(ee (on edah yw ui lterasy ASSET-BASED VALUATION in business, there are alot of opportunities available inthe Investors are eager to expand their portfolio by securing more a and improving their basket of investment to mitigate the risk anj ; AUS, im their returns. Most investors diversify their investment in various" opportunities, but the challenge is determining the value on how my | ct are willing to acquire it. they Asset has been defined by the industry as transactions that wg yield future economic benefits as a result of past transactions. Hence wf \alue of investment opportunites is highly dependent on the value that asset will generate from now until the future. The value should ~ aS0 includ all cash fiows that will be generated until the disposal of the asset, In practice, observe valuation as a sensitive and confidential activ in their portfolio management. Valuation should be kept confidential to ato, the company to negotiate a better position for them to acquire an ‘opportunity. Since the value of the assets will depend on its ability to ‘generate economic benefits. It is more challenging to determine the values green field investment since all shall be based on purely estimate than brown field. Recall, the green field investments are those started from scratch while brown field investment are those opportunities that either partially or fully operational. Brown field investments are those already in te going concem state, as most business are in the optimistic perspective tha they will grow in the future. Therefore, they can also be considered as going concer business opportunities (CBOs). Going concem business opportunities are those businesses that has a long term into infinite operational period. The beauty of GCBOs is that we already have a reference for the performance either on similar nature of business or from its historical performance. With this, the risk indicators can be identified easily and therefore can be quantified accordingly. The Committee of Sponsoring Organization of the Treadway Commission (COSO) suggests that risk management principles must be observed as well in doing businesses and determining its value. It was noted in their report that the benefits of having a sound Enterprise-wide Risk Management allows for the company to: (1) increase the opportunities; os (2) facilitates the management and identification of the risk fac! that affect the business; es a ee —!Seca (3) identify or create cost-efficient opportunities (4) manages the performance variability (6) improve management and distribution of resources across the enterprise; and (6) make the business more resilient to abrupt changes. ‘The importance of identifying the risk is to enable the investors to quantify the impact of the risk and/or the cost of managing these risks. Theoretically, in valuation since it is more on the economic benefits valuation to determine the asset value, the pertinent and anticipated outfiows must be included. The critical part in valuing an opportunity is determining is value as an asset for the investor or the enterprise. For GCBOs, there are different ‘approaches that can be used, the most popular are: discounted cash flows or DCF analysis and comparable companies analysis, and economic value added Discounted Cash Flows Analysis In Financial Management, it has been discussed that a way to determine the value of an investment opportunity is by determining the actual cash generated by 2 particular asset. Recall that discounted cash flows analysis can be done by determining the net present value of the Net Cash Flows of the investment opportunity. In Conceptual Framework and ‘Accounting Standards, it was discussed the that the cash flows are presented and analyzed based on their sources and activities which are categorized as operating, investing and financing. In determining the value of an asset, the cash flows are important reference or inputs. Note that in determining the value of the asset what should be included are the amount of cash that will be available for the claims of the equity owners. ‘The Net Cash Flows are the amounts of cash available for distribution to both debt and equity claim from the business or asset. This is calculated from the net cash generated from operations and for investment over time, For GCBO, the net cash flows generated will be based on the cash flows from operating and investing activities, since this represents already the amount eared or will be earned from the business and the ‘amount that is required for you to infuse in the operations to generate more profit. Theoretically, it can be equated as:Lr Free Cash Flows = Revenue ~ Operating Expe ~ Capital Expenditures AEE Mae tyars nditures — Taxes Let's bear in mind that this is cash flows ba majors and professionals, you should consider t expenditures mentioned here pertains to those Level of Eamings Before Interest, Depreciation allow the investor to determine the true value o amount it economically generated less the am advantage of EBITDA is that it already exclud cost of financing the asset, taxes you pay to t! ‘should be accounted separately, and depreci Bart ofthe capital expencitures which will be deducted separ, EBITDA Margin or the level of earnings you earn from the sales eni ab investor to have an overview ofthe opportunity they are going to wea among others. a Sed. For rm above the EBITDA , and Amortization, yy Velo: f the asset based on Aa unt youve spent, te? 5 interest that epretens he government because st? lation and amortization 4 ately as There are two levels of