Value Measurement

VALUATION
M&A

Rishit Ankola

Need for valuing shares (or

business)
As far as unlisted companies are concerned the price of
shares of such company is not readily available, so we
need to determine the value of shares of such companies,
but this is not the case with the listed companies. The
price of share of a listed company is already available on
the stock market. Then why do we need to calculate the
value of shares or business separately?
The reasons are:
The market price may not represent fair value.
There is no guarantee that the market price is not
rigged or manipulated.

Steps in Valuation
Obtaining information
Management Discussion and Industry
Overview
Data analysis and review
Selection of Method
Applying Method
Conducting sensitivities on assumptions
Assigning Weights
Recommendation
Reporting

Sources of Information
Historical data such as audited results of
the
company
Future projections
Stock market quotations
Discussions with the management of the
company
Representation by the management
Data on comparable companies
Market surveys, news paper reports

Methods of Valuation

Asset based valuation

Earnings or dividend based valuation
CAPM based valuation
Valuation based on Present Value of
free cash flows
Valuation of Intangible Asset
Did
You
Ever
Notice how come
the Apple Brand is
Valued at $ 93.8

Assets Based Valuation

The book value of a firm is based on the balance sheet value
of owner's equity or in other words Assets minus liabilities.
For assets value to be useful, the target company should
have followed a regular depreciation, replacement and
revaluation policy.
The reasons for using this method are
It can be used as a starting point to be compared and
complemented by other analysis
Where large investment in fixed assets is required to
generate earnings, the book value could be a critical factor
especially where plant and equipment are relatively new.
The study of firm's working capital is also necessary.

Earnings based Valuation

(Dividend Discount Model)
The dividend discount model (DDM) is a
method of valuing a company's stock price
based on the theory that its stock is worth
the sum of all of its future dividend
payments, discounted back to their present
value.
In other words, it is used to value stocks
based on the net present value of the future
dividends.

DISCOUNTED CASHFLOW VALUATION

Cashflow to Firm
EBIT (1-t)
- (Cap Ex - Depr)
- Change in WC
= FCFF

Value of Operating Assets

+ Cash & Non-op Assets
= Value of Firm
- Value of Debt
= Value of Equity

Firm is in stable growth:

Grows at constant rate
forever

Terminal Value= FCFF n+1 /(r-g n)

FCFF1
FCFF2
FCFF3
FCFF4
FCFF5
FCFFn
.........
Forever
Discount at WACC= Cost of Equity (Equity/(Debt + Equity)) + Cost of Debt (Debt/(Debt+ Equity))

Cost of Equity

Riskfree Rate :
- No default risk
- No reinvestment risk
- In same currency and
in same terms (real or
nominal as cash flows

Expected Growth
Reinvestment Rate
* Return on Capital

Cost of Debt
(Riskfree Rate
+ Default Spread) (1-t)

Beta
- Measures market risk

Type of
Business

Operating
Leverage

Weights
Based on Market Value

Risk Premium
- Premium for average
risk investment

Financial
Leverage

Base Equity
Premium

Country Risk
Premium

CAPM based valuation

The Capital Asset pricing model can be used to value
the shares. This method is useful when we need to
estimate the price for initial listing in the stock
exchange. The crux of this model is to arrive at the cost
of the equity and then use it as the capitalization of
dividend or earning to arrive at the value of share.
CAPM = Rf + beta of the firm (Rm-Rf)
where
Rf : Risk Free Rate of Return
Rm : Market Rate of Return

Free Cash flow model

Free cash flow model facilitates estimating the maximum worthwhile
price that one may pay for a business. Free cash flow analysis utilizes the
financial statements of the target-business, to determine the distributable
cash surpluses, and takes into account not merely the additional
investments required to maintain growth, but also the tie-up of funds
needed to meet incremental working capital requirements. Under this
model value of the firm is estimated by a three step procedure:
Determine the free future cash flows:
Net operating income + Depreciation - incremental
investment in capital or current asset for each year separately.
Determine terminal cash flows, on the assumption that there would be
constant growth, or no growth.
Present values these cash flows can then be compared with the price
that we would pay for the acquisition.
However while estimating future cash flows, the sensitivity of cash flows
to various factors should also be considered.

Valuation of Intangible Asset

(BRAND)

Brand Value = Brand Earning Brand

Value
Multiple

Damodaran on Brand
Valuation

= Value of firm/sales ratio of the firm with
the
benefit of the brand name
= Value of firm/sales ratio of the firm with
the
generic product

Example: Valuing A Brand Name

Kelloggs Generic

Kellogg's

Substitute

Pre-Tax Operating Margin

22.00%

10.50%

After-Tax Operating Margin

14.08%

6.72%

Return on Asset

32.60%

15.00%

Retention Ratio

56.00%

56.00%

Expected Growth

18.26%

8.40%

Cost Of Equity

13.00%

13.00%

E/(D+E)

92.16%

92.16%

D/(D+E)

8.50%

8.50%

3.39

1.1

Length of High Growth Period

Value/Sales Ratio

This is How Brand Apple is Valued at $

Selection of Methods

RBI Pricing Guidelines

Transfer of shares by Resident to Non-resident
(i.e. to foreign national, NRI, FII and
incorporated non-resident entity)
In case of listed companies- the price shall not be
less than the price at which a preferential allotment
of shares can be made under the SEBI Guidelines
In case of unlisted companies - the price shall not
be less than the fair value to be determined by a
SEBI registered Category I Merchant Banker or a
Chartered Accountant as per the Discounted free
cash flow method.

CONCLUSION