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Topic 10

VALUING A FIRM (I)

TOPIC 10: CONTENT U
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1. Introduction to Valuation of a Firm.

2. Analytical and synthetic methods of Valuing Firms.

3. Compound methods.
10.1 INTRODUCTION TO VALUATION OF A FIRM U
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Possible reasons:

• If one firm is about to make a takeover offer of another firm

• If a firm is considering the sale of one of its divisions and has to

decide some reference price to negotiate with potential buyers

• When a firm goes public, the investment bank must evaluate

how much the firm is worth.

• Change of the accounting reporting norms,

10.1 INTRODUCTION TO VALUATION OF A FIRM
Possible reasons (continuation):
Internal reasons
Information about equity changes
Management of the company
Dividend policy
Evaluate the possibility of debt issuing
Updating of the accounting
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External reasons
Ownership transmission of the company
Operations such as MBOs and LBOs
Mergers or takeovers
Asking for external financing
Privatization of public enterprises
10.1 INTRODUCTION TO VALUATION OF A FIRM U
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Google To Acquire YouTube for $1.65 Billion in Stock

Combination Will Create New Opportunities for Users and Content Owners Everywhere
MOUNTAIN VIEW, Calif., October 9, 2006 – Google Inc. (NASDAQ: GOOG)
announced today that it has agreed to acquire YouTube, the consumer media company for
people to watch and share original videos through a Web experience, for $1.65 billion in a
stock-for-stock transaction. Following the acquisition, YouTube will operate
independently to preserve its successful brand and passionate community.
10.1 INTRODUCTION TO VALUATION OF A FIRM U
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10.1 INTRODUCTION TO VALUATION OF A FIRM U
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Steve Jobs
dies on
06/10/2011

Goes public on
18/05/2012
10.1 INTRODUCTION TO VALUATION OF A FIRM U
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Definition:
It is a price that an average buyer would pay an average
seller whose tastes and preferences coincide with those
of the society in which they live.

It´s established in terms of utility of

SUBJECTIVE VALUE the object based on individual
interests of people involved.

OBJECTIVE VALUE
?
10.1 INTRODUCTION TO VALUATION OF A FIRM U
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VALUE ≠ PRICE

✓ Is the objective of the ✓ Not always.

evaluation to determine ✓ The evaluation will serve
a price? as a starting point for
negotiation.
✓ Is the price a good ✓ Only in the case of
reference for efficient and perfect
determining the value? markets.
10.1 INTRODUCTION TO VALUATION OF A FIRM U
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Does the company have a unique value? Is it possible to determine different

values for the same company?

▪ The calculation gives the information about possible future scenarios for
which the uncertainty forces to establish a range of values​​ where the most
probable value of the company will be found.

▪ The particular characteristics and preferences of the person who performs the
assessment can lead to different values ​of the same company.

▪ The objective of the evaluation can lead us to get different values ​such as tax
value, net asset value, the value of a company in operation, etc.
10.1 INTRODUCTION TO VALUATION OF A FIRM U
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CLASSIFICATION OF VALUATION METHODS

There is no unique value and the method varies according to the

objective:

➢ To know the value of a minority share (shareholding)

(The value of the listed shares).

➢ To know the overall value of the company or the value of its

majority share that allows the control of the company.
10.1 INTRODUCTION TO VALUATION OF A FIRM U
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Traditional methods. It is the oldest methodology that includes the analytical,

accounting based (asset based) or simple methods, as well as the mixed or
compounded models (Topic 10).

Comparative methods. It is a relatively simple approach. Recently these

methods are gaining more importance. They are the simple relative valuation
methods or the valuation using multiples based on the Account-based
Profitability Analysis (sample companies of a similar profile) (Topic 11).

Discounted Cash Flow methods. Most widely used in finance and well
established methodology. They are the methods based on the Discounted
Cash Flow (DCF) and value creation (Adjusted Present Value method –
APV) (Topic 12).
10.2. TRADITIONAL METHODS: ANALYTICAL AND SYNTHETIC U
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A. SIMPLE METHODS OF VALUATION

B. COMPOUNDED METHODS OF VALUATION

10.2. TRADITIONAL METHODS: ANALYTICAL AND SYNTHETIC U
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SIMPLE METHODS OF CLASSIFICATION (ACCOUNTING BASED)

A.1. NET EQUITY

ANALYTICAL A.2. NET REAL ASSETS
(BALANCE SHEET
BASED) A.3. SUBSTANTIAL VALUE
A.4. PERMANENT CAPITAL
STATIC APPROACH REQUIRED FOR OPERATION
(CPNE)

SYNTHETIC
(PROFIT BASED)
A.5. VALUATION BASED ON
PROFITS.
A FIRST DYNAMIC
APPROAHC
10.2. TRADITIONAL METHODS: ANALYTICAL AND SYNTHETIC U
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A.1. NET EQUITY

