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CHAPTER 5.

Corporate (Business)
Valuation
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Content

PART I:
INTRODUCTION ABOUT CORPORATE VALUATION
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Value of Corporation?

Nguồn: Corporate Valuation: A easy guide for valuation, p.3

Factors impact Corporate Valuation

❖ External environment:
▪ Economic/political/cultural-social/scientific-technological
environment
▪ Specific environment: relationships with
customers/suppliers/competition/relationships with state
management agencies.
❖ Internal environment:
▪ Property status
▪ Business position and reputation
▪ Labor
▪ Management capacity
▪ Business culture,…

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 Purposes of Corporate Valuation

❖ Internal stakeholders: assessing enterprise prospects

and risks for business decision-making purposes.

❖ External stakeholders: evaluating business prospects

and risks for the purpose of making investment or
credit decisions.

❖ State management agencies

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 Data source for Corporate Valuation

❖ Quantitative ❖ Qualitative
• Financial reports, Annual • Management discussion
reports and analysis
• Announcement from the
• Macroeconomic president
indicators, industry • Mission/vision report
statistics
• Financial publications and
• Required explanatory other published
documents publications
• Other reports • Comment on the
website,…

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 5 steps of analysis…
1. Analyze the macroeconomic environment::
 International and/or national environment
→ forecast prospects and risks of the macroeconomic environment
2. Industry analysis
 Identify industry characteristics
 Industry structure
 Industry competition level
→ forecasting industry prospects and environmental risks affecting the
corporate
3. Analyze business strategy
 Product, service, market, customer strategies
→ forecast?
4. Corporate financial analysis
 Evaluate financial reporting quality
 Past profitability, risk management ability
 Predict future profits and risks
75. Corporate valuation: Valuation model
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Step 1&2: Analyze the macroeconomic

environment and industry analysis
 Determine the economic characteristics of the
industry

▪ Different industries/sectors have different expectations

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 Specific economic and industry characteristics

❖ Grocery store chain :

▪ High cost of goods, low profit margin due to high competition.
Profit from volume. High turnover (asset turnover, inventory
turnover).
❖ Pharmaceutical company :
▪ High barriers to market entry, large R&D investment. Marginal
profit is very high. High business risk (liability for product-related
issues) therefore typically has low levels of debt financing.
Patented products: high marginal profit. Conventional products:
low profit margins.
❖ Electrical company :
▪ High investing capital, income depends highly on the
government's regulatory framework due to its monopoly position.
❖ Commercial banks:
▪ The source of funding for loans is customer deposits -> high
liquidity is required => high levels of cash reserves. Marginal
returns on loans are small. Profit from service fees is high.

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Industry economic analysis tool: Porter’s Five Forces

 Porter’s Five Forces: Competitive Rivalry

❖ Looks at the number and strength of your competitor: consider

how many rivals you have, who they are, and how the quality of
their product compares with yours.
❖ In an industry where rivalry is intense, companies attract
customers by cutting prices aggressively and launching high-
impact marketing campaigns. This can make it easy for
suppliers and buyers to go elsewhere if they feel that they're
not getting a good deal from you.
❖ On the other hand, where competitive rivalry is minimal, and no
one else is doing what you do, then you'll likely have
tremendous competitor power, as well as healthy profits.

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Porter’s Five Forces: Supplier Power

❖ Suppliers gain power if they can increase their prices

easily, or reduce the quality of their product. If your
suppliers are the only ones who can supply a
particular service, then they have considerable
supplier power. Even if you can switch suppliers,
you need to consider how expensive it would be to
do so.
❖ The more suppliers you have to choose from, the
easier it will be to switch to a cheaper alternative.
But if there are fewer suppliers, and you rely heavily
on them, the stronger their position – and their
ability to charge you more. This can impact your
profitability, for example, if you're forced into
expensive contracts.
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Porter’s Five Forces: Buyer Power

❖ If the number of buyers is low compared to the

number of suppliers in an industry, then they have
what's known as "buyer power." This means they
may find it easy to switch to new, cheaper
competitors, which can ultimately drive down
prices.
❖ Think about how many buyers you have (that is,
people who buy products or services from you).
Consider the size of their orders, and how much it
would cost them to switch to a rival.
❖ When you deal with only a few savvy customers,
they have more power. But if you have many
customers and little competition, buyer power
decreases.
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Porter’s Five Forces: Threat of Substitution