Net Cash Flows: (1) Net Cash Fi Firm; and (2) Net Cash Flows to Equity. The Net Cash Fiowe 1 represents the cash flows which was described in the This is the amount made available to both debt and e the company. The Net Cash Flo flows made available to the equi or the outstanding liabilities to the company, |0WS to the 10 the Finn Preceding paragraph quity claims against ws to Equity represents the amount of cash lity stockholders after deducting the net deb he creditors less available cash balance of ‘Since GCBOs is assumed to Operates in a long period of time to almost perpetuity. The risk and fetums are inherent to the ‘Opportunity ‘should also be quantified. Furthermore, the economic value that will be Generated by the assets is expected to stable after some point in time, since the projections are reliant on certain assumptions made. The challenge for the determination of the value of the asset is to also account for the economic returns that it will generate in perpetuity. This is addressed by the Terminal Value. Terminal Value represents the value of the company in Perpetuity or in a going concern environment. The convenient way to determine the terminal value or terminal cash flows is through this equation CFnMeera uae TV = Terminal Value CFn = Farthest net cash flows 9 = growth rate To illustrate, suppose that a company assumes net cash flows as follows: ‘Year| Net Cash Flows (in million Php) __| | 5.00 — 5.50 6.05 6.66 7.32 eo} lon} In the given illustration, you may note that the net cash flows are growing annually. Assuming this is a GCBO, and itis expected that the net cash flows will behave on a normal trend. The growth rate (g) is computed using compounded annual growth rate formula NCFe = net cash flows at the beginning latest net cash flows latest time Substituting the given figures the growth is computed as g= 0.10 ‘The growth rate is 0.10 or conversely 10%. In the illustration it will be assumed that the company will continuously grow by 10% from 5 year onwards. With this, the terminal value is Php 73.20 Million computed as followsTV = 73.20 The net present value of the Net Cash Flows represents the assets. It may be recalled futher that the assets are financed by gett and equity. Hence, these are the claims which are presented at the ight side of the Statement of Financial Position, under an account form of reporting the value og The discounted cash flows analysis factors in all the projecteg stream of cash flows that the project, opportunity or investment it in present ime to determine whether the investment made on this year would be less than the value it will generate in the future, that means the investment yielded an amount sufficient to cover the investment and allowing the investors to eern more. Same principle applies that the best Cpportunity is the one that wil yield the highest net present value or solely the opportunity will result into a positive amount it should be accepted Conservatively, the total outstanding liabilities must be considered and deducted versus the asset value to determine the amount appropriated to the equity shareholders. This is called the equity value, The opportunity that will result to the highest equity value is considered. NG Valuing DCF Analysis is most applicable to use when the following are available: * Validated Operational and Financial Information + Reasonable appropriated cost of capital or required rate of reun * New quantifiable information Supposed Bagets Corporation projected to generate the following for the next five years, in million pesos: Revenue | Operating Exp™ Taxes 2.88 65.01 8.36 102.17 71.52 9.19 112.38 78.67 70.11 123.82, 86.53 11.43 135.98 95.19 12.24Me eae oats “Operating Expenses exclude depreciation and amortization The capital expenditures that was purchased and invested in the company amounted to Php 100 Million. The terminal value was assumed to be computed using 10% growth rate. It was noted further that there is an outstanding loan of PhpS0 Million. If you are going to purchase 50% of Bagets Corporation, assuming a 7% required return, how much would you be willing to pay? (ron pesos Year 2 2 eee Reverse Toni] 1238] 2362 Les: Operating Expenses (exd Depredaton] 7s? 3553 ess Income Taves Paid [ 929 101] 1233 ess Capital Exp Tae [ Net Cash Flows toaco| 1950] 2145] 7500) 2596 [ 2856) fas: Terminal value T_T 556 [ree Cosh Flows wooo] 1950] zia5| 2500] a5s6| 3140 |yttply Dscount Facer OD zoo] oss[ oar] om] 076] 7 [Discounted Fre Cash Flows sono | 1a23 | aa7e[ 1926] 1980] 2356 Fre cash Flows. firm 200.00 Les: Oustanding oars 0) Free Cash Flows Equity 7000 Based on the foregoing information, the value of Bagets Corporation equity is Php 150 Million. If the amount at stake is only 50% then the amount to be paid is Php13.33 Million (Php26.65 x 50%). Comparable Company Analysis In Financial Management, financial ratios are used as tools to assess and analyze business results. Recall that one of these purposes can be used to determine the value. These financial ratios are P/E Ratio, Book to Market Ratio, Dividend Yield Per Share and EBITDA Multiple. Ratios or Multiples are useful tools for doing comparative company analysis. The advantage of having ratios and multiples is that it creates better and relevant comparison knowing that opportunities or investments have distinct drivers of their performance. Economic Value Added can also be used as a ‘comparator or as tool in comparable company analysis. Comparable company analysis is a technique that uses relevant drivers for growth and performance that can be used