VALUE = NET EQUITY

• Based on accounting reports and therefore the evaluation is made on

available accounting records.
• The advantages of using accounting data: it normally comes in a
verifiable and reliable form. The accounting prepares information
taking into consideration that it will be used by heterogeneous groups
of users whose relationships with the company are different.
Accounting statements have to be made according to GAAP norms.
• The disadvantage: accounting data refers to a company’s history but not
to its prospects. Book value of assets may not necessarily reflect their
market value. Accounting valuation is also sensitive to the choice of an
accounting method.
10.2. TRADITIONAL METHODS: ANALYTICAL AND SYNTHETIC U
A.2. NET REAL ASSETS VALUE (Activo neto real) B
Definition: It is a difference between real value of the assets and actual
value of liabilities, and therefore, it is a part of equity which
corresponds to the equityholders (owners). The net real assets
represent the true value of the company.
It´s not included “Non real Assets / Activos Ficticios” or assets
which doesn´t have value on the market (Capitalization of hiring
company expenses, financial accounts as dividends to be
paid,….). But it´s included Intangible Assets (Trademarks,
Patents, I+D capitalization expenses,…).
Formula: adjustments of assets to market prices

Value = The net real assets value

Net real assets value = Assets book value – Liabilities book value
+ Gains arising from revaluation – Losses arising from revaluation =
= Real assets value - Real Liabilities’ value
10.2. TRADITIONAL METHODS: ANALYTICAL AND SYNTHETIC U
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A.3. SUBSTANTIAL VALUE (Valor Sustancial)

Definition: Substantial value is the real value of operating assets

employed in the main activity of the firm (production,
service). It is analyzed independently from the financial
structure of a firm.
Therefore, the Substantial Value method differ from the Net Real Assets
method in two aspects:
• It does not consider the assets which are not employed in the main
operation activity of a company. Hovewer does include intangible assets
needed for operation activity.

• It does not take into account the financial structure of a firm.

In practice, the net substantial value is also used

Net substantial value (NSV)= Gross Substantial value (GSV) – Liabilities
10.2. TRADITIONAL METHODS: ANALYTICAL AND SYNTHETIC U
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A.4. (LTCNO) LONG-TERM CAPITAL NECESSARY FOR OPERATION
(CPNE) Capitales Permanentes Necesarios para Explotación

Definition: This is the value of fixed assets used by a company in its

operational activity at the current market prices plus the
Operation Nessecities in Funds (Necesidades Operativas de
=working capital
Fondos.)
The Operation Funds requirements (*) are defined as the necessary investment
in current assets net of the short-term operational financing (includes financing
without cost, that is to say, payables to suppliers, taxes to pay, etc.).
(*) Operation Funds requirements are calculated as:
Inventories + Receivables + Cash – Payables - Other short-term financing
without cost
10.2. TRADITIONAL METHODS: ANALYTICAL AND SYNTHETIC U
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A.5. VALUATION BASED ON EXPECTED PROFITS (1/3)

The underlying idea of these valuation methods is that value of a firm

stems from the stream of the expected profits discounted by the r. r is
defined taking into account the risk of a business, cost of capital, potential
growth of a firm.

P1 P2 Pn
PV= + + ……+
(1 + r)1 (1 + r)2 (1 + r)n

PV = Profitability Value.
P = Net Profit.
10.2. TRADITIONAL METHODS: ANALYTICAL AND SYNTHETIC U
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A.5. VALUATION BASED ON EXPECTED PROFITS (2/3)

In practice, evaluators have to define the expected flow of profits. To

simplify this process the concept of the average and constant profit which a
firm is likely to generate and maintain in the future is commonly used. In
this case the ability of a firm to generate profits will be equal to the present
value of future constant profits discounted at r:

PV = P a n¯| r

(1+r)n -1
Where: a n¯| r =
(1+r)n *r
PV = Profitability Value.
P = Net Profit.
10.2. TRADITIONAL METHODS: ANALYTICAL AND SYNTHETIC U
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A.5. VALUATION BASED ON EXPECTED PROFITS (3/3)

If we consider the ability of generating profits as a perpetual

stream (P = constant, and n → ∞):

P
PV =
r
10.3. COMPOUND METHODS U
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COMPOUND METHODS are

obtained as a combination of :
MIXING
ANALYTICAL METHODS
+
SYNTHETIC METHODS
B.1. CLASSICAL METHOD
B.2. INDIRECT OR PRACTICAL
METHOD
B.3. DIRECT ANGLO-SAXON
METHOD
B.4. CAPITALIZATION OF GOOD
WILL
10.3. COMPOUND METHODS U
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B.1. CLASSICAL METHOD

