Asset-Based Valuation

Asset has been defined by the industry as transactions that

would yield future economic benefits as a result of past
transactions.

Hence, the value of investment opportunities is highly

dependent on the value that the asset will generate from now
until the future. The value should also include cash flows that
will be generated until the disposal of the asset.
Since the entire company is driven by its asset base, the value of the
company can be best attributed to the value of its asset.
The advantage of using this approach is it enables the analyst to
validate the firm through the value of its asset. However, this only
focuses on the current and historical value of the asset and will
disregard the value it can generate in the future and may not fully
represent the true value of the asset.

In asset-based valuation, familiarity with the GAAP is a key attribute for

an analyst to enable them to establish the value. Asset-based valuation
can be used if the basis of the value is concretely established and
complete. Information required for asset-based valuation include total
value of the assets, the financing structure (i.e total liabilities and total
equity) classes of equity and other sources of funding.
Popular methods used to determine the
value using assets as its bases are:

• Book value method

• Replacement value method
• Reproduction value method
• Liquidation value method
Book Value Method
Can be defined as the value recorded in the accounting records of a company.
The book value is highly dependent on the value of the assets as declared in the
audited financial position. IAS no. 1 requires that the statement of financial
position to summarize the total value of its assets, liabilities and equity of a firm.

The assets are required to be categorized into current and noncurrent assets;
liabilities is also categorized as current and noncurrent liabilities.
In the book value method, the value of the enterprise is based on the book value
of the asset less all non-equity claims against it. Hence, the formula is as follows:
Replacement Value Method
The National Association of Valuators and analysts has defined the replacement
cost as the cost of similar assets that have the nearest equivalent value as of the
valuation date.

Under the replacement value method , the value of the individual assets shall be
adjusted to reflect the relative value or cost equivalent to replace that asset. The
following are the factors that can affect the replacement value of an asset:
• Age of the asset- It is important to know how old the asset is. This will enable
the valuator to determine the cost related in order to upkeep a similarly aged
asset and whether assets with similar engineering design are still available in
the market.
• Size of the assets- This is important for fixed asset particularly real where asset
of the similar size will be compared. Some analysts find that the asset can
produce the same volume for the assets of the same size.
 • Competitive advantage of the asset- Asset which have distinct characteristics
are hard to replace. However, the characteristics and capabilities of the distinct
asset might be found in similar, separate assets. Some valuators combine the
value of the similar, separate assets that can perform the function of the
distinct asset being valued.
There is a specific discipline in determining the replacement value. Appraisers have
their own technique to determine the replacement value. Insurance company use
the replacement value in determining the appropriate insurance premium to be
charged to their clients.
Reproduction Value Method
It is an estimate of cost of reproducing, creating, developing or manufacturing a
similar asset. The reproduction value method requires reproduction cost analysis
which is internally done by companies especially if the assets are internally
developed . Hence, this method is useful when calculating the value of new or
start-up business, ventures that use specialized equipment or assets, firms that are
heavily dependent on tangible assets and those with limited market information.
While, this is a convenient approach, the challenge of using reproduction value
method is the ability to validate the reasonableness of the value calculated since
there are only limited sources of comparators and benchmark information that can
be used.
Reproduction Value Method
Steps in determining equity value using the reproduction value method:
1. Conduct reproduction costs analysis on all assets
2. Adjust the book values to reproduction costs values (similar as replacement
value)
3. Apply the replacement value formula using the figures calculated in the
preceding step.
To illustrate using the information of Grapes and Vines Corp., supposed that it was
noted that the 80% if the total noncurrent assets cheaper by 90% of the book value
when reproduced. 20% of the total noncurrent assets are comprised of goodwill
which upon testing was proven to be valued correctly.
Reproduction Value Method
1. Conduct reproduction costs analysis on all assets

80% of the Total Noncurrent Assets if reproduced is equal to 90% of its value

Noncurrent assets Php 1,000,000,000

% of affected item 80%
Php 800,000,000

• Since the remaining 20% or Php 200 million is goodwill an already in its
proper value, it will not be adjusted.
Reproduction Value Method
2. Adjust the book values to reproduction costs values