as proxy to set a reasonable estimate for the value of an asset or investment prospective(Rene In determining the value using comparable company ana following factors must be considered: NSIS the eae Urey + Comparators must be at least with the similar o similar industry * Total and absolute values should not be compareg + Variables used in determining the ratios must be ¢ + Period of observation must be comparable + Non quantitative factors must also be considered Perations oy he same Price - Earnings Ratio PIE Ratio represents the relationship of the m share and the earnings per share. It sends the signal the market perceives the value of the company as cor it actually earned. P/E Ratio is computed using the fo arket Valu py on how much MPAKEd to vty mula Market Value Per Share ee ne Fe Earnings Per Share To illustrate, Chandelier Co. is a listed company with the market value per share of Php12.0 and reported earnings per share ‘of Php4.0. Using the equation the P/E ratio is 3. This means that he Chandelier Company can create 3x the value of what it earns. PIE Ratio is also known as P/E Multiples or Price Mutiples To determine the value of a company, using P/E ratio. Management accountants and analysts uses P/E of the comparable company. Far instance, an Jopet Hotels and Leisure is a hospitality company. Based on the income statement of the company, it reported earnings of Php7.00 per share. Based on the listed companies under hospitality industry the average P/E ratio is 4.25. With the foregoing information, you can expect that the value of Jopet Hotels and Leisure is Php29.75 per share [Php29.75 = Php7.00 x 4.25] Book-to-Market Ratio Book-to-Market ratio is used to determine the appreciation the market to the value of the company as oppose tothe valle feported under its Statement of Financial Position. It may ber that the book values of the company are based on historical cos"MUN anes and does not purely incorporates the value of the market. However, the only limitation of this ratio is that certain values incorporated does not represent the true value of the company. Hence, further due diligence is imperative Book-to-Market ratio is computed using this equation: Net Book Value Per Share Book to Marker oot ereernae iz Market Value Per Share Book Value per share can be derived by dividing the net book value to the number of outstanding shares available to common or ordinary. Net book value is the difference of the total assets and the total liabilities, This represents the claim of the equity stockholders to the company To illustrate, Chandelier Co. reported a Book Value per share of Php36 and with a market value per share of Php12.50. The Book-to- Market ratio is 2.80 which is computed as follows: 35.0 Mu = Book to Market = ==, Book to Market = 2.80 This means that for every Php36 per share that is owned by a stockholder it is 2.8x larger than its value in the market. If Book-to-Market approach is used for comparable company analysis, the key component of the financial statement needed is the Statement of Financial Position. To illustrated, Jopet Hotels and Leisure reported a book value per share of Pnp16.5 and the hospitality industry average Book-to-Market is 0.5 then the value of Jopet Hotels and Leisure can be estimated around Php33 per share [Php33 = Php 16.50 / 0.5} Dividend-Yield Ratio Dividend Yield Ratio describes the relationship between the dividends received per share and the appreciation of the market on the price of the company. Dividend-Yield Ratio is also known as dividend multiple. Next to Price Earnings Multiple this is more popular tool because it provides the investors with the value which PEMETHODOLOGIES PETE hace een they can actually get from the company. This 's under the pri Bird-incthe-Hand Theory popularized by Myron Gordon ang ome Lintner. The theory assumes that the value of the firm is affe John the dividends the company pays. ted by The Dividend Yield Ratio (DYR) is computed using this equation Dividend Per Share DYR = Trarket Value Per Share To illustrate, Chandelier Co. declared and paid dividends of Php1.50 per share and their market value per share is Php12.50 Based on the foregoing, the dividend yield ratio is 0.12 computed as follows. Dividend Per Share Php1.50 yR= DYR = Fipi250 DYR = 0.12 This means that for every Php1.50 dividends they pay it wil translate into 12% of the market value of the equity. Using this as @ tool for comparable company analysis, DYR will works as a multiplier to the dividends per share declared by the company. ‘Suppose, that Jopet Hotels and Leisure declared Php1.5 pet share and the average dividend multiple of the similar industry, 0.047. The market value per share is then can be estimated to be around Php31.91 per share [Php31.91 = Php1.50 / 0.047] EBITDA Muttiple EBITDA or Earnings Before Interest, Taxes, Depreciation and ‘Amortization represents for the net amount of revenue after deducting operating expenses and before deducting financial fixed costs, taxes and non-cash expenses. Given the components, EBITDA can serve as a proxy of cash flows from operating activi before tax. Traditionally, cash flows from operating activitiesCerrar erered represents is computed by collections less payments for operating expenses or indirectly, net income add back depreciation and amortization and adjusted to working capital adjustments. EBITDA Multiple is determined by this equation EBITDA Multiple = Market Value per Share EBITDA per share EBITDA per share is derived by dividing EBITDA into outstanding share for common equity or ordinary