Valuation – an overview

and
General Principles of
Valuation
CA R Suriyanarayanan

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WELCOME TO THIS COURSE

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 This Course will address
• Valuation – Overview
• Concepts of Value and General Principles
of Valuation
• Selection of Valuation Techniques
• Use of Forecasting Techniques
• Present Value
• Fair Value Measurement

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 This Course will address
• Impairment measurement
• Valuation for Mergers and Acquisitions
• Due diligence and its impact on valuation
• Valuation of Shares
• Valuation of other securities incl. complex
instruments
• Valuation for Tax purposes

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 This Course will address
• Intangible Assets – General considerations
in valuation
• Brand Valuation
• Valuation of Intellectual Properties
• Valuation of Human Resources
• Valuation of ESOP
• Valuation of Options

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 This Course will address
• Valuation of closely held businesses
• Valuation of stressed businesses
• Effective use of Excel spread sheets
• Drafting a valuation report
• Valuation as a profession – competence, quality and
ethics
• The whole sessions will be interspersed with
examples from specific industries, case studies
and practical thoughts

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 Fundamentals of
Valuation
• Accountant’s valuation sans business
knowledge…

– Mere arithmetical exercise

• Business valuation sans accountant’s
knowledge…

– Lead to investment oblivion!

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 Fundamentals of
Valuation
• What is required – an amalgam of

– Indepth business understanding

– Overview of process understanding

– Firm rooting in financial basics

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 Chartered Accountants
and valuation…
CY PY
Share Capital • We are not new to Valuation
Reserves and Surplus
Term Loans
Working Capital Loans
Deferred Tax Liability • Only the principles and basis
Total
of valuation changes…
Fixed Assets - GrossCost
Less: Accumulated Depreciation
Net Fixed Assets
Investments - Cash investments
• CA’s most aptly suited for
Inventories business valuations
Sundry Debtors
Cash and Bank Balances – Our understanding of
Loans and Advances
Gross Current Assets
businesses across multiple
industries
Current Liabilities and Provisions
– Our intricate knowledge of
Net Current Assets financials and its inter-
Total
linkage to businesses across
industries
 Opportunity awaiting…
• Need for Business Valuations is on the growth path…
• Our own case
– Were doing probably one in a year 15 years back
– Now maybe handling about one in a week
• With the IFRS alignment coming in
– Fair valuation will be required by many clients
– Need for CAs who can provide valuation service

• CAs have the required mix of business and accounting

knowledge to make it happen

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 VALUATION

What Does Valuation Mean?

• The process of determining the current

worth of an asset or company.

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 Background

• Valuation is neither a pure art nor a pure

science but a perfect combination of both

• Valuation has ‘Goldmines' and so also has

‘minefields’

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Basic understanding & Perspective
• What is Value
Value is an expression of ‘ Worth’ of something

• International Valuation Standard Committee defines Value as

 An economic concept
 An estimate of likely price
 Not a fact
 An estimate of likely price at a given time

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 Concept - Price
• Amount asked for / offered
• Sale price is a Historical fact
• Price may or may not have relationship
with the value ascribed to the underlying
– However, in many cases, price could be an
indication of value under particular
circumstances

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 Concept - Cost
• What is paid to create the underlying
• When its ready and complete, it’s a
historical fact
• Price to one become the cost later.

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 Concept - Market
• The environment in which
– goods and services trade
– between buyers and sellers
– through a pricing mechanism
• Implies
– trade without undue restrictions
– with free flow of information and knowledge

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 Concept - Value
• Economic concept of what can be
ascribed to the underlying
• It is not a fact but merely an estimate
• Reflects
– Market’s view of the benefits
– As of the effective date of valuation

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Business Valuation and Process
Business Valuation is defined as
“The act or process of determining the value of a business
ownership interest, Security, or Intangible assets”
Business Valuation Process
 Purpose
 Standard of Value
 Premise of Value
 Historical Analysis
 Environment Scan
 Appropriate valuation approaches
 Appropriate methods
 Value Conclusion

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 Purpose and role
 Buy & Sell Mandate
 Going Public
 Private placement of securities
 Implementation of Basel II
 Borrowing Decisions
 Tax related valuation including transfer pricing
 Equity research area
 Credit Rating
 Corporate Planning

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 Standards of value

“The Identification of the type of value being

utilized in a specific engagement”

Commonly used ‘Standard of Value’ used in

practice are:-
1. Fair Market Value
2. Investment Value
3. Intrinsic Value
4. Fair Value
5. Market Value

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 1. Fair Market Value

The Essence of FMV are

 Cash Equivalent Price

 Hypothetical willing & able buyer& seller
 At arms length in an open and unrestricted market
 No Compulsion
 Reasonable knowledge of the facts

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 2. Investment Value
• “The Value of particular Investor based on individual
investment requirements & Expectations”

• The Investment Value is personal as it reflects the unique

situation of a particular investor.

• Value may add to the stand alone value of the business the
following:-
 The control Premium
 The synergy Premium

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 3. Intrinsic Value or Fundamental Value
• Graham (Father of value investment) and Dodd Defines Intrinsic Value
as “ the value which is justified by assets, earnings, dividends, definite
prospects, and the factors of management”

Four major components of Intrinsic Value of going concern

 Earnings power & profitability in the employment of assets as
distinguished from the reported earnings
 Dividends paid or capacity to pay dividends currently & in future
 A realistic growth expectation on earnings power
 Stability & predictability of the future economic Value of the enterprise

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 4. Fair Value

 Are willing to transact

 Are independent

 Are knowledgeable having understanding about the asset or liability

 Are able to transact

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 5. Market Value
• Generally used in property Valuation
Market value
 Is the estimated amount for
 which Property could be Exchange
 On the date
 Of valuation between a willing buyer
 And a willing seller
 In am arms length transaction after proper marketing
 wherein the parties had each acted knowledgeably, prudently
 & without compulsion

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 Premises of Value

Going Concern

Value to
Value in Value in Value in
specific
use Place exchange
holder

Fair Value FMV or Fair

for Financial Investment Value for
Reporting Value financial
reporting 1

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 1 Liquidation

Forced Ordered

Value of specific
holder Value to specific
Value in exchange
holder

Investment Value or Investment Value or

Fair Value for legal FMV or Fair Value Fair Value for legal
purpose purpose

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 Valuation Myth

Myths grown with valuation profession

The myth is The truth is

 Valuation is objective.
 Valuation gives precise number
 A single valuation servers more
than one purpose.
 A complex financial model gives
better valuation
 Valuation is worthless as it
involves lot of assumptions
 It is subjective
 Valuation only gives an estimate
 That the value will change if the
purpose is changed
 That it doesn’t give better
valuation
 That it is useful in decision

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VALUATION METHODS

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 Methods
• Asset value
• Liquidation value
• Relative value (Multipliers)
• Discounted cash flow value
– Dividend discount models
– Free cash flow models

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Equity versus Entity Value
Assets Liabilities

Fixed