Professional Documents
Culture Documents
Corporate valuation is the process and set of procedures used to estimate economic value of a business firm. It
refers to a process of determining the value of a business entity or shareholders' interest in a business Corporate
valuation gives the worth of a company.
In corporate world valuation of a firm is done for a wide variety of purposes. Corporate valuation done when a
management of a business firm is planning to sell or an individual/firm is interested in buying a business firm,
initial public offer, mergers, acquisitions, portfolio management. restructuring like spin-off, split-off equity
carve out, divestiture, settlement of disputes
Mergers and
acquisitions
Borrowings
FPO
and expansion
Why/
purpose
Capital Voluntary
restructuring assessment
Mergers and acquisitions: It becomes essential to know the value of the organization in case if the
approval is given by the shareholders for either merger or acquisition.
FPO: The Company wants to issue further public offering at the time of preparation of the prospectus and filing
of requisition note with the securities exchange Board of India, it is essential for them to do the corporate
valuation.
Voluntary assessment: Sometimes, with the lag of time the shareholders may prefer to know what is the
value at that time it becomes voluntary assessment.
Capital restructuring: In case if the company is planning for corporate restructuring through capital
restructuring, it becomes essential for them to do the corporate valuation by adopting the suitable and relevant
method.
Borrowings and expansion: If company has plans for expansion and if they are approaching the financial
Agencies for funding, the Agencies demand the organizations to go ahead with corporate valuation.
:
Assets value
Capitalized earning power
Market value
Book value
Investment value
Cost basis
Replacement cost
Assets value is the value which is used by the company at the time of acquiring a particular asset.
Capitalized earning power is the amount which is calculated by identifying the minimum amount of earnings
that a company has to make and converting it with the expected percentage of earnings without risk.
Market value is the value which the organization will obtain if the asset is been disposed off immediately.
Book value is the value which is the amount recorded in the financial statements of the company it is after
deducting the depreciation.
Investment value is understood by the money that will be obtained immediately if it is sold in the market
minus incidental expenses that are incurred in the process.
Cost basis of the basis which helps in recording the amount at the same price which was spent at the time of
purchase.
Replacement Cost is the cost which will be taken into consideration by identifying the prevailing market price
if the same asset has to be replaced by another asset.
Business Performance Selecting proper Forecast to
Conclusion
objectives forecast valuation model valuation
Business objectives: The process of corporate valuation begins with identification of the objectives of the
business as listed in the memorandum of association. It gives a broader perspective to the analysis which can be
based upon the possible growth in the near future.
Performance forecast: Performance forecast is the second most important process whereby applying certain
economic tools the possible income of the future will be assessed by the organization.
Selecting proper valuation model: Step 3 involves selecting proper valuation model by identifying the
purpose why the valuation is done.
Forecast to valuation: Setting up of certain assumptions and identifying the parameters that has be considered
for valuation and then forecasting is the major step in the process of Corporate valuation.
Conclusion: Drawing up of meaningful conclusions with clear cut guidelines is one of the important process.
There are different methods available for valuation of a business firm. The following are the
main methods:
Under this method firm value is the difference between the fair market value of the business
assets and its liabilities. Here analyst adjusts the book value of the assets to fair market value
(normally measured on the basis of replacement or liquidation value) and then reduces the total
adjusted value of assets by the fair market value of all recorded and unrecorded liabilities. Both
tangible and intangible assets are considered in determining total adjusted net assets.
Net Asset per Share = Net Assets + Number of Equity Shares Outstanding
Advantages
Realistic: It is more realistic as the shareholder will get to know the amount each share will
receive, if the company is liquidated immediately.
Easy: It is very easy to calculate as the values are readily available in the disclose financial
statements
Management targets: It is easy for management to set the targets based on the results that are
obtained by this method.
Decisions: It is easy to obtain the data to take certain relevant decisions at the Macro level.
Comparison: It facilitates comparison between the organization based on the size and also the
number of holders holding the shares.
Investor’s perception: It is easy to win the perception of the investor on a positive note if the
net value of the assets is more.
Disadvantages
Ignores time value: This method completely ignores time value and considers only the realizable and cost
value.
Assumption based: It is based on certain assumptions as the valuation of the property cannot be made on day
to day basis.
Short term requirement: It can be used on short term requirement as obsolescence is completely ignored in
this method.
