Valuation: is the estimate of the value or worth of an asset and the company.

Value: refers to the worth of an object in another person's point of view.

Three major factors in valuation of business:

• current operations - refer to the performance of the firm in the current year
• Prospects - refer to the long-term or strategic plans of the entity
• embedded risk - refer to the risks attached to the operation of the business.

Four Types of Values:

• intrinsic value - refers to the assumption that there is a hypothetical knowledge about the
"true" or "real" characteristics of an asset.
• Going concern value - determined by going concern assumption wherein the business is
perceived to continue up to a foreseeable future time.
• liquidation value - is essential to companies with financial distress as it results in the value of
the firm after its termination and all its assets are sold in piecemeal.
• fair market value. pertains to the price which the potential buyer is willing to buy, and the
potential seller is willing to sell.

Five Roles of Valuation in Business:

• portfolio management - the importance of valuation highly depends on the investment

objectives of the investors/ financial managers managing the investment portfolio.
• Analysis of business transactions - valuation is essential specifically, to the investors in terms of
their investment decisions.
• Corporate finance - valuation is vital as it assures that corporate strategy and financial
outcomes drive maximization of a firm value.
• legal & tax purpose - valuation is also important as it assesses values of buy-in or sell out, issues
fairness opinion and etc.
• other purposes.
o Issuance of a fairness opinion for valuations provided by third party
o Basis for assessment of potential lending activities by financial institutions
o Share-based payment/compensation

Five Valuation Process:

• Understanding the business - enables the analysts to come up with assumptions which
encapsulate the business realities that affect the firm's value
• Forecasting financial performance - summarizes the financial performance or future looking
view of an entity which eventually can be used in selecting and preparing valuation methods.
• Selecting the right valuation method -
• Preparing valuation method based on forecasts - analysts will examine whether the result in
forecasting makes sense in accordance with the objectives of the firm
• Applying valuation conclusions & providing recommendations - analysts come up with
recommendations in making decisions that fit the principles of the investment.
Key Principles in Valuation:

• The value of a business can only be determined at a specific time;

• differs on the ability of an entity to produce future cash flows and is influenced by its
transferability;
• market's dictation of appropriate rate of return for investments;
• impacted by liquidity;
• underlying net tangible assets.

Risks in Valuation:

• facts that produce uncertainty of results.

• predictability
• innovations
• new entrants

Porter's Five Forces:

• industry rivalry - pertains to the rivalry of the market players in the industry.
• new entrants - acts as a barrier for the company to enter the industry.
• substitute and compliments - produces greater profitability as it makes the company's product
more unique
• supplier power – suppliers have the power to negotiate better terms on their favor
• buyer power - buyers have the power to negotiate better terms on their favor

Three Corporate Strategies to achieve Competitive Advantage:

• Cost leadership - the entity produces products at a lower cost but has the same quality as its
competitors, which enables them to price such products in the average amount in the industry.
• Differentiation - pertains to the uniqueness of the product that enables the buyer to pay for it in
a premium.
• Focus - induces that the firm select market targets and produce products that are within their
needs.

Two Lenses used to view forecasting financial performance: T

• Macro perspective - views the economic industry or environment where the firm operates.
• Micro perspective - focuses to the company's operating characteristics and financial outcomes.

Two Approaches used in forecasting financial performance:

• Top-down approach - forecasting starts from the international/national projection and applied
in the specific industry forecast
• Bottom-up approach - forecasting starts from the lower level of the company and is completed
after it is applied in the company based on its segments input.

Four Types of Investors under Portfolio Management:

 • Fundamental analysts - interested in determining and measuring the true intrinsic value of the
firm.
• Activist investors - tend to look for a firm that is improperly managed but has a potential
growth value once run properly.
• Chartists - believe that the stock prices are highly affected by how investors think and act.
• Information traders - those who depend on their investment in accordance with new
information publicized in the market.

Value Investors vs. Growth Investors (Fundamental Analysts):

• Value investors - mostly interested in buying shares that exist and for less than their true value.
• Growth investors - lean towards the growth prospects of the share and buy it at a discount.