❖ This refers to the likelihood of your customers

finding a different way of doing what you do. It
could be cheaper, or better, or both. The threat of
substitution rises when customers find it easy to
switch to another product, or when a new and
desirable product enters the market unexpectedly.
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Porter’s Five Forces: Threat of New Entry

❖ Your position can be affected by potential rivals' ability to enter

your market. If it takes little money and effort to enter your market
and compete effectively, or if you have little protection for your
key technologies, then rivals can quickly enter your market and
weaken your position.
❖ However, if you have strong and durable barriers to entry, then
you can preserve a favorable position and take fair advantage of
it. These barriers can include complex distribution networks, high
starting capital costs, and difficulties in finding suppliers who are
not already committed to competitors.
❖ Existing large organizations may be able to use economies of
scale to drive their costs down, and maintain competitive
advantage over newcomers.
❖ If it costs customers too much to switch between one supplier
and another, this can also be a significant barrier to entry. So can
extensive government regulation of an industry.
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Step 3: Analyze the business's strategy

 Strategic analysis framework

1. Nature of product/service
 High profit - identical product? Or low profit - popular product?
2. Degree of integration along the value chain
 Vertical integration? Or at some stage?
3. Degree of geographic diversification
 Other countries = growth but risks
4. Degree of industry/field diversification
 One or more industries/fields

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Step 4: Analyze and evaluate the business's

financial reports
Income statement for the year ended 20XX

❖ Revenue
❖ Other income
❖ Cost of goods sold
❖ Management costs
❖ Other costs
❖ Depreciation
❖ Operating income
▪ Or EBIT
❖ Interest payment expenses
❖ Tax
❖ Net income or Profit after tax

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Accounting balance sheet

What do corporates own? What type of capital source?

❖ Short-term assets ❖ Short-term liabilities
▪ Cash ❖ Long-term liabilities
▪ Customer receivables ▪ Includes long-term debt
▪ Inventory
❖ Long-term assets
▪ Tangible assets ❖ Equity
• Land/Offices
▪ Invisible assets
• Registered brand
• Goodwill

Total Assets = Total liability + Equity

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Accounting balance sheet

Early identification of risks from the Balance Sheet:

Financial imbalance
❖ Long-term assets need to be financed by corresponding
long-term capital sources
❖ Net Working Capital (NWC):
Net working capital (NWC) = Short-term assets – Short-
term liabilities
❖ If NWC tends to decrease and especially turns negative,
this is signaling the increasingly obvious appearance of
financial imbalance. NWC < 0, shows that the company
has used short-term debt to finance long-term assets.

Định giá TSVH 22

Which part reflects shareholder value?

A. Cash
B. total assets
C. total liabilities
D. Total assets minus (-) Total liabilities

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Cash Flow Statement

❖ The Cash Flow Statement shows how much money a

business actually earned and how much money it spent
over a given period of time.
The cash flow statement is presented corresponding to 3 cash
flows:
❖ Cash flow from business activities: is the cash flow arising
in the process of paying suppliers, customers, employees,
paying interest on loans, and paying taxes to the state...
❖ Cash flow from investment activities: includes cash inflow
and outflow related to investment activities, purchases,
liquidation... fixed assets and other long-term assets.
❖ Cash flow from financial activities will involve
increases/decreases in equity and debt
Định giá TSVH 24
Cash Flow Statement

What should you keep in mind when reading the Cash Flow
Statement?
❖ Among the 3 groups, groups 2 and 3 have the nature of
increasing in the current period, decreasing in the future
period, or vice versa.
▪ A business that borrows 10 billion will have to repay 10 billion in
the future. If there is a new asset purchase, there must be asset
liquidation...
❖ The research focus is Cash Flow from Operating Activities.
Because it shows the actual ability of the business to
generate money.
❖ Cash and cash equivalents at the end of the period may
decrease compared to the previous period.This is not
necessarily a bad thing, because the business has paid its
Địnhloans before
giá TSVH 25
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Step 5: Valuing the business

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PART II: METHODS OF CORPORATE VALUATION

Introduction to Corporate Valuation

❖ Approaches to Corporate valuation include:

1) Market approach
▪ Corporate value is determined through the value of the
enterprise compared with enterprises that need to be appraised
in terms of factors: scale; Main business sectors; business risks,
financial risks; financial indicators or successful transaction
prices of the enterprise that needs to be appraised.
2) Cost approach
▪ Enterprise value is determined through the value of the
enterprise's assets that need valuation.
3) Income approach
▪ Enterprise value is determined through the conversion of
predictable future free cash flows to the time of valuation
Introduction to Corporate Valuation

