Lesson 2 – GOING CONCERN ASSET BASED VALUATION

Unit 1 – Discounted Cash Flow Analysis

Overview:
This lesson will discuss how investors will determine how much they are willing to acquire it.
Since asset has been identified by the industry as transactions that would yield future economic
benefits as a result of past transactions. Therefore, the value of investment opportunities is
highly dependent on the value that the asset will generate from now until the future.

Learning Objectives:
After successful completion of this lesson, you should be able to:
1. Differentiate the valuation methods.
2. Describe the going concern and liquidation concern asset based approach.
3. Illustrate the capitalizing and discounted future earnings.

Course Materials:

Green field investments - those investments that started from scratch.

Brown field investments – those opportunities that are either partially or fully operational.
These are investments that are already in the going concern state, as most businesses are in
the optimistic perspective that they will grow in the future.

Going Concern Business Opportunities (GCBOs)

These are the businesses that has a long term into infinite operational period. The risk
indicators of GCBOs are identified easily as it provides reference for the performance of similar
nature of business or from historical performances.

Sound Enterprise-wide Risk Management allows the company to:

1. Increase the opportunities;
2. Facilitates the management and identification of the risk factors that affect the business;
3. Identify or create cost-efficient opportunities;
4. Manages the performance variability;
5. Improve management and distribution of resources across the enterprise;
6. Make the business more resilient to abrupt changes.

Discounted Cash Flows Analysis

This can be done by determining the Net Present Value of the Net Cash Flows of the
investment opportunity. 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. Therefore, free cash flows can be
computed as:
Free Cash Flows = Revenue – Operating Expenditures – Taxes – Capital Expenditures

Two Levels of Net Cash Flows

1. Net Cash Flows to the Firm – represents the amount of cash made available to both
debt and equity claims against the company.

5
SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS
PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA
2. Net Cash Flows to Equity – represents the amount of cash flows made available to the
equity stockholders after deducting the net debt or the outstanding liabilities to the
creditors less available cash balance of the company.

Terminal Value – represents the value of the company in perpetuity or in a going concern
environment. This can be computed as:
TV = CFn
G

TV = Terminal Value
CFn = Farthest net cash flows

g = Growth rate
NCF0 = net cash flows at the beginning
NCFn = latest net cash flows
n = latest time
To illustrate, suppose that a company assumes net cash flows as follows:
Year Net Cash Flows (in million Php)

1 5.00

2 5.50

3 6.05

4 6.66

5 7.32

Assuming this is a GCBO, and it is expected that the net cash flows will behave on a normal
trend. The growth rate is computed as:

g=
 g = 1.10 – 1

g = 0.10

TV = 7.32/0.10
TV = 73.20

DCF Analysis is most applicable to use when the following are available:
1. Validated operational and financial information
2. Reasonable appropriated cost of capital or required rate of return
3. New quantifiable information

Supposed Bagets Corporation projected to generate the following for the next five years, in
million pesos:
Year Revenue Operating Expense* Taxes

1 92.88 65.01 8.36

2 102.17 71.52 9.19

3 112.38 78.67 10.11

4 123.62 86.53 11.13

5 135.98 95.19 12.24

*Operating Expenses exclude depreciation and amortization

The capital expenditures that was purchased and invested in the company amounted to
Php100Million. The terminal value was assumed to be computed using 10% growth rate. It was
noted further that there is an outstanding loan of Php50 Million. If you are going to purchase
50% of Bagets Corporation, assuming a 7% required return, how much would you be willing to
pay?
In million pesos Year
0 1 2 3 4 5

Revenue 92.8 102.1 112.3 123.62 135.98

8 7 8

Less: Operating Expenses (excluding 65.0 71.52 78.67 86.5 95.1

Depreciation) 1 3 9
 Less: Income Taxes Paid 8.13 9.19 10.11 11.1 12.2
3 4

Less: Capital Expenditures Purchased 100.0

0

Net Cash Flow -100.00 19.5 21.46 23.60 25.9 28.5

1 6 5

Add: Terminal Value 285.50

Free Cash Flows -100.00 19.5 21.46 23.60 25.9 314.05

0 6

Multiply: Discount Factor (7%) 1.00 0.93 0.87 0.82 0.76 0.71

Discounted Free Cash Flows -100.00 18.1 18.67 19.35 19.7 222.98
4 3

Free Cash Flows – Firm 100.0

0

Less: Outstanding Loans 50.00

Free Cash Flows - Equity 50.00

Based on the foregoing information, the value of Bagets Corporation equity is Php50 Million. If
the amount at stake is only 50% then the amount to be paid is Php25 Million