Noncurrent assets Php 800,000,000

Reproduction cost estimate 90%
Reproduction Cost Php 720,000,000

Noncurrent Assets - Reproduction Cost Php 720,000,000

Add: Goodwill 200,000,000
Total noncurrent assets Php 920,000,000
Add: Current assets 500,000,000
Total Assets Php 1,420,000,000
Reproduction Value Method
3. Apply the replacement value formula using the figures calculated in the
preceding step.
Liquidation Value Method
It is an equity valuation approach that considers the salvage value as the value of
the asset. This assume that the reasonable value for the company to be purchased
is the amount which the investors will realize in the end of its life or the value of the
when it is terminated. While the value it provides is the most conservative, the
limitation of this approach is that the future value is not fully incorporated in the
calculated equity value.
Tools Used in Asset-Based
Valuation
Module 7: Valuation and Concepts
Lecture/Content
• Tools Used in Asset-Based Valuation
• Financial Models in Going Concern Business Opportunities
• Steps in Developing Financial Models:
• Gather Historical Information and References
• Establish Drivers for Growth and Assumptions
• Determine the Reasonable Cost of Capital
• Execute the Formulae to Compute for the Value
• Make Scenarios and Sensitivity Analysis Based on the Results
• Components of Financial Model
• Summary
Tools Used in Asset-Based
Valuation
Tools Used in Asset-Based Valuation
Valuation is a sensitive and meticulous task for every analyst and investors. This
activity must account for all drivers of growth and risks. It was discussed that the
value of the asset is an important representation of the value of the firm, and
effectively a good reference for the value of the stake of the creditors and more
importantly the investors or stockholders.
Since the process would require incorporation of a lot of factors, there are tools
that can be used to facilitate the calculation. These tools will enable us to execute
the formulae and fundamentals that are necessary to determine the value and at
the same time to determine the share from the company.
It is always discussed what formula can be used to determine the value but it is also
important to know what are the sources of information that can serve as
reasonable inputs and estimates in order to quantify the value that will be
generated in the future.
Tools Used in Asset-Based Valuation
Valuation can be calculated manually with the use of pen, paper or just calculators.
There are investors that uses multiples as ballpark figures. Ballpark figures are
quantitative drivers or multipliers that allow the investors to quickly make an
estimate or offer. Usual multiples used are P/E ratio or EBITDA multiples.
The limitation of using ballpark figures is that these are mere estimates and certain
information where not included. Although ballpark figures and quick computation
are enough reference for risk seeking and risk neutral investors. Then again, parties
will still be negotiating for the amount acceptable between them based on their risk
and returns that they are recognizing.
Since there are a lot of limitation of ballpark figures, sanitary checks or measures
are needed to be administered. Financial ratios, multiples and estimates are needed
based on financial reports validated through due diligence. Still, in practice, the
most popular is the discounted cash flows. Since discounted cash flows are heavily
dependent on long-term projections, electronic spreadsheets were used to develop
financial models.
Tools Used in Asset-Based Valuation
Financial Models are mathematical models designed to aid in coming up with a
recommended decision and at the same time can be used to validate the assumptions
made. Hence, it must be clear and auditable. It is like a financial plan or quantification of
strategies and operating plans of the enterprise, which is used to facilitate the following:
• determination of asset value or enterprise value and equity value
• identification of risk
• development of scenarios and sensitivities