V = Net real assets value + n . P

Where,

n – number of periods
P = Annual Average Net Profit
10.3. COMPOUND METHODS U
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B.2. INDIRECT METHOD OR PRACTICAL METHOD

PV - Profitability value,
PV + SV SV - Substantial value (Gross)
V= = SV + 1/2 (PV - SV) G - Goodwill not deducting liabilities
2

If V = SV + G i
PV + SV PV - SV
G i = V - SV = - SV =
2 2

In practice, SV (Substantial Value) or NSV (Net Substantial Value) can be used,

knowing that the NSV = GSV – Liabilities
10.3. COMPOUND METHODS U
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B.3. DIRECT OR ANGLO-SAXON METHOD

(P – SV*i)
V = SV + G d G d=
r

Where, P = Net Profit (perpetual)

(P – SV * i) = SUPERPROFIT
r = discount factor, superior to:
i = risk-free market interest rate
PV - Profitability value,
SV - Substantial value
Gd -Goodwill
10.3. COMPOUND METHODS U
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B.3. DIRECT OR ANGLO-SAXON METHOD

If, r = 2i

P – SV*i P SV*i SV + P/i

V = SV + = SV + - = =
r 2i 2i 2

PV + SV Coincides with the

V= indirect method
2

PV - Profitability value = P/i,

P = Perpetual Net Profit
SV - Substantial value
10.3. COMPOUND METHODS U
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B.4. METHODS BASED ON CAPITALIZATION OF GOOD WILL

V = SV + G G = n *( P - SV * i )

Steps, PV, or value based on

Expected Profits method

1) Determining n,

2) actualization of Superprofits, V = SV + a n¯| r ( P- SV * i ),

3) and supefrofit actualization calculated over V (replace SV by V),

V = SV + a n¯| r * ( P – V* i ) SV + a n¯| r *P
V = SV + a n¯| k * P - a n¯| k* V* i =======>
V=
1 + a n¯| r * i
In practice we can use GSV as well as NSV
REFERENCES U
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SPECIFIC:

▪ ACCID, Valoració d’empreses. Bases conceptuals i aplicacions pràctiques,

Profit Editorial, 2009.

▪ ANSÓN LAPEÑA, J.A. Valoración de empresas. Análisis de los métodos

utilizados en la práctica, ICJCE, 1997.

▪ FAUS, Josep, Valoración de empresas. Un enfoque pragmático, Ediciones

Folio, 1997.

GENERAL:

▪ BREALEY, Richard A., MYERS, Stewart C. y ALLEN, Franklin, Principios de

Finanzas Corporativas, McGraw Hill, 2010.

▪ MASCAREÑAS PÉREZ-IÑIGO, Juan, Fusiones y adquisiciones de empresas,

McGrawHill , 2000.
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Topic 10

PROBLEMS SET
TOPIC 10 - EXERCISE 1 U
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CARBULA Company has the following balance sheet in millions of euros:

ASSETS LIABILITIES + EQUITY

Cash 55 Equity and Retained Earnings 300

Recievables 250 Liabilities L/P 20
Inventories 45 Liabilities S/T 190
Package materials 40 Payables 40
Fixed Assets 90 Deferred Income taxes 30
Patents 100
TOTAL ASSETS 580 TOTAL LIABILITIES 580
TOPIC 10 - EXERCISE 1 U
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The detailed study of the assets reveals that 10% of the balance of receivables is a bad debt
(irrecoverable) and 50% of the packaging materials has to be sold as recycled material for
only 2 million euros.
The expectations about the future company profitability are very positive due to the trade-
marks they have in property and its goodwill is valued at 400 millon euros.
The company generates 100 millions euros of profits annually and it is expected that this
number will increase twice, for the expected annual profits during forthcoming 4 years.
Required:
Given this data and assuming r is equal to 12% determine the value of a company
considering a time horizon of 4 years, the residual value of 50 millions euros and risk free
rate of interest i equal to 4%.
Guidance:
A.use asset-based methods: B-using profitability methods, C- using compound methods.
Take net substantial value (SVN) instead of gross substantial value whenever it is needed.
TOPIC 10 - EXERCISE 2 U
A company, which is an important producer of cava is considering to aquire a B
small family firm, which is declared to be on sale due to the disagreements
among the owners of the third generation. The charactersitics of this small family
firm are the following:

Expected annual profit: 50 million euros /year

Value of net equity: 103 million euros
Non-operational assets* 3 million euros
Time horizon: 5 years

*Assets which are not employed in the main operational activity of the firm
*There are no gains or losses arising from reevaluation.
The buyers estimate that the annual profit will be not greater than 40 million
euros during the next 5 years.

Required: Determine the value of the company using a) the Indirect method b)
actualization of the Good will method r = 16 % and interest rate = 5 %.
Represent graphically the possible range of the estimated profits that
could be used during the negotiation (Use the substantial net value -
SVN).