Managerial

Economics - 09.02.2023

Valuations
 Recap
Defined Managerial Economics
Identify the Fields of Economics and issues
involved
Detailed the related disciplines that will be used in
the course/subject
Discuss the basic economic concepts
Supply and demand
Cost of Production
Market Competition
 Let’s Put Things in Perspective

Php75,000 Php50,000

If the buyer offers My Store a

Php180,000 in exchange of
Php25,000 the business, shall My Store
My Store take it?

Assets
Php150,000

Earnings per Year

Php35,000
 What is valuation

Valuation What is the importance of valuation

What are the different methods in Business Valuation
 Valuation

✓ is the process of determining the economic value of a business

✓ All business areas are analyzed to determine the value of the business
 Misconception about Valuation

✓ A valuation is an objective search for “true” value

✓ Truth: All valuation are biased. The only questions are “how much” and in which direction
✓ Truth: The direction and magnitude of the bias in your valuation is directly proportional to who
pays you and how much you are paid.

✓ A good valuation provides a precise estimate of value

✓ Truth: There are no precise valuation

✓ Truth: The payoff to valuation is greatest when valuation is least precise

✓ The more quantitative a model, the better the valuation

✓ Truth: Your understanding of a valuation model is inversely proportional to the number of

inputs required for the model
✓ Truth: Simpler valuation models do much better than complex ones
 Why Value a Business?

✓ Identify the sale value of the business

✓ Investment and Business Partnership decision

✓ Taxation

✓ Personal Matters such as divorce proceedings

 Basis for all valuation approaches

✓ The use of valuation models in investment decisions are based upon

✓ a perception that markets are inefficient and make mistakes in assessing value
✓ an assumption about how and when these inefficiencies will get corrected

✓ In an efficient market, the market price is the best estimate of value. The purpose of any
valuation model is then the justification of this value
 Valuation Methods
✓ Common approaches to business valuation include a review of financial statements,
discounting cash flow models and similar company comparisons.
Multiples/Market Value
✓ Works best for investors who :
• who have relatively short time horizons
• are judged based upon a relative
benchmark (the market, other portfolio
managers following the same
investment style etc.)
• can take actions that can take advantage
of the relative mispricing. For instance, a
hedge fund can buy the underovervalued
valued and sell the over valued assets. A long-
only investor cannot.
Discounted Cash Flow (DCF) or
Cost or Asset-based Approach
Intrinsic Value
✓ Works best for investors who :
✓ Works best during:
• have a long-time horizon, allowing the
• Liquidation valuation, where you are
market time to correct its valuation
valuing the assets for sale
mistakes and for price to revert to
“true” value
• Accounting valuation, where you are
valuing individual assets for accounting
• are capable of providing the catalyst
reasons (fair value or goodwill
needed to move price to value, as would
estimation
be the case if you were an activist
investor or a potential acquirer of the
• Sum of the parts valuation, to either see
whole firm
if a company is cheap as an investment
or a good target for acquisition/
• are not easily swayed or affected by peer
restructuring
pressure, i.e., market movements that
are contrary to their “value” views
 Valuation Methods
Suppose we wanted to value Company A, with earnings of Php9
Multiples Approach
Multiples Approach
Name Price Earnings P/E Multiples
An approach to
estimate the value by Company Z Php10 Php7 1.43
looking at what others Company Y Php15 Php9 1.67
are paying for
'comparable' Company X Php18 Php12 1.5
(earnings, revenues, Company V Php12 Php8 1.5
subscribers).
Company U Php13 Php7 1.86

Criteria Average 1.02

✓ Industry Group Company A’s Price per share is Php9.18, which we can compare
✓ Geography from current share price of the company
✓ Size/Financials
 Valuation Methods
Suppose we wanted to value Company A, with earnings of Php9
Multiples Approach
Multiples Approach
Name Price Earnings P/E Multiples
Set back Company Z Php10 Php7 1.43
Company Y Php15 Php9 1.67
Company X Php18 Php12 1.5
✓ Depends on
earnings Company V Php12 Php8 1.5
✓ Use of average Company U Php13 Php7 1.86
(outliers)
Average 1.02

Company A’s Price per share is Php9.18, which we can compare

from current share price of the company
 Valuation Methods
Intrinsic CFt = Cash Flow in the Period
Value/Discounted r = the interest rate or discount rate
Cash Flows t = the period number