It is similar to budget but the difference is that financial models are usually longer in terms
of the period, more conservative and designed to determine the value and not the
financing requirements of the firm. Although nowadays, companies started to be more
conservative in the financial plan that they use, they also use financial models to enable
them to identify and incorporate the risks and facilitate the development of other
scenarios that win enable there to make the plan more implementable.
Financial Models in Going
Concern Business
Opportunities
Financial Models in Going Concern
Business Opportunities
Financial Modelling is a sophisticated and confidential activity in a
company or for an analyst. Information can also be considered as
competitive advantage of a company or a person. Most of the
companies hire financial modellers to assist them in determining the
value of GCBOs or any opportunities. They also have them to validate
their ballpark estimate and may also be used to determine their
impairments. Most financial modellers have extensive financial
acumen and vast knowledge and experience. Financial modellers
normally are economists, financial managers and accountants.
Management accountants are good candidates for this role given
their ability to understand operational models and design long term
financial strategies.
 Financial Models in Going Concern
Business Opportunities
In order to develop financial models, the following steps are needed to
be observed:
1. Gather historical and market information and references
2. Establish drivers for growth and assumptions
3. Determine the reasonable cost of capital
4. Execute the formulae to compute for the value
5. Make scenarios and sensitivity analysis based on the results
Steps in Developing
Financial Models
I. Gather Historical Information and
References
Historical information must be made available before the financial
model is to be constructed. Historical information may be generated
from, but not limited to the following: audited financial statements,
corporate disclosures, contracts, and peer information.
Audited Financial Statements are the most ideal reference for the
historical performance of the company. The components of the
audited Financial Statements enable the analyst or the financial
modeller to assess the future of the company based its past
performance.
 I. Gather Historical Information and
References
Statement of Income is used to determine the historical performance.
Statement of Financial Position is used to determine the book value of the assets
and the disclosed stakes of the debt and equity financiers.
Statement of Cash Flows illustrates how the company is historically financing its
operations and investments.
Statement of Changes in Stockholder’s Equity provides the information on how
much is the claim and dividend background of the company.
One of the most important components of the financial statements are the Notes
to the Financial Statements. It provides the summary of important disclosure that
should be considered in the valuation. The financial modeller must be able to
quantify these disclosures and more importantly, the risks involved.
 I. Gather Historical Information and
References
Corporate disclosures are also key in developing the financial model. Corporate
disclosures provide more context for the future plans and strategies of the company. This
will enable the analysts or the financial modellers to identify the risks about the GCBO
and quantify them accordingly. Since these are available to the public, it is the same
information that is known to others. The difference among the modellers are their
personal appreciation to risk and their client's appetite for risks.
Contracts are formal agreements between parties. In valuing the GCBOs, it is important
for the modeller to also know the existing contracts and the covenants. Large accounting
firms offer transaction advisory services to assist their clients entering into new ventures.
Due diligence is necessary to verify any contingent liability and other legal risks
surrounding that opportunity and quantify it accordingly to have a more conservative
value. The modeller must be able to classify the probability of these from occurring. But
what is more important is to gather the information to have a reasonable basis to
quantify and incorporate it in the financial model.
 I. Gather Historical Information and
References
Peer information and other public information are also essential inputs to the financial
model. Peer information provides more context and even supports the risks identified or will
be assumed in the valuation process. Peers may be the other analysts, industry experts and
other consultants. Internal members of the organization may also be considered as peers.
However, the information sharing is restricted by law since these are insider information and
is not fair for the public. Researches and studies can also be used as peer information. In the
Philippines, reliable sources could be the National Library and Philippine Institute on
Development Studies. Researches and studies shared through conventions and forums will
also be relevant inputs in the development of the financial model and in valuation.
Collectively, the financial model must be able to filter the information that would be
necessary for the valuation. Relevance and reliability of information are important. Not all
information should be given consideration. Materiality is another consideration. Even if there
are additional information gathered, there should be a sense of materiality assessment
involve. Note that projections remain to be estimates. Therefore, only relevant cash flows
should be considered in the valuation.
II. Establish Drivers for Growth and
Assumptions
Once all relevant information were gathered and validated, drivers
and assumptions can be established by conducting financial analysis.
Drivers are suggested to be those validated and is represented by
authorities like government or experts. Growth drivers are normally
based on population, since most of the businesses are consumer
goods.
If services, industry growth may be used as a driver. In the Philippines,
information is available from the Philippine Statistics Authority.
Because the government needs to be transparent to its citizens. it
fortunate that the information can be found in the government
website or is disclosed to public through media with wider reach and
scale.
II. Establish Drivers for Growth and
Assumptions

