Professional Documents
Culture Documents
Objectives:
1. An understanding of ‘Value’
2. The nature and scope of Valuation
3. Importance of Business Valuation and Objectives of Valuation
What is Value?
Value is the ‘worth’ of a thing. It can also be defined as ‘a bundle of benefits’
expected from it. It can be tangible or intangible.
Value is defined as:
a. The worth, desirability, or utility of a thing, or the qualities on which these depend
b. Worth as estimated
c. The amount for which a thing can be exchanged in the market
d. Purchasing power
e. Estimate the value of, appraise (professionally)
Valuation is defined as:
• Estimation (esp. by professional valuer) of a thing’s worth
• Worth so estimated
• Price set on a thing
Why Value?
Value is sought to be known in a commercial context on the eve of a transaction
of ‘buy or sell’ or to know the ‘worth’ of a possession.
When to Value?
Valuation is done for “numerous purposes, including transactions, financings,
taxation planning and compliance, intergenerational wealth transfer, ownership
transition, financial accounting, bankruptcy, management information, and
planning and litigation support”, as listed by AICPA.
We see that the corporate world has increasingly become more dynamic, and
sometimes volatile. Globalization, enhanced IT capabilities, the all-pervasive role
of the media, and growing awareness of investors have rendered the situation
quite complex. Mergers, acquisitions, disinvestment and corporate takeovers
have become the order of the day across the globe, and are a regular feature
today.
MODULE VALUATION CONCEPTS AND METHODS
Understanding the factors that determine the value of any business will pay
tangible dividends by focusing the management on ways to increase the firm’s
short and long - run profitability.
Investors in shares and companies seeking to make acquisitions need to know how
much a company is worth and how much to pay for their investment. We need to
determine ‘Value’ mainly on the following occasions:
1. Portfolio Management/transactions: A transaction of sale or purchase,
i.e., whenever an investment or disinvestment is made. Transaction
appraisals include acquisitions, mergers, leveraged buy-outs, initial public
offerings, ESOPs, buy-sell agreements, sales of interest, going public,
going private, and many other engagements.
Mergers and Acquisition: Valuation becomes important for both the parties
– for the acquirer to decide on a fair market value of the target organization
and for the target organization to arrive at a reasonable for itself to enable
acceptance or rejection of the offer being made.
2. Corporate Finance: The desire to know intrinsic worth and enhance
value is important, as financial management itself is defined as
“maximization of corporate value”. A proper valuation will help in linking
the value of a firm to its financial decisions such as capital structure,
financing mix, dividend policy, recapitalization and so on.
3. Resolve disputes among stakeholders/litigation: Divorce, bankruptcy,
breach of contract, dissenting shareholder and minority oppression
cases, economic damages computations, ownership disputes, and other
cases.
4. Taxes (or estate planning), including gift and estate taxes, estate
planning, family limited partnerships, ad valorem taxation, and other tax-
related reasons.
What to Value?
Value all assets and liabilities to know the value of ‘what we own’ and ‘what we owe’.
Assets will include both the tangibles and intangibles.
Liabilities will include both the apparent and contingent.
MODULE VALUATION CONCEPTS AND METHODS
How to Value?
There are several tools and techniques, covered in the field of valuation,
depending on what is valued. These range from simple thumb rules to
complex models.
Business Valuation:
Valuation Approaches:
Discounted Cash Flow Valuation: This approach is also known as the
Income approach , where the value is determined by calculating the net present
value of the stream of benefits generated by the business or the asset. Thus,
the DCF approach equals the enterprise value to all future cash flows discounted
to the present using the appropriate cost of capital.
Relative Valuation: This is also known as the market approach . In this
approach, value is determined by comparing the subject company or asset with
other companies or assets in the same industry, of the same size, and/or within
MODULE VALUATION CONCEPTS AND METHODS
the same region, based on common variables such as earnings, sales, cash
flows, etc.
The Profit multiples often used are: (a) Earnings before interest tax depreciation
and amortization (EBITDA), (b) Earnings before interest and tax (EBIT), (c)
Profits before tax, and
(d) Profits after tax.
Contingent Claim Valuation: This approach uses the option pricing models to
estimate the value of assets.
Asset-based approach: A fourth approach called asset-based approach is
also touted as another approach to valuation.
The valuation here is simply the difference between the assets and liabilities taken
from the balance sheet, adjusted for certain accounting principles.
Two methods are used here:
a. The Liquidation Value, which is the sum of estimated sale values of the
assets owned by a company.
b. Replacement Cost: The current cost of replacing all the assets of a company.
However, the asset-based approach is not an alternative to the first three
approaches, as this approach itself uses one of the three approaches to
determine the values.
This approach is commonly used by property and investment companies,
to cross check for asset based trading companies such as hotels and
property developers, underperforming trading companies with strong
asset base (market value vs. existing use), and to work out break – up
valuations.
Other Approaches:
The two other approaches are the EVA and Performance-based
compensation plans. Refer CPA article titled “Building Long-Term
Value” included in the Reader.
Extracts are given below:
Economic Value added (EVA): This analysis is based on the premise that
shareholder value is created by earning a return in excess of the company’s
cost of capital. EVA is calculated by
subtracting a capital charge (invested capital x WACC) from the company’s net
operating profit after taxes (NOPAT). If the EVA is positive, shareholder value has
increased. Therefore, increasing the company’s future EVA is key to creating
shareholder value.
An EVA model normally includes an analysis of the company’s historical EVA
performance and projected future EVA under various assumptions. By changing the
assumptions, such as for revenue growth and operating margins, management can
see the effects of certain value improvement initiatives.
https://www.youtube.com/watch?v=w8G3rhsWl2s
https://www.youtube.com/watch?v=3_R14_eFCOg
https://www.youtube.com/watch?v=xVtyyJPGo1o