✓ relates the value to Suppose we wanted to value Company B

its capacity to
generate cash flows Discounted Cash Flow (DCF) Approach
and the risk in
Year 1 2 3 4 5
these cash flows
✓ Focuses on the Cash Flow 100.00 110.00 121.00 133.10 146.41
company’s internal 92.58 93.43 94.29 95.16
Present Value at 9% 91.74
operation as
opposed to
external factors Valuation 467.21
✓ Finding the value
of a company
today based on
Additional Information: (1) Discount rate is at 9%
income projections
in the future
 Valuation Methods
Value of Company = Value of Assets – Value of Liabilities
Cost Approach
(Replacement Cost) Can use:
- Book values from Statement of Financial Position
✓ Common in real - Net Realizable Value
estate - Replacement Cost

✓ The value of the

business is the Supposed we are to value a building; the valuation is as follows:
cost to replace it
with an Valuation = Replacement Cost – Depreciation Cost + Land
equivalent new
one Replacement Cost = Cost of material and Labor to construct a
new house
✓ Works best in
tangibles Replacement Cost = Cost of material and Labor to construct a
new house
 Football
Field Chart
Used to analyze the company
valuation

Multiples Approach
Pros • Easy to do
• Based on similar, listed
companies
• Includes impact of brand
• Widely used and accepted
Cons • Hard to find comparables
• Relies on proxy P/E ratio
• Uses historic earnings
• Needs adjustment for non-
marketability
Pros & Cons
Discounted Cash Flow (DCF)
Approach (Intrisic Value)
• Doesn’t depend on external
factors
• Very detailed
• Includes forecasted growth
• Uses cash flows, not profits
• Time Consuming
• Relies on forecasts or heavily
assumption-based (base, best,
worst)
• Complex
• Heavily reliant on cost of
capital
Cost Approach
• Quick and Easy to do
• Can set a minimum price
• Valid for loss-making
companies
• Hard to get exact cost (may
be outdated)
• Ignores intangibles
• Not forward-looking
 Valuation Methods
Intrinsic Value/Discounted Cash Flows

1. Forecast free cash Step 1: Forecast free cash flow:

flow
2. Calculate the FCF – Cash flow available to both debt and equity holders after
Weighted Average the business pays of for everything it needs to continue operating
Cost of Capital
(WACC) – discount Formula:
rate to be used
3. Calculate the FCF = EBIT * (1 – tax rate)
Terminal Value + Depreciation and Amortization
4. Discount the Free - Capital Expenditures
Cash Flow and - Increase in non-cash working capital
Terminal Value
5. Get the Equity Non-cash working capital = Current Assets – cash – current liabilities
Value
 Valuation Methods
Intrinsic Value/Discounted Cash Flows

1. Forecast free cash Step 2: Calculate WACC

flow
2. Calculate the
Debt Cost of Debt Interest Payments
Weighted Average
Cost of Capital
(WACC) – discount Capital Cost of Equity Expected return
rate to be used
3. Calculate the
Terminal Value
4. Discount the Free
Cash Flow and
Terminal Value
5. Get the Equity
Value
 Valuation Methods
Intrinsic Value/Discounted Cash Flows

1. Forecast free cash Step 3: Calculate the Terminal Value.

flow
2. Calculate the Terminal Value is defined as the value of the business after the forecasted
Weighted Average period.
Cost of Capital
(WACC) – discount Perpetuity Growth Exit Multiple
rate to be used
3. Calculate the
Terminal Value
4. Discount the Free
Cash Flow and
Terminal Value
5. Get the Equity
Value G could be based on GDP or Industry Rate
 Valuation Methods
Intrinsic Value/Discounted Cash Flows

1. Forecast free cash Step 4: Discount the Free Cash Flow and Terminal Value
flow
2. Calculate the
Weighted Average
Cost of Capital
(WACC) – discount
rate to be used
3. Calculate the
Terminal Value
4. Discount the Free
Cash Flow and
Terminal Value
5. Get the Equity
Value
 Valuation Methods
Intrinsic Value/Discounted Cash Flows

1. Forecast free cash Step 5: Compute the Equity Value and Implied Share
flow
2. Calculate the Formula:
Weighted Average
Cost of Capital Equity Value = Enterprise Value – Debt + Cash
(WACC) – discount
rate to be used
3. Calculate the
Terminal Value
4. Discount the Free
Cash Flow and
Terminal Value
5. Get the Equity
Value
Thank you!