For other economic factors, drivers, and estimates, Bangko Sentral ng Pilipinas and
National Economic and Development Authority are also other agencies that can be
relied into. Certain statistical information can also be found from the websites or
research of the Local Government and National Government Agencies. Research
organizations may also be used however strong validation and evaluation needs to
be done to isolate any form of biases that may affect the value.
II. Establish Drivers for Growth and
Assumptions
The usual growth indicators used are: inflation, population growth, GNP or GDP
growth. In economics, the inflation is the result of the movement of prices from a
year to another. This is calculated by comparing the movement of the price of the
basket of commodities from a year to another or a period to another. Inflation is
computed using this formula:
II. Establish Drivers for Growth and
Assumptions
The consumer price index represents the price of the basket of
commodities for a particular period. In financial modelling, you need
the inflation to be used as driver for certain operating and capital
expenditures. There are two ways to calculate the value: (1) nominal
and (2) real. Nominal financial models are already in current prices
meaning the prices stated in the model already assumes that the
prices grew or decline, in the case of inflation or deflation
respectively. Some uses the headline inflation to determine the
current price. Real financial model, on the other hand, does not
include the effect of changes in prices, but rather preserve the price
of operating expenses and capital expenditures, as if no changes in
prices occur. If the financial model is in real prices the cost of capital
should also excludes the effect of inflation.
II. Establish Drivers for Growth and
Assumptions
With the given equation, to illustrate, that in year 2019 the CPI is 151
meaning the cost of the basket is Php151. In year 2020, the CPI
published is Php155. Obviously the price of the basket grew, hence,
inflation is on n the other hand, if the CPI expected to be 2.64%
[(155/151 )-1 x 100%]. On the other hand, the CPI published for 2020 is
Php149, then it will be a deflation or decrease in prices at 1.32%
[(149/151) - 1 x 100% ].
To illustrate its application, supposed you are projecting for how
much is the communication costs for 2021 when the cost in 2020 is
Php5 Million. Given the calculated inflation of 2.64%, the
communication costs to be incorporated in the financial model is
Php5.132 Million.
II. Establish Drivers for Growth and
Assumptions

0.0264=[(n/5M)-1]x100%
0.0264=[(n/5M)-1]
0.0264+1=(n/5M)
1.0264=(n/5M) cross multiplication
n=5M(1.0264)
n=5,132,000
II. Establish Drivers for Growth and
Assumptions
Other indicator is population growth rate. Population growth rate is factored in to
serve as a growth driver the demand of the product, particularly for the
merchandising or manufacturing business. The services sector may use the growth
rate in the businesses or the industry or sector that they are going to serve. The
formula to calculate for the population growth rate is similar with the inflation,
except that the input is the population count of a particular segment in a particular
year.
To illustrate, suppose that population in Barangay A in 2019 is 25,200. The survey is
conducted in 2020 and the population is 26,460. Using the formula of inflation to
calculate for population growth rate:
II. Establish Drivers for Growth and
Assumptions
To illustrate the application, assuming that the estimated consumption of pandesal
in Barangay A is 5 pcs average per head. If you are going to project the number of
pandesal to be sold in 2021, it will be 138,915 units computed as follows:
Current pandesal sold (26,460 x 5) 132,300
Increase in pandesal (26,460 x 5% x 5) 6,615
Total estimated pandesal 138,915
Financial ratios may be used as tools to determine the growth drivers and
assumptions. Trend analysis will also help you establish the trajectory of growth
pattern. The financial modeller must assess whether the company can sustain the
pattern otherwise it is conservative to assume a less aggressive growth. Normally
the weighted growth pattern will be considered in the long term financial
perspective. It must be assessed whether the average year on year growth will be
sustained or may be surpassed.
II. Establish Drivers for Growth and
Assumptions
To illustrate, PUP Company's historical production grows 10% per year. It is expected that in the next five years the
probability are as follows:

Scenario Rate Probability

A 5% 10%
B 10% 40%
C 15% 50%

With the given information, the weighted average growth rate to be used is 12% computed as follows:

Scenario Rate (1) Probability (2) Weighted (1) x (2)

A 5% 10% 0.50%
B 10% 40% 4.00%
C 15% 50% 7.50%
Total 12.00%
In this situation, the financial modeller can safely us the 12% for projecting sales moving forward. Hence, if the sales for
this year was reported to 8,500 units, then under the average sales computed will result to 9,520 units sold.
III. Determine the Reasonable Cost of
Capital
In determining the reasonable cost of capital, the financial modeller must be able to
use the appropriate parameters for the company. Generally, cost of debt and cost
of equity are weighted to determine the cost of capital reasonable for the
valuation. The Weighted Average Cost of Capital (WACC) can be used determine the
appropriate cost of capital by weighing the portion of the asset was funded
through equity and debt.

