Republic of the Philippines

Cagayan State University

Andrews Campus
COLLEGE OF BUSINESS, ENTREPRENEURSHIP, AND ACCOUNTANCY
Caritan, Tuguegarao City 3500, Cagayan

VALUE
- It pertains to the worth of an object from another person’s point of view.
- In the corporate setting, “a company creates value if and only if the return on capital invested
exceeds the cost of acquiring capital.” - Alfred Marshall
» Current operations - how is the operating performance of the firm in the recent year?
» Future prospects - what is the long-term, strategic direction of the company?
» Embedded risk - what are the business risks involved in running the business?

VALUATION
- (Chartered Financial Analyst Institute) The estimation of an asset’s value is based on variables
related to future investment returns, on comparisons with similar assets, or, when relevant, on the
estimated immediate liquidation proceeds.
- It places a great emphasis on professional judgement and includes using forecasts to come up with
a reasonable estimate of the value of an entity’s assets or equity.

The definition of value may also vary depending on the context and objective of the valuation exercise.
1. Intrinsic Value - the true value of an asset assuming that there is a complete understanding of its
investment characteristics
 Market equilibrium - if the market price equals the intrinsic value
 Grossman-Stiglitz Paradox - if the market prices which can be obtained freely, perfectly reflect the
intrinsic value of an asset, then a rational investor will not spend to gather data to validate the value
of a stock
2. Going Concern Value - firm value is determined under the going concern assumption, a belief that
the entity will continue to do its business activities into the foreseeable future.
3. Liquidation Value - the net amount that would be realized if the business is terminated and the
assets are sold piecemeal.
4. Fair Market Value - the price, expressed in terms of cash, at which property would be traded
between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at
arm’s length in an open and unrestricted market. Neither the seller nor the buyer must be under
compulsion to buy or sell and they both must have reasonable knowledge about the relevant facts
that might affect their decision.

ROLES OF VALUATION IN BUSINESS

1. Portfolio Management
- It involves making decisions about investment mix that meet the long-term financial objectives and
risk tolerance of a client or company
- It depends on the investment objectives of the investors or financial managers managing the
investment portfolio
 Fundamental Analyst - the persons interested in understanding and measuring the true value of
a firm that are mispriced in the market
o Value Investors – mostly interested in purchasing shares that are existing and prices at less
than their true value
o Growth Investors – lean towards purchasing businesses at a discount that are not profitable
now but has high expected value in the future
 Activist Investors - usually do takeovers on companies with good growth prospects that have
poor management
 Chartists - relies on the concept that stock prices are significantly influenced by how investors
think and act. They assume that stock price changes and follow predictable patterns such as the
available trading KPIs (e.g. price movements, trading volume, and short sales).

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 Republic of the Philippines
Cagayan State University
Andrews Campus
COLLEGE OF BUSINESS, ENTREPRENEURSHIP, AND ACCOUNTANCY
Caritan, Tuguegarao City 3500, Cagayan

 Information Traders - buy or sell shares based on new information about firms that are revealed
in the stock market.

Activities that can be performed under the portfolio management:

STOCK SELECTION
Is the market price aligned with the prevailing computed intrinsic value and prices of comparable
assets?
DEDUCING MARKET EXPECTATIONS
Is the share’s prevailing market price reflects investor’s expectations about a company’s future
performance?
Sell side Analysts - issue valuation judgement that are contained in research reports that are
disseminated to current and potential clients
Buy-side analysts - look at specific investment options and make valuation analysis and report to
the portfolio manager or investment committee

2. Analysis of Business Transactions or Deals

Business deals with the ff. corporate events:

 ACQUISITION
- A strategy through which one firm (acquirer) buys a controlling, or 100% interest in another firm with
the intent of making the acquired firm a subsidiary within its portfolio.
 MERGER
- A strategy through which two companies agree to integrate their operations on a relatively coequal
basis.
» A + B = A/B
 DIVESTITURE
- Sale of a major component or segment of a business to another company.
 SPIN-OFF
- Separating a segment or component business and transforming this into a separate legal entity.
 LEVERAGED BUYOUT
- Acquisition of another business by using significant debt which uses the acquired business as a
collateral.

Valuation in deals analysis considers two important, unique factors:

 SYNERGY
o Potential increase in a firm value that can be generated once two firms merge with each
other
o A/B (combined value of two firms) > A+B (sum of separate firms

 CONTROL
o Change in people managing the organization brought about by acquisition.

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 Republic of the Philippines
Cagayan State University
Andrews Campus
COLLEGE OF BUSINESS, ENTREPRENEURSHIP, AND ACCOUNTANCY
Caritan, Tuguegarao City 3500, Cagayan

3. Corporate Finance
- involves managing the firm’s capital structure, including funding sources and strategies that the
business should pursue to maximize the firm value.
 Small Private Businesses - use valuation in order for them to get capital from the private entities

Example: Mang Inasal prior to being purchased by the Jollibee food corporation.

 Large Companies - need valuation to estimate the price they are going to fetch in the stock market
to obtain additional funds

Example: The Monde Nissin Corporation, from being a private entity they listed their company in
Philippine Stock exchange then went into initial public offering to get additional fund for
expansion.

4. Legal & Tax Purposes

Examples: if there is a dissolution the partnership should be valued to identify how much should be
the buy-in or sell-out. Firms are also valued for estate tax purposes if the owner passed away.

5. Other purposes
 Issuance of a fairness opinion for valuations provided by the third party (e.g. Investment Bank)
 Basis for assessment of potential lending activities by financial institutions.
 Share-based payment/compensation.