Cannot be taken as basis for ROI: Since, the calculations are made using the balance sheet values it cannot be
considered as data to calculate return on investment.
Restricts expansion: Its restricts the process of expansion as expansion may topple its value.
This method is used when determination of a profitably by running business firm. , The value of a business firm
is based on the concept of 'going concern'. It refers a continuing business with profitable record. This methods
needs to estimate future earnings with a level of net earnings need to be arrived after adjusting non-recurring
extraordinary items of income and expense.
Meaning:
Capitalization of earnings is a method of determining the value of an organization by calculating the worth of its
anticipated profits based on current earnings and expected future performance.
Advantages
Easy to calculate: It is also very easy to calculate as the basis required is only pay
expected earnings and the required rate of return.
Based on return on investment: It is based on ROI as the profits and investments are
considered.
Considers fair market value: It considers fair market value as the earning ability of the
organization in the present trend is considered for valuation.
Based on the prevailing normal rate: It is based on prevailing normal rate so it is easy
to segregate between risk free and market risk Returns.
Disadvantages
Inaccurate projections: It is based on the profits that are earned by the company which
sometimes may be misleading to take up the projections.
Insufficient data: The data is insufficient as the method does not deal with identification
of any values in the balance sheet.
Buyers risk tolerance is not taken into consideration: The risk tolerance level is not
taken into consideration 9 risk premium is taken into consideration.
Market characteristics is ignored: Since market values are completely ignored the
behavior in the market is not considered under this method.
Under this method value of an asset or firm is determined based on the prices of similar assets in the market. A
relative valuation model compares a firm's value to that of its competitors to determine the firm's financial
worth. One of the most popular relative valuation multiples is the price-to-earnings (P/E) ratio. A relative
valuation model can be used to assess the value of a company's stock price compared to other companies or an
industry average.
Identify comparable companies with similar businesses, similar size, similar technology, similar geographies,
etc.
Obtain market values for those assets or company or business of comparable companies
Create multiples (ratios) using market values and financial data for these comparable companies
Control for any differences that may exist between the comparable firms and the subject of valuation, to judge
whether the value of the target is under or overvalued.
Advantages
Vast usage: This is a method which is vastly used as we have too many businesses which requires
comparison.
Simple to calculate: It is very simple to calculate as the parameters are extracted from the published
data.
Considers internal and external values: It considers internal and external values as the internal
performance is equated with regard to the market price of the shares to fetch the comparative results.
It is very objective in nature: It is very objective in nature in the sense that the comparison parameters
are well defined and the purpose of comparison is known.
Average price earnings value is considered to identify the industry standards: Average price of
earnings of similar Industries taken as the basis for comparison which makes sense to this method.
Disadvantages
Too much of assumptions: It is based on assumptions and the Limited parameters are considered for
comparison.
Dependence on demand and supply: It is purely dependent on demand and supply forces acting upon the
corporate valuation.
Overestimating market behavior: It overestimate the market behavior has Market price is one of the main
source that is used to compare the organizations.
Multiplicity of ratios Multiple ratios are used which sometimes yield rivers results with one being positive The
Other being negative.
Settings standardized procedure for longer time: Setting standardized procedure for comparison for a longer
period of time is a very difficult task under this method.
The “chop-shop” approach to valuation was first proposed by Dean Lebanon and Lawrence Speidell
of Battery march Financial Management. Specifically, it attempts to identify multi- industry
companies that are undervalued and would be worth more if separated into parts.
ADVANTAGES
Justice to profitable products: Since there is a break-up of activity profitable products can be
easily identified.
Fixes accountability: It fixes accountability on the employees who are taking care of a specific
product as performance is driven on divisional basis.
Helps in measuring human resource: It helps in measuring the human resources and
converting their time into money.
Helps in comparing with business valuation: Helps in comparing with the overall business
valuation.
DISADVANTAGES
May not be justifiable: It may not be justifiable in the long run as it leads to closing down of
certain non-performing units.
Does not consider value of assets: It does not consider the value of assets the comparison is
purely based on internal revenue performance with external market performance.
Revenue based valuation model: This model is purely concerned with revenue and does not
concentrate on any other performance.
May inflate the value of organization: Sometimes it pay increase the value of the organization
owing to breaking down of certain products.