WACC may also include other sources of finances like Preferred Stock and Retained
Earnings.
III. Determine the Reasonable Cost of
Capital
The cost of equity may be derived using Capital Asset Pricing Model or CAPM. The
formula used is as follows:

To illustrate, the risk free rate is 5% while the market return is roving around at 11.91
%, the beta is 1.5. The cost of equity is 15.365% [5% + 1.5 (11.91% - 5%)]. If the prospect
can be purchased by purely equity alone, the cost of capital is 15.365% already.
However, if there will be portioned raised through debt it should be weighted
accordingly to determine the reasonable cost of capital for the project and to be
used for discounting.
III. Determine the Reasonable Cost of
Capital
The cost of debt can be computed by adding debt premium over the risk-free rate.

To illustrate, the risk free rate 5% and in order to borrow in an industry a premium was
considered to be about 6%. Given the foregoing, the cost of the debt is 11% (5% +6%). Now,
assuming that the share of financing is 30% equity and 70% debt and the tax rate is 30%. The
weighted average cost of capital will be computed as:

The WACC is 10%. Observe that tax was considered in the picture to factor in that the
interest incurred or cost of debt is tax deductible, hence, there is tax benefit from it. You
may also note that the cost of equity is higher than cost of debt, this is because cost of
equity are more risk s compared to cost of debt, which is fixed.
IV. Execute the Formulae to Compute
for the Value
Normally in Financial Modelling, DCF is used to calculate for the value. Since most
information already available in financial model, it can be easier to use other capital
budgeting techniques like Internal Rate Return, Profitability Index etc.
To demonstrate, Cyrus Company’s last year EBITDA reported was Php50 Million.
Historically, their sales grew by 12% every year. The plan of the company is to
purchase an asset within the year with cost of Php150 Million to enable 12% growth
in the succeeding years. Terminal cash flow was estimated to be Php250 Million. The
outstanding total liabilities of the company is Php100 Million. If the interest rate is
5.5% per year. Corporate taxes to be paid is 30% of the EBITDA. Using the 10% WACC,
the Equity Value is Php63 Million.
IV. Execute the Formulae to Compute
for the Value
 IV. Execute the Formula to Compute
for the Value
With the results, if the company has 1
Million shares, then the share price is valued
at Php63 per share. Enterprise Value is the
value of the company or the asset for this
case, calculated as present value of the cash
flows to be generated in the future.
Theoretically, Asset = Liabilities + Equity.
Hence, if you subtract the liability from the
Enterprise Value it will now be the value
stockholder from the cash flows which
remaining for the claims of the equity
stockholder from the cash flows which
known to be Equity Value. Using the
electronic spreadsheet like Microsoft Excel,
certain valuation tools or capital budgeting
techniques can easily be calculated like Net
Present Value and Internal Rate of Return.
Using the given information, the
spreadsheet can be presented as:
V. Make Scenarios and Sensitivity
Analysis Based on the Results
The advantage of having a financial model is that you can easily tweak the given information and
get the results immediately. For instance, in the previous illustration the cost of capital used is 10%.
How about if you find that cost of capital will be 1 2% or 1 5%, what will be the Enterprise Value.

If this is the case, we need to design the financial model to accommodate this through the use of
Data Table feature in Microsoft Excel. First, design a table where the values will be inputted.
V. Make Scenarios and Sensitivity
Analysis Based on the Results
Next, select the table we prepared by highlighting cells C17 to D19 and you go to
DATA Tab and go to “What If” Analysis then select “Data Table”.

Data Table Dialogue box will appear and will ask you to enter the inputs. Since the
table we are doing provides for a columnar input, then we’ll input C17 in the
COLUMN INPUT and click OK.
V. Make Scenarios and Sensitivity
Analysis Based on the Results
Then the results will now be shown to you in the table.