VALUATION PROCESS

Applying valuation
Understanding Preparing valuation
Forecasting financial Selecting the right conclusiosn and
model based on
the business performance valuation model
forecasts
providing
recommendation

1. Understanding the business

It includes:
 Industry analysis (Porter’s Five Forces)
o Industry rivalry – nature and intensity of rivalry between market players in the industry
o New entrants – barriers to entry to industry by new market players
o Substitutes and complements – relationships of interrelated products and services in the industry
 Substitutes – can replace the sale of an existing product
 Complementary products – can be used together with another product
o Supplier power – how suppliers can negotiate better terms in their favor
o Buyer power – how customers can negotiate better terms in their favor for the products or
services they purchase
 Competitive position – how the products, services, and the company itself is set apart from other
competing market players
o Cost leadership - incurrence of the lowest cost among market players with quality that is
comparable to competitors
o Differentiation - offer differentiated or unique product or service characteristics

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 Republic of the Philippines
Cagayan State University
Andrews Campus
COLLEGE OF BUSINESS, ENTREPRENEURSHIP, AND ACCOUNTANCY
Caritan, Tuguegarao City 3500, Cagayan

o Focus strategy - uses cost leadership or differentiation strategy to focus on identifying specific
demographic or category segment
2. Forecasting Financial Performance
 Top-down approach - Forecast starts from international or national macroeconomic projections (e.g.
GDP forecasts, consumption forecast, inflation projection, foreign exchange currency rates, industry
sales, and market share)
 Bottom-up approach - Forecast starts from the lower levels of the firm (e.g. store expansions and
increase in product availability is collated and revenues resulting from these are calculated)

3. Selecting the right valuation model

- The appropriate valuation model will depend on the context of the valuation and the inherent
characteristics of the company being valued.

4. Preparing valuation model based on forecasts

 Sensitivity Analysis - multiple other analyses are done to understand how changes in an input or
variable will affect the outcome
Commonly used assumptions:
 Sales Growth
 Gross Margin Rates
 Discount Rates
Other Variables:
 Market Share
 Advertising Expense
 Discounts
 Differentiated Features
 Situational Adjustments/Scenario Modeling - for firm-specific issues that affect firm value that
should be adjusted by analysts since there are events that are not quantified when analysts only look
at core business operations but will still influence value regardless.
o Control Premium — additional value considered in a stock investment if acquiring it will give
controlling power to the investor.
o Lack of marketability discount — stock cannot be easily sold as there is no ready market for it
(e.g., non-publicly traded discount).
o Illiquidity discount – the price of particular shares has less depth or is generally considered less
liquid compared to other active publicly traded shares
Note: Both a lack of marketability discount and an illiquidity discount drive down share value.

5. Applying valuation conclusions and providing recommendation

- Once the value is calculated based on all assumptions considered, analysts and investors use the
results to provide recommendations or make decisions that suit their investment objectives.

KEY PRINCIPLES IN VALUATION

1. The value of business is defined only at a specific point in time
- Valuations from yesterday may not hold true and not reflect the prevailing firm value today. The value
of a business is subject to change as it responds to market demands, adopts new technologies, and
navigates economic and regulatory shifts.

2. Value varies based on the ability of business to generate future cash flows
- The value of a business is influenced by its capacity to generate cash flows - includes cash generated
from operations and reductions that are related to capital investments, working capital, and taxes.

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 Republic of the Philippines
Cagayan State University
Andrews Campus
COLLEGE OF BUSINESS, ENTREPRENEURSHIP, AND ACCOUNTANCY
Caritan, Tuguegarao City 3500, Cagayan

3. Market dictates the appropriate return for investors

- The market dictates an appropriate rate of return by reflecting the risk and potential rewards of
various investment opportunities influencing an investor's decision.

4. Firm value can be impacted by underlying net tangible assets

- Higher net tangible assets generally indicate a more stable or safer investment, as they reduce the
potential risk of loss and results in higher going concern value.

5. Value is influenced by transferability of future cash flows

- The transferability of cash flows refers to how well the business can continue to generate cash flows
without the owner's involvement. A business that can operate without the owner's involvement is
more attractive to potential buyers, and therefore, it has a higher value.

6. Value is impacted by liquidity

- It is based on the theory of demand and supply. In a crowded market with few quality targets,
valuation multiples rise; conversely, with many targets but few buyers, multiples drop. Higher liquidity
leads to higher value as it is more desirable. lower liquidity tends to depress value as it is difficult to
sell.

KEY RISKS IN VALUATION

1. Market risk
- refers to the potential losses that may arise due to the volatility of financial markets or changes in
market conditions. This risk arises from factors such as fluctuations in interest rates, exchange rates,
commodity prices, and overall economic conditions.

For example, if valuing a real estate property, changes in interest rates and overall economic
conditions can affect the rental income and property value, thereby impacting the overall valuation.

2. Company-specific risk
- relates to factors that are specific to the particular asset or business being valued. These risks may
include industry-specific risks, competitive risks, technological risks, and management risks.

For instance, when valuing a manufacturing company, the valuation professional needs to consider
factors such as the company's competitive position in the market, the quality of its management team,
potential obsolescence of its products, and other industry-specific risks.

3. Financial risk
- refers to the potential impact of the company's financial structure, including its leverage or debt levels,
on the value of the asset or business being valued. Higher levels of debt can increase the financial
risk associated with the investment and reduce its value.

4. Regulatory and legal risks

- arise from changes in legislation, regulations, or legal issues that can impact the value of an asset or
business.

For example, changes in tax laws can affect the profitability and value of a business, while legal
disputes can impact its reputation and future cash flows.

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