Not ideally true value of the organization: It cannot be considered as the true value of the
organization.
Value of an asset or a business firm under this method is the sum of present value of
expected cash flows from an asset or a business firm over the select time period. Discounted
cash flow (DCF) of firm expresses the present value of the business as a function of its future
cash earnings capacity. In other words, the value of business firm depends on the ability to
generate cash, which is further influenced by the rate discount used.
This method is more suitable for firm valuation when expected future cash flows are to
be substantially different from current operations. Since cash flows are earnings of a business
firm it is also called as the Discounted Earning Method (DEM), and it is an income-oriented
approach.
Steps in DCFM
There two steps in determination of a business firm using DCFM:
1. Estimation of future earnings or cash flows of the select asset or a business firm,
2. Calculation of terminal value of select asset or a business firm.
3. Determination of weighted average cost of capital (WACC) to be used as discounting rate, lt
should be equal to the safe rate of return plus the rate for accepting perceived level of risk for
the business being valued.
4. Multiplying the cash flows (arrived in step 1 and step 2) with discounting factor to get
present value.
5. Adding the present values over the select period to get total present values of cash flows ie.
Value of a business firm.
ADVANTAGES
Target setting: Discounted cash flow model ideal is useful in setting the relevant targets that
has to be achieved in earnings by the company.
Earnings forecasting: The method insurance forecasting of earnings to beat inflation in the long
run.
Expansion: It facilitates plans of expansion by comparing the capital outlay with the cash inflow.
Profitability: It studies the profitability of the company and its sustainability with growing
inflation rate.
DISADVANTAGES
May not be justifiable: It may not be justifiable because the rates of inflation are not uniform
throughout.
Does not consider value of assets: It does not consider value of assets and expected increase
due to some kind of unforeseen exigencies.
Revenue based valuation model: It is purely based on Revenue model with the comparison of
outlay with the cash inflows and over a period of life of project.
Basis of forecasting may not be acceptable: The basis of forecasting may not be acceptable
because many external factors cannot be maintained uniformly throughout the life of the project.
Adjusted Present Value (APV) is used for the valuation of projects and companies. The value of a
project which is financed with debt funds may be higher than the project that is completely
financed with equity capital, since use of debt affects cost of capital i.e., cost of capital decreases.
Since, cost of capital is used for discounting cash flows, it will automatically turns some negative
NPV of projects into positive NPV. Hence, with the use of NPV, a project which was rejected if
financed with purely equity, but may be accepted when it is financed with the use of debt along
with equity
APV Formula:
The formula used to calculate the adjusted present value (APV) consists of two components:
1. Present Value (PV) of Unlevered Firm: Present value of an unlevered firm refers to the
present value of the firm assuming the firm did not use debt in its capital structure, i.e. is 100%
equity finance. The project FCFF are discounted using unlevered cost of capital (cost of equity)
the value of the unlevered firm can be estimated.
2. Present Value (PV) of financing Net Effects: The net benefit 'tax shield on interest' is
discounted with the cost of capital.
As studied earlier, the APV approach allows the analyst to see impact of using debt or more debt
in value of a firm or project, as well as enables us to quantify the effects of debt.
3. Add the present value of unlevered firm (arrived step 1) and present value of debt financing
(arrived in step 2) to get Adjusted Present Value of the firm..
ADVANTAGES
Equity cost based Adjusted present value method is purely based on equity and does not consider the levered
portion while calculating.
Considers abnormal instances It considers abnormal instances and exchange and sees thereby protecting the
true value.
Measures optimal capital structure It helps in company to design the optimal capital structure with maximum
possible benefits of tax exemptions
Debt equity mix to be considered It also guides the organisation in deciding the debt equity mix in the long
run.
Suitable for long run This method is ideal for long run measurement of Going Concern organizations.
DISADVANTAGES
Assumption based It is assumption based as unlevered portion is not considered for calculating.
Estimation of tax benefit Tax benefit is estimated based on the present criteria and cannot be estimated for the
future.
Probability of bankruptcy The probability of bankruptcy is taken into consideration under this method where
buy the risks associated with borrowing is slightly exuberated.
Unlevering condition It considers unlevering conditions, so the view is that it is not complete corporate
valuation it is only equity based valuation.
Direct and indirect cost It doesn't consider direct and indirect cost while calculating the corporate valuation.