It will be easier for you to determine which value to use. Since, in our example the
outstanding debt is Php100 Million then you have to play in the range of Php19.86
to Php63 per share.
V. Make Scenarios and Sensitivity
Analysis Based on the Results
The scenarios will be developed based on the set of possible occurrences like level
of operating expense, mode of operations, capital expenditure development period
etc. Emerging trend is having a Risk Based
Valuation, wherein major systematic risk are incorporate such as climate change,
war, economic sabotage, pandemic etc.
Sensitivity Analysis is almost similar with Scenario Modelling. The difference is that
sensitivity analysis will have to select a driver or few drivers, ceteris paribus, and
check the degree of change it will cause to the results. Sensitivity analysis is a useful
exercise in developing ballpark estimates.
Components of Financial
Model
 Components of Financial Model
As described in the earlier part of this chapter, a financial model should be understandable, printable and
auditable. The financial model should be designed in a way that the investor or the client of the analysts or
the proponent themselves can understand the dynamics and follow the drivers to enable them to have a
better appreciation and sound judgment of the results. Please bear in mind that the results of the financial
models are just guide for the investors or even sellers of investment to determine the reasonable value.

What is a financial model used for?

● Raising capital (debt and/or equity)
● Making acquisitions (businesses and/or assets)
● Growing the business organically (e.g., opening new stores, entering new markets, etc.)
● Selling or divesting assets and business units
● Budgeting and forecasting (planning for the years ahead)
● Capital allocation (priority of which projects to invest in)
● Valuing a business
● Financial statement analysis/ratio analysis
● Management accounting
Components of Financial Model

How to Plan your model

1. Define the model’s end goal
2. Understand the timelines for both building the model and for its
useful life.
3. Determine optimal trade-off between “detail” vs. “reusability.
 Components of Financial Model

As a quick guide in developing a financial model, the following components are

recommended, particularly when using Microsoft Excel:
❑ Title Page
This provides an overview of the project being valued or assessed. This includes also
necessary information to secure the proprietary rights of the modeller or the firm he or
she is working with. It may also include data cut-off to serve as a guide to the readers.

❑ Data Key Results

This sheet summarizes the result of the study. This will serve as the dashboard to
enable the modellers to analyze the results and to facilitate the reader’s appreciation
on the results of the project. This also facilitates preparation of pertinent reports.
This also contains the valuation results, scenarios, and sensitivity analysis. Graphs can
also be found in this sheet.
Components of Financial Model
❑ Assumption Sheet
This sheet summarizes the assumption used in the model. This is normally an
input sheet where all inputs should be made. The information that can be found
in this sheet must be linked to all the output sheets like pro-forma financial
statements, supporting schedules and data key results.

❑ Pro-forma Financial Statements

This presents the 3 components of the financial statements namely: Statement
of Comprehensive Income, Statement of Financial Position and Statement of
Cash Flows. In this sheet, you can also find some key financial ratios particularly
those that has to do with financial performance and efficiency ratios.
Some modellers also find it convenient to have their valuation computation be
done in this sheet since the inputs of cash flows are already available here.
Components of Financial Model

❑ Supporting Schedules
This is like a subsidiary ledger which provides supporting computation to the
components of the pro-forma financial statements. There is no limit for the
supporting schedules. The only challenge is that the electronic financial models
consume large amount of data because of the supporting schedule.
Summary
Summary
❑ Calculating for the value of the asset has a lot of complication since there are a lot
of consideration involved. Hence, the tools are made available to facilitate the
determination of the reasonable value of the equity based on the value of its
assets.
❑ The approach could be manual or electronic/computer-assisted. Manual approach
or the conventional approval simply uses pen, paper and calculator using ballpark
figures. Electronic or computer-assisted may be done using electronic
spreadsheets or applications designed to calculate equity value.
❑ Financial Modelling is a sophisticated and confidential activity in a company or for
an analyst. Information can also be considered as a competitive advantage of a
company or a person.
Summary
❑ In order to develop financial models, the following steps need to be observed:
i. Gather Historical Information and References
ii. Establish Drivers for Growth and Assumptions
iii. Determine the Reasonable Cost of Capital
iv. Execute the Formulae to Compute for the Value
v. Make Scenarios and Sensitivity Analysis Based on the Results
❑ Financial models should be understandable, printable and auditable. Suggested
components of the financial models are: title page, data key results, assumption
sheet, pro-forma financial statements, and supporting schedules.
End of Discussion