Two Activities can be performed with the use of valuation techniques:

• Stock selections - refers to the assets value and how it relates to the prevailing intrinsic value
and price of comparable assets.
• Deducing market expectations - focuses on which estimates thus the future performance of the
firm in line with the prevailing market price of its stocks.

Three Principles encapsulated in long-term strategies:

• Relationship between value and underlying factors can be reliably measured

• Above relationship is stable over an extended period
• Any deviations from the above relations can be corrected within a reasonable time.

Sell-side analysts vs. Buy-side analysts:

• Sell-side analysts - issue valuation judgment that are contained in research reports that are
disseminated widely to current and potential clients.
• Buy-side analysts - tend to perform more in-depth analysis of a firm and engage in more
rigorous stock selection methodologies.

Passive Investor vs. Active Investor:

• Passive investors - are disinterested in valuation.

• Active investors - are interested in valuation to participate intelligently in the market.

Five Corporate Events:

• Acquisition - the buying firm wherein he needs to determine the fair value of the target
company to negotiate better terms and the selling firm should know its firm value to create
reasonableness in bid prices.
• Merger - event wherein two companies' combined their assets to form a wholly new entity
• Divestiture - sale of a major component of the business to another company.
• Spin-off - separation of a company's segment and transform it into separate legal entity.
• Leveraged buyout - acquisition of another business used as collateral.

Two aspects to be considered in preparing valuation model based on forecasts:

 • Sensitivity analysis - multiply analyses are done to know how changes on a variable will affect
the outcome.
• Scenario modelling - a firm specific issue that affects the firm value that should be adjusted by
analysts.

Three Factors that don't affect value but still has an influence:

• Control premium: is an additional value considered in a stock investment if acquiring such will
give controlling power of the investor
• Lack of Marketability Discount: the stock cannot be sold immediately as there is no available
market for it.
• Illiquidity discount: should be considered when an investor will sell a large portion of stock that
is significant compared to the trading volume of the stock.

Two Deals Analysis Unique Factors:

• Synergy - two companies merged and believed that their combined value is greater than the
sum of their separate firms.
• Control - is the change in people managing the company brought by the acquisition.

General Principles in Liquidation value:

• When liquidation value is greater than income based approach, liquidation must come into
consideration.
• If the business has a limited life, its terminal value must be based on liquidation value. The sale
of non-cash assets must be based on liquidation value because the cost of sales and taxes
reduces its value.
• Liquidation value must be used when the business continuity is dependent upon the current
management that will not stay.

Two Types of Liquidation:

• Orderly liquidation - the assets are sold strategically over an order period.
• Forced liquidation - the assets are sold immediately on the market.
•

Assets based Valuation: states that the entire company is driven by its assets base wherein the value of
the company can be best attributed to the value of its assets.

Red Flags of Aggressive Accounting:

• High Management or direct turnover

• Material non-audit services performed by audit firm
• Management pressure to meet earnings expectations
Two Types of Investments

• Green Field Investments – investment started from scratch

• Brown Field Investments – investments already in the going concern state.

Going Concern Business – business that has a long term to infinite operational period.

Benefits of Enterprise-wide Risk Management:

• Increase the opportunities

• Facilitate management & identification of the risk factors that affect the business
• Identify or create cost-efficient opportunities
• Manage performance variability
• Improve management and distribution of resources across the enterprise
• Make the business more resilient to abrupt changes

Four Methods in identifying the Value using Assets:

• Book Value – value recorded in the accounting records of a company.

• Replacement Value – cost similar assets that have the nearest equivalent value as of the
valuation date.
• Reproduction Value - estimate of cost of reproducing, creating, developing or manufacturing a
similar asset.
• Liquidation Value

Factors that Affect the Replacement Value:

• Age of the Asset -

• Size of the Assets – important for fixed assets
• Competitive Advantage of the Asset – assets have a distinct character that are hard to replace

Steps Equity Value using the Reproduction Cost:

• Conduct reproduction costs analysis on all assets

• Adjust the book values to reproduction costs values
• Apply the replacement value formula using the figures calculated in the preceding step.

