de Ae"3i@n de 71pre"a". FIaluing Co1panie" by Ca"5 Flo9 >i"(oun3ing+ *en 4e35od" and Nine *5eorie". Copeland. 4iller. %9/#/#. FIn3erne3 Ialua3ion"+ *5e Ca"e o8 *erraEHy(o"G. No. Jo"ep .July.2004.C. . R. and ). L0EL9.2000.G %ournal o& (usiness.200#(. 4urrin . Iol. F9L Co11on and Bn(o11on 7rror" in Co1pany Ialua3ion. Fernánde .. 274972. Willia1"on . 4/#E4L%.G %ournal o& Financial Econo'ics. Reading.G ))RN Working Paper n. 2/L9%7. C!. Fernande . *. 4#. o(3ober..#99L. Pablo . 4yer" .. Pablo . pp. Pablo . .G ))RN Working Paper n. FFinan a" opera3iva". *. Pablo . Fernánde . Pablo and Jo"e 4aria Carabia" . Ne9 Qork.#9%%. Wiley.#9%/. FFinan(ial *5eory and Corpora3e Poli(y$G &rd edi3ion.K. Pablo .!. Copeland and We"3on . Fernánde .IESE Business School-University of Navarra .200#a. F)o1e eviden(e on 35e value o8 35e dividend di"(oun3 1odel.. Fernánde .. F'e5avioral Ra3ionali3y in Finan(e+ *5e Ca"e o8 >ividend".200L.U ))RN Working Paper n..2000.200#b. #4/E#L/. &rd edi3ion. 7. pp.#9%L. !ddi"onE We"ley. )an >iego. Pablo . 7.