share. To illustrate, Chandelier Co. reported EBITDA per share of Php6 and the market value per share being Php12.0. Given the equation the EBITDA Multiple is 2 (2 = Php12.0 + Php6.0] This means that the value of the firm to the market is 2x for every peso of EBITDA eared, In practice, others adjusted the EBITDA to incorporate costs relative to other quantified risks. This is done by adding more costs or recognizing contingent expenses to generate @ more conservative EBITDA results which will serve as river for the value of the market. To illustrate, Jopet Hotels and Leisure reported an EBITDA multiple of Php8.50 per share. The average EBITDA multiple of the hospitality industry is 3.5. Given the foregoing, the value of the equity is about Php29.75 [Php29.75 = Php8.50 x 3], To illustrate further, it also assumed that will have to procure insurance and security costs to protect the plant assets of the company. This is about Php0.5 per share. Given this additional information on the foregoing, the value of equity is Php28.0 [Php28.0 = (Php8.50 ~ Php0.50) x 3.5]. You may note that the value of the firm decreased by Php1.75 [Php1.75 — Php29.75 - Php28.0] after the risk management cost is incorporated. In summary, comparable company analysis uses tools to enable the comparison between companies given the differences in 3s — Strategy, Structure and Size. The objective is to enable the analyst or management ‘accountant to determine the value of the company based on the behavior of similar businesses in the industry that more or less captured the risks factors and other micro and macro-economic considerations.(Renee Inthe given itstration we can compare the results generated yi comparable company analysis under various tools discusseg: EBA Multicle Dividend Mutile Book to-market We can say that after using various comparative tools the price of Jopet Hotels and Leisure is between Php29.75 to Php33.00, subject to due diligence. Economic Value Added The most conventional way to determine the value of the asset is through its economic value added. In Economics and Financial Management, economic value added (EVA) is the convenient for this is assessing the ability of the firm to support its cost of capital with i's earings EVA Is the excess of the earnings ater deducting the cost of capital The assumption is that the excess shall be accumulated for the fir the higher the excess the better. The elements that must be considered in using EVA are. + Reasonableness of earnings or returns + Appropriate cost of capital The earnings can easily be determined, especially for GCBOs, based on their historical performance or the performance of the similarly situated company in terms of the 3s and risk appetite. The appropriate cost Of capital will be lengthily discussed in the succeeding chapters can beCea or ater determined based on the mix of financing that will be employed for the asset. The EVA is computed using this formula. EVA = Earnings ~ Cost of Capital Cost of Capital = Investment value x Rate of Cost Capital To illustrate, Chandelier Co. projected earnings to be Php350 Million per year. The board of directors decided to sell the company for Php1,500 Million with a cost of capital appropriate for this type of business is 10%. Given the foregoing the EVA is Php200 [Php350 — (Php1,500 x 10%}. The result of Php200 Million means that the value offered by the company is reasonable to for the level of earnings it realized on an average and sufficient to cover for the cost for raising the capital Other factors to be considered in Valuation: Once the value of the asset has been established, there are factors that can be considered to properly value the asset. These are the earning accretion or dilution, equity control premium and precedent transactions. Earning accretion are additional value inputted in the calculation that would account for the increase in value of the firm due to other quantifiable attributes like potential growth, increase in prices, and even operating efficiencies. Eamings dilution works differently. But in both cases, these should also be considered in the sensitivity analysis. Equity Control premium is the amount that is added to the value of the firm in order to gain control of it. Precedent transactions, on the other hand, are experiences, usually similar with the opportunities available. These transactions are considered risks that may affect further the ability to realize the projected earings.In determining the value of equi first. Asset based valuation Methodologies on asset based valuation are discounteq cas or DCF analysis, comparable company analysis and €Conoy added. Discounted cash flows analysis is meticulous but more Conservatins method or approach that can be use to determine the asset vais it clearly demonstrate the movement of the transactions mi Comparable company analysis is used to value the asset based op the performance of simitar companies or firms within the same industry. Ratios and multiples are good tools in order to Compare the companies apples to apples e.g. PIE ratio, Book-to-Market Rati, Dividend Yield, and EBITDA Multiple Economic Value Added is a form of income approach in determing the value of the company by determining any excess of the average earnings after deducting the cost of capital. Other valuation approaches are Earning Accretion that based the value on the incremental attributes of the Project or assets; and Equity control premium is the amount added to the value of the firm in order to gain control IS necessary t0 value the ay Set Sh flys MI val