Situations to consider Liquidation Value

• Business Failure – most common reason why businesses close or liquidate

o Insolvency – happens when the company cannot pay liabilities as they come due.
o Bankruptcy – liabilities become greater than asset balance.
• Corporate or Project End of Life
• Depletion of Scarce Resources

External Factors that affect Business Failure:

 • Severe Economic down-turn
• Dynamic Consumer preferences
• Material adverse governmental action or regulation
• Occurrence of natural disasters or calamities
• Occurrence of pandemic or general health hazards

Liquidation Value should be used:

• When liquidation value is greater than going concern value

• When business has finite life
• To value non-operating assets
• If business continuity depends on the current management who will not stay

Income – amount of money that the company or the assets will generate over the period.

Two Approaches in Income Based Valuation:

• Dividend Irrelevance: the return on dividend does not affect the stock price but more on the
ability of an asset
• Bird in the Hand: the return on dividend does affect the stock price

Four Factors to be considered to Properly Value the Asset:

• earning accretion - additional value input in the calculation for the increase in value of the firm
• earning dilution - reduces the value of the entity when there are future circumstances that will
affect the firm negatively.
• equity control premium - amount added to the value of the firm to gain control.
• precedent transactions - previous deals or experiences that can be like the investment being
evaluated.

Two ways to compute Cost of Capital:

• weighted average cost of capital - used to determine the appropriate cost of capital through
weighing the portion of the asset funded through equity and debt.
• capital asset pricing model - used to determine a theoretically appropriate required rate of
return of an asset.

Three approaches in determining the Value of the Cash Flow:

• Economic Value Added - convenient metric in evaluating investment as it rapidly measures the
firm’s ability to support its cost of capital using its profits.
• Capitalization of Earnings Method - determined the value of an asset using the anticipated
earnings of the company divided by the capitalization rate.
• Discounted Cash Flows Method - the most popular method in determining corporate value as it
determines the present value of the projected net cash flow of the firm.

Elements to be considered in using EVA:

• Reasonableness of earnings or returns

 • Appropriate cost of capital

Capitalization of Earnings method provides for the relationship of the:

• Estimated earnings of the company

• Expected required rate of return
• Estimated equity value

Limitation of Capitalization of Earnings Method:

• May not fully account for future cash flows

• Inability to incorporate contingencies
• Assumptions used to determine the cashflows may not hold true since the projections are based
on a limited time horizon.

Net Cash flows – amount of cash available for distribution to both debt and equity claims of the
business.

Conditions where Net Cash Flows is preferred:

• When the company doesn’t pay dividends

• When the amount paid out for dividends significantly differs to the capacity of the entity to pay
dividends
• Net cash flows and income are aligned within a reasonable forecasted period
• Investor has a control perspective

Three Factors why Net Cash Flows and its Sources are helpful to analysts:

• Source of financing for needed investments

• Reliance on debt financing
• Quality of earnings

Two Levels of Net Cash Flow:

• Net Cash Flow to the Firm – amount available to both debt and equity claims
• Net Cash Flow to Equity – amount available to equity stockholders

Three approaches to compute Net Cash flow to the Firm and to Equity:

• Statement of Cash Flows

• Net Income
• EBITDA

Basis of Terminal Value

• Liquidation Value
• Estimated Perpetual Value
• Constant Growth
• Scientific Estimates

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 return
• New quantifiable information

Steps needed to develop financial models:

• Gather historical information and references

• Establish drivers for growth and assumptions
• Determine the reasonable cost of capital
• Apply the formulae to compute for the value
• Make scenarios and sensitivity analysis based on the result

TERMINOLOGIES IN DCF

• Net Income Avail. To Common Shareholders – amount left to common shareholders after
deducting all costs
• Non-Cash Charges – non-cash items
• Restructuring Charges – change in the org. Structure of a company to adapt in changing world.
• After Tax Interest Expense – cash flow intended for the debt providers (interest expense)
• Working Capital – represents the net investment in current assets reduced by current liabilities
• Proceeds from Borrowing – amount of cash received because of borrowing loans.
• Debt Service – total amount used to service loans or debt financing.