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Business

Valuation

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My background..
wijantini@pmbs.ac.id
http://pmbs.ac.id/faculty_member/Wijantini,_Ph.D

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www.widyapresisisolusi.com

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Business Valuation
Jobs, Employment

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Jobs related to Business Valuation

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Jobs related to Business Valuation

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What did you know
about how to
evaluate a Business ?

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Did you know this Big Picture?
Sales revenues

Operating costs and taxes

Required investments in operating capital

Free cash flow


=
Investment Decision (FCF)
Business Valuation
Risk & Return

FCF1 FCF2 FCF


Value = + + + ...
(1 + WACC)1 (1 + WACC)2 (1 + WACC)

The Cost
Weighted average of Capital
cost of capital
(WACC)
Valuing Stocks
Valuing
Market interest rates Bonds Firms debt/equity mix
Cost of debt

Market risk aversion Cost of Firms business risk


equity
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Increase Cash Flows
Reduce the cost of capital

Make your
More efficient product/service less Reduce
operations and Revenues discretionary Operating
cost cuttting: leverage
Higher Margins * Operating Margin
= EBIT Reduce beta

Divest assets that - Tax Rate * EBIT


have negative EBIT Cost of Equity * (Equity/Capital) +
= EBIT (1-t) Pre-tax Cost of Debt (1- tax rate) *
Live off past over- (Debt/Capital)
Reduce tax rate + Depreciation investment
- moving income to lower tax locales - Capital Expenditures Shift interest
- Chg in Working Capital
- transfer pricing
= FCFF Match your financing expenses to
- risk management to your assets: higher tax locales
Reduce your default
risk and cost of debt
Change financing
Better inventory mix to reduce
management and cost of capital
tighter credit policies
Firm Value

Increase Expected Growth Increase length of growth period

Reinvest more in Do acquisitions


projects Build on existing Create new
Reinvestment Rate
competitive competitive
* Return on Capital advantages advantages
Increase operating Increase capital turnover ratio
margins
= Expected Growth Rate

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What is the Art of
increasing your
Business Value?
The following are 10 proven ways
to increase the value of your
company when you sell it

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How to Increase the Value of
Business

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Competing Bids (1)

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Competing Bids (2)

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Can you sell a business that is not
making money?

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Strategic Benefits for Company (2)

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Blocking Competitors (3)

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Acquiring Patents, Copyrights, etc (4)

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Access to New Markets, Customers (5)

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Rapid Growth Rate in Sales (6)

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Economies of Scale (7)

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Companys Reputation (8)

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Key Management, Employees,
Expertise (9)

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Splitting the Company into Part (10)

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Example of valuation in the real
world: Starbucks (SBUX)
2006 SBUX acquisition of Seattles Best Coffee

Internal Analysts determine the


Intrinsic Value of Seattles Best Coffee

SBUX management determines


whether the companys shares are
over- or under-valued

Wall Street security analysts to


perform valuation to determine Buy-
Sell or Hold rating and to evaluate
potential synergies

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Major Investment Decisions
We will discuss how firms evaluate investments and grow and expand through:

Project valuation: firms acquire


productive capacity by assembling
necessary assets.
Enterprise valuation: acquisitions of
entire businesses - acquiring the
productive assets of an existing firm
Common valuation tools and underlying
principles can be used for both types of
analysis.

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Project & Enterprise Valuation
We will discuss how firms evaluate investments and grow and expand through:

Project Valuation Enterprise Valuation


Rio Tinto joint venture Kraft Foods Inc. acquisition
agreement with CODELCO of Cadbury plc
for copper exploration in
Chile Walt Disney Cos
Microsoft and HP 3-year acquisitions of Marvel and
$250 million investment Pixar
into cloud computing Coca-Cola Co. and PepsiCos
Coca-Colas bottling and respective deals to acquire
distribution joint-ventures bottler operations
in China
As of July 2010, Google has
Fashion retailer Zaras acquired 76 companies
(parent company Inditex) including Doubleclick and
77 market entries across YouTube
the world including the
most recent into India.

