FIN544:Corporate Valuation

Other Non-DCF Approaches

Learning Outcome

 Estimate value of a listed firm by using

market value of its stock and debt.
 Outline
 Book Value Approach
 Stock and Debt Approach
 Strategic Approach to Valuation
Today class

 Yesterday we have discuss about the Book

Value approach …….
 In this class , we learn about Stock and Debt
approach for Valuation
 Book Value Approach

 The simplest approach to valuing a firm is to

rely on the information found on its balance
sheet.
 Two equivalent ways of using the balance
sheet information to appraise the value of a
firm.
1. Book values of investor claims may be
summed directly.
2. The assets of the firm may be totaled and
from this total, non-investor claims may be
deducted.
 Illustration
Adjusted Book Value Approach: An Illustration
 
In October 1999, the market price of the equity of Reliance Industries Limited
(RIL) was hovering around Rs.400 per share. At that time the paid-up equity
capital of RIL was about Rs.1000 crore, 100 crore shares of Rs.10 each. Anil
Ambani issued a public statement that the market was significantly
undervaluing the RIL share. He argued that the intrinsic value per share of RIL
was about Rs.650 per share. He arrived at this number as follows:
 Replacement cost of RIL’s plants Rs. 40,000 crore
 Value of RIL’s 50 percent shareholding in Reliance Rs. 15,000 crore
 Petroleum Limited
 Value of RIL’s shareholdings in BSES and L&T Rs. 10,000 crore
 Value of RIL’s 30 percent stake in Panna, Mukti, and Tapti Rs. 2600 crore
 oil ventures
 Cash holdings Rs. 6,000 crore
 
A: Value of Assets Rs. 73,600 crore
Less: Outstanding Debt Rs. 9,000 crore
B: Net Asset Value (NAV) Rs. 64,600 crore
C: NAV Per Share (64,600/100) Rs.646
 Fair Value Accounting
From late 1990s, accounting rule makers and regulators have
been pushing for “fair value accounting.” Apparently, this
initiative has been inspired by the ideal that the balance sheet
should provide a reliable estimate of the value of the assets
and equity in the firm.
 
The accounting community, however, seems to be divided on the
issue of fair value accounting. Proponents of fair value
accounting argue that it will improve the alignment of
accounting statements and value and provide useful
information to financial markets.
 
Opponents of fair value accounting believe that it will increase
the scope for accounting manipulation and financial
statements would become less informative. They point toward
the widespread manipulation that was prevalent in the U.S.
when firms revalued their assets at fair value until 1934,
before the SEC plugged this practice.
 FINANCIAL BALANCE SHEET

While the accounting balance sheet provides useful information about

how a firm has raised capital and invested the same, it is backward
looking. To get a more forward-looking picture, you can look at the
financial balance sheet, as illustrated below:
A Financial Balance Sheet
Equity and Liabilities Assets
• Market value of equity  Value of assets in place
• Market value of debt  Value of growth assets

Superficially, a financial balance sheet resembles an accounting

balance sheet. However, it differs in two important ways.
• It does not classify assets on the basis of asset life or tangibility,
instead it classifies them into assets in place( these represent the
investments already made by the company) and growth assets (these
represents the investments the company is expected to make in future).
• The values assigned to these investments are not what has already
been invested, but based upon expectations for the future.
 STOCK AND DEBT APPROACH
• PUBLICLY TRADED

• WHAT PRICE ?
AVERAGING ?
EMH . . .

• TWO IMPLICATIONS
• S & D . . MOST RELIABLE ESTIMATE OF
VALUE
• SECURITIES . . VALUED . . LIEN DATE
Stock and debt approach

 Stock and debt approach can be applied

only to companies which are traded on
the market.
 In this approach, value of a firm can be
calculated by adding the market value of
all its outstanding securities.
 It is also called as market approach.
Example

 Stock price of a share on NSE- Rs 200

 No of shares outstanding for the company-10 cr
 Market value of the equity- 2000 cr =(200*10)

 Value of firm debt (like bond, debentures etc)=

500 cr

 Total Value of firm= Market value of equity +

Market value of debt=2000+500=2500 cr
Efficient Market Hypotheses

 Stock and debt approach is based on the

concept of market efficiency
 (Efficient Market Hypotheses (EMH))
 What is EMH

 Efficient market hypothesis (EMH), alternatively known

as the efficient market theory, is a hypothesis that states
that share prices reflect all information .
 According to the EMH, stocks always trade at their fair
value on exchanges, making it impossible for investors to
purchase undervalued stocks or sell stocks for inflated
prices.
 Therefore, it should be impossible to outperform the
overall market through expert stock selection.
Key points for EMH

 The efficient market hypothesis (EMH) or

theory states that share prices reflect all
information.

 The EMH hypothesizes that stocks trade at

their fair market value on exchanges.
Efficient Market
Hypotheses
Strong - form
Semi-strong form
Weak-form
Three forms of EMH
 There are three forms of EMH: Weak, Semi-strong, and Strong.

 Weak Form EMH: Prices reflect all information found in the record of past prices or
suggests that all past information is priced into securities.

 Semi-Strong Form EMH: Prices reflect not only all past information but also all other
publically available information ( in media , stock exchanges etc)

 Strong Form EMH.: Prices reflect all available information, both public and private
Weak form : example

 Suppose a trader observe Infosys  stock price

continuously decline on Mondays and
increase in value on Fridays. He may assume
he can profit if he buys the stock at the
beginning of the week and sells at the end of
the week. If, however, Infosys’s price declines
on Monday but does not increase on Friday,
the market is considered weak form efficient.
 Evidence in Favour of EMH
There are three important predictions of
EMH .. Supported by empirical
evidence.
1.Even professional investors (such as
mutual fund managers) cannot earn
superior risk-adjusted rates of return.
2.Prices behave like a random walk.
3.Stock prices respond immediately and
unbiasedly to new information.
 Evidence Against Market
Efficiency
 Patterns in stock prices
. Monday effect
. January effect
 Mispricing of securities
. Small firms
. Value stocks
 Excess volatility in stock returns
Indirect Applications of the
Stock and Debt Approach
Since the stock and debt approach can be
applied directly only to companies which
are traded on the market, its usefulness
may seem limited. However, the stock and
debt approach provides valuable inputs in
other appraisal procedures. In particular,
it serves as the basis for developing
multiples that are used in the direct
comparison approach (relative valuation
approach)
THANK YOU