❖ Matrix: Approaches and methods of corporate valuation:

APPROACH

MARKET COST INCOME

Assets-Based X

Average Ratio X
METHOD

Transaction prices X

Discounted dividend X
stream
Discounted free cash flow X
to the firm
Discounted free cash flow X
to equity
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Source: Corporate Valuation: A easy guide for valuation, p.27

 DCF: Discounted Cash Flow Valuation

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DCF: Some methods

Valuate free cash flows:

1. FCFF: Free Cash Flow to the Firm
2. FCFE: Free Cash Flow to Equity

Unlevered CF (FCF to firm) and ‘levered’ cash flow method

(Free Cash Flow to Equity), ‘in theory’ at least, should provide
the same outcome, but unlevered is the more commonly
used.
Unlevered is the operating cash flows (Free Cash Flow To
Firm), whereas levered is the cash flows available to
shareholders once other claims (i.e. debt) has been paid.

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 DCF Valuation Model

Cash flows:
- Firm: Unlevered FCF.
- Equity: Levered FCF
Expected growth:
- Firm: Operating income growth
- Equity: Net Profit Growth /EPS
Stable phase

CF1 CF2 CF3 CF4 CF5 CFn

Terminal value
Valuation: ……
- Firm valuation
- Equity valuation perpetually

High growth phase

Discount rate:
Firm: Weighted Average cost of capital (WACC)
Equity: Cost of equity capital

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5 steps to evaluate a corporate according to the model DCF

I. Estimate the discount rate

II. Measure cash flow
III. Estimate expected growth rate
IV. Estimate terminal value
V. Determine business/corporate value

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 Step 1: Estimate Discount rate

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Step 1. Estimate Discount rate

➢ Calculate the cost of equity (KE):

➢Determine risk-free rates ;
➢Estimate the market risk premium
➢Calculate the company's beta coefficient:
• Past beta coefficient
• Fundamental beta coefficient (Bottom-Up)
➢ Calculate the cost of debt (KD) :
▪ Yield-to-maturity
▪ Default spreads
▪ Synthetic Ratings
➢ Calculate the proportions of Equity and Debt Capital
36 → calculate the cost of capital (WACC);
Risk-free rate

❖ For risk-free assets, actual return equals expected return

❖ An investment is risk-free when:
▪ No default risk: the securities must be issued by a government that is
unlikely to default. If the government is likely to default, it may be difficult
to estimate the risk-free rate;
▪ No reinvestment risk: for example, if you are evaluating a 5-year
project with a risk-free interest rate of a 6-month government bond,
reinvestment risk arises when you do not know what the bond interest
rate will be after 6 months.
❖ If the government is not considered risk-free (like Brazil, Spain,...):
▪ Adjust the government borrowing rate according to the default spread
on that country's bonds to obtain the risk-free rate
▪ Ex: Rf (Brazil) = Brazilian government's long-term bond interest rate -
Default reserve ratio (for Moody's rating is Baa2)
= 12% - 1.75% = 10.25%;

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 Moody's Ratings and Default Provision Rates of Countries
Country Long-Term Rating Adj. Default Spread Country Long-Term Rating Adj. Default Spread Country Long-Term Rating Adj. Default Spread

Albania B1 4.00% France [1] Aaa 0.00% Oman A1 0.85%

Angola Ba3 3.25% Georgia Ba3 3.25% Pakistan B3 6.00%
Argentina B3 6.00% Germany [1] Aaa 0.00% Panama Baa3 2.00%
Armenia Ba2 2.75% Greece [1] Caa1 7.00% Papua New Guinea B1 4.00%
Australia Aaa 0.00% Guatemala Ba1 2.40% Paraguay B1 4.00%
Austria [1] Aaa 0.00% Honduras B2 5.00% Peru Baa3 2.00%
Azerbaijan Baa3 2.00% Hong Kong Aa1 0.25% Philippines Ba2 2.75%
Bahamas A3 1.15% Hungary Ba1 2.40% Poland A2 1.00%
Bahrain Baa1 1.50% Iceland Baa3 2.00% Portugal [1] Ba3 3.25%
Bangladesh Ba3 3.25% India Baa3 2.00% Qatar Aa2 0.50%
Barbados Baa3 2.00% Indonesia Baa3 2.00% Romania Baa3 2.00%
Belarus B3 6.00% Ireland [1] Ba1 2.40% Russia Baa1 1.50%
Belgium [1] Aa3 0.70% Isle of Man Aaa 0.00% Saudi Arabia Aa3 0.70%
Belize Ca 2.00% Israel A1 0.85% Senegal B1 4.00%
Bermuda Aa2 0.50% Italy [1] A3 1.15% Singapore Aaa 0.00%
Bolivia Ba3 3.25% Jamaica B3 6.00% Slovakia A2 1.00%

Bosnia and Herzegov B3 6.00% Japan Aa3 0.70% Slovenia [1] A2 1.00%
Botswana A2 1.00% Jordan Ba2 2.75% South Africa A3 1.15%
Brazil Baa2 1.75% Kazakhstan Baa2 1.75% Spain Baa3 2.00%
Bulgaria Baa2 1.75% Korea A1 0.85% Sri Lanka B1 4.00%

Cambodia B2 5.00% Kuwait Aa2 0.50% St. Vincent & the Grenad B1 4.00%
Canada Aaa 0.00% Latvia Baa3 2.00% Suriname Ba3 3.25%
Cayman Islands Aa3 0.70% Lebanon B1 4.00% Sweden Aaa 0.00%
Chile Aa3 0.70% Lithuania Baa1 1.50% Switzerland Aaa 0.00%

China Aa3 0.70% Luxembourg [1] Aaa 0.00% Taiwan Aa3 0.70%
Colombia Baa3 2.00% Macao Aa3 0.70% Thailand Baa1 1.50%
Costa Rica Baa3 2.00% Malaysia A3 1.15% Trinidad and Tobago Baa1 1.50%
Croatia Baa3 2.00% Malta [1] A3 1.15% Tunisia Baa3 2.00%
Cuba Caa1 7.00% Mauritius Baa1 1.50% Turkey Ba1 2.40%
Cyprus [1] Ba3 3.25% Mexico Baa1 1.50% Ukraine B2 5.00%
Czech Republic A1 0.85% Moldova B3 6.00% United Arab Emirates Aa2 0.50%
Denmark Aaa 0.00% Mongolia B1 4.00% United Kingdom Aaa 0.00%

Dominican Republic B1 4.00% Montenegro Ba3 3.25% United States of America Aaa 0.00%
Ecuador Caa2 8.50% Morocco Ba1 2.40% Uruguay Ba1 2.40%
Egypt B2 5.00% Namibia Baa3 2.00% Venezuela B1 4.00%
El Salvador Ba2 2.75% Netherlands [1] Aaa 0.00% Vietnam B1 4.00%
Estonia A1 0.85% New Zealand Aaa 0.00%
Fiji Islands B1 4.00% Nicaragua B3 6.00%
Finland [1] Aaa 0.00% Norway Aaa 0.00%
Market risk premium

❖ 3 approaches to calculating market risk premium:

1. By surveys (individual/institutional investors, CFOs,

financial science researchers);

2. By historical data: superior returns of the market index

compared to risk-free securities over a long period of time;;

3. By calculations: using pricing models.

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Estimate the Beta coefficient of the company

2 approaches:
1) Historical Beta: use one of the following models:
➢ CAPM
➢ APM
➢ Multi-factor model
➢ Proxy model

2) Fundamental Beta: depends on the characteristics of

product and service business activities, operating
leverage, and financial leverage.

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Historical Beta (CAPM)

❖ To estimate beta, regress stock returns (Rs) on market index returns

(market index, RMKT) over a long period of time (e.g., 5 years):
Rs = a + b RMKT (characteristic line)

The slope (b) of the regression corresponds to the beta coefficient (β)
of the stock, and measures the risk level of that stock.

In this way, the beta coefficient will have 3 limitations:

1. Standard error is high;
2. High sensitivity to market index selection (e.g. VN Index, S&P/ASX200);
3. Reflects the combination of business activities over the regression time (in
the past) rather than the current time;
4. Reflects the average financial leverage of a business over time rather than
its current leverage.

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Historical Beta (CAPM) (cont.)

1. Choose whether stock income is annual, monthly, weekly or daily?

Usually monthly income. Because although daily income increases the
number of observations, they include periods of non-trading (when
income = 0) => reducing correlation with the market and causing the
beta coefficient to trend. go down incorrectly..

2. What length of time is chosen to perform the regression?

A longer estimation period (e.g., 10 years) will provide more data, but
the business itself may have changed its risk characteristics over time.
Usually use a length of 60 months (5 years);

3. Which market index should I use?

Avoid narrow market indexes (containing few stocks) or industry
indexes. Usually choose a broad index (many stocks) that is weighted
by value.

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Fundamental beta

❖What factors affect the basic beta coefficient of a business?

1) Products/services: the beta coefficient of a business depends on the

sensitivity (elasticity) of demand for products/services provided by that
business, and the cost sensitivity of the business to macroeconomic factors:
➢ Businesses that affected by the economic cycle (e.g., vehicle manufacturing)
have larger beta coefficients than businesses that not affected by the economic
cycle (e.g., food processing and tobacco);
➢ Businesses providing luxury goods and services have a higher beta coefficient
than businesses providing basic goods and necessities

2) Operating Leverage: The higher the proportion of fixed costs in the

business's cost structure, the larger the beta coefficient. Because in
general, higher fixed costs will increase the business's exposure to risks,
including market risks.

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Fundamental beta (cont.)

3) Financial leverage: The more debt a firm has, the higher its
beta coefficient will be. Because Debt creates fixed costs (eg
interest costs) => increases the risk of firms facing market
risks.

❖ Assuming the firm has no market risk (beta = 0), the beta of
equity is a function of beta (the enterprise has no debt,
unlevered beta) and the debt/equity ratio :
ᵝL = ᵝu * (1+((1-t)*D/E)
Trong đó,
ᵝL : beta of a financially leveraged firm (levered beta)
ᵝu: beta of the firm without financial leverage (unlevered beta)
t : tax rate
D: market value of debt
E: market value of equity
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Cost of equity

Historical/Fundamental Beta

Risk-free Market
Cost of
interest Beta risk
Equity
rate (Rf) premium

Use the currency as the cash

flow, and the same terms as
the cash flow (real or nominal)

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 Cost of equity (cont.)

In Practice:

❖ Interest rates on short-term government securities are used as risk-free rates,

even though these securities are not always risk-free;
❖ Historical risk premiums are used as risk premiums for calculations although
there may even be better ways to calculate these risk premiums;
❖ Beta is estimated by regressing stock returns against market returns, although
there may even be a better way to calculate beta.
Cost of debt

❖ Cost of Debt is the cost rate at which you can currently

borrow. It will reflect not only the business's default risk
but also the interest rate level in the market.

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Cost of debt (cont.)

Scenario (1): f the enterprise issues long-term bonds and they are widely
traded => the enterprise's cost of debt is yield to maturity of the bond

Scenario (2) If the enterprise does not issue long-term bonds or they are not
traded => use one of the following two ways to assess the enterprise's default
risk:
1.Information from rating organizations (such as S&P's, Moody's, Fitch,...). However,
many small companies are not rated?
2.Self-rank and evaluate the default risk of the enterprise: now you play the role of a
credit rating organization: use the characteristics of the enterprise to rank and evaluate
the default reserve ratio of the enterprise (default spread). Can use Z-score or interest
coverage ratio.
Cost of Debt= Rf + Default spread
Scenario (3): if (a) the enterprise is not rated, (b) it is not possible to calculate
the self-rating for the enterprise, and (c) the enterprise has recently borrowed
long-term from the bank => use that loan interest rate as the cost of corporate
debt (this is the final solution)

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What part should be included in Debt to value a business?

❖ Principles: In general, debt has the following characteristics::

➢ Commitment to make future payments
➢ Interest payments are tax deductible
➢ If the payment commitment is not fulfilled, it can lead to bankruptcy or
loss of control of the business to the creditor.
→ DEBT should include:
➢ Any payable debt that generates interest, whether short or long term..
➢ The present value of all obligations under a lease, whether an operating
lease or a finance lease
❖ Debt value is market value:
➢ Some analysts use the accounting value of debt (or equity) but this will
lead to a high estimated cost of capital in developed markets. Why?

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What happens if financial leverage changes during the
business valuation period?

❖ After obtaining all the parameters (cost of debt, beta

coefficient, ratios), remember that the business (in the
initial or stable stage) will likely change its financial
leverage to target and maintain the target debt ratio (this
ratio may be higher or lower than the current level)

❖ Typically, for accuracy, you should adjust the input

parameters by D/E weight each year when calculating
WACC, beta estimates, and cost of debt.

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