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Valuation: Tool for Value Creation

The objective of a firm is to create wealth by


initiating and managing investments that
generate future cash flows that are worth more
than the amount invested.
Managements goal is to avoid decision errors based on
flawed or incomplete analysis
Valuation provides tools for the evaluation of new
investment opportunities
From capital budgeting to mergers & acquisitions, valuation
is more than discounting cash flows
Effective valuation analysis involves a disciplined 3-phase
investment evaluation process

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Investments that Create Value

Invest $100 million today in a project that generates a


stream of cash flows valued at $150 million.
Investment generates an incremental $50 million in wealth
for its shareholders.
The project has a net present value (NPV) of $50 million.1

1You will recall that NPV is equal to the difference between the value of expected future cash flows derived from an investment
and the cost of making the investment.

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Investments that Destroy Value

Over half of all large investment projects


fail to achieve their hoped-for results.1
Potential causes:
Managers go with their gut
Investments in risky projects
Uncertain future events
Incomplete information

1Nadim F. Matta and Ronald N. Ashkenas, 2003, Why good projects fail anyway, Harvard Business Review (September), 109114.
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Project Valuation Issues to Consider
In any situation in which a company must value a major new
investment, five key issues arise:

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Enterprise Valuation

Acquisitions involve similar issues, i.e Ciscos acquisition of Linksys.


Review the example provided in the chapter on Cisco/Linksys (pages 8-9).
Practice Assignment: Research a recent acquisition and consider the
framework of issues identified in the earlier examples.
Issue 1: Does the story make sense?
Issue 2: What are the sources of risk and can they be managed?
Issue 3: How can the investment be financed?
Issue 4: What is the short-term effect of the investments acceptance on the firms
reported earnings?
Issue 5: Dies the investment have inherent flexibilities that allow the firm to modify
it in response to changing circumstances?
Recent suggested acquisitions for consideration:
Oracles acquisition of Sun Microsystems ($7.4 Billion)
Disneys acquisition of Marvel ($4 Billion)
Pfizers acquisition of Wyeth ($68 Billion)

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Dealing with Complexity Process &
Discipline
The three-phase investment evaluation process:

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CP3 Executive Summary

CP3 Austin, TX plant is requesting $547,000 to


purchase and install a new scrap materials-
handling system for its medical-packaging
operations to:
Reduce waste in the firms packaging operations,
$300,000 savings per year
Reduce head count from the test area, $35,000 savings
per year
Recycle plastic materials that historically were part of
waste, $8,800 savings per year.
Earn a 20% rate of return on invested capital.

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CP3 Proposal, Justification, Risks &
Timeline
Proposal: CP3s medical-packaging unit expected production:
400 million vials of over-the-counter drugs this year.
Justification: Packaging of these vials will generate 1.5
million pounds of scrap plastics; 1/3 recycled, remainder
becomes scrap.
Existing system: disposal cost for 1 million pounds of scrap
plastic: $8,800 per year
New system: ground-up scrap can be sold for $300,000 per
year while eliminating the scrap disposal cost of $8,800 per
year.
Risks: stoppages
Timeline: 3 months to get the new system up and running.
Installation must coincide with existing production shifts

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CP3 Financial Analysis
These estimates span a period of 5 years ending in 2010.1

(Detailed estimates are found in Problem 2-6 at the end of Chapter 2.


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Summing Up

Process can be:


Very costly and time-consuming
Subject to biased estimates of project value
such as conflicts of interest and incentive
problems
Affected by problems arising out of differences
in the information available to project
champions and the internal review or control
group (the strategic planning committee)

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Looking Forward

Finance academics sometimes strip away


complexities to focus on what determines
value; sometimes creating a disconnect
between what should be done in theory
and what is done in practice.
Our study of valuation integrates the
analysis of individual projects and entire
enterprises along two dimensions. Both
build upon the same theoretical base.

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Summary

Valuation is more than about discounting cash flows


and determining NPV. Evaluating investments and
acquisitions has come along way.
Firms must consider:
Cash flow estimation
Risk assessment
Financing opportunities
The effects on earnings
Staged investments
Follow-on investments

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Notes:

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Looking Forward

Topic Outline
Chapters 2-3: valuation for project valuation
Chapters 4-5: cost of capital
Chapters 6-7: review and analysis of essential
accounting issues and financial statement
analysis
Chapters 8-10: valuation of the business
enterprise
Chapters 11-13: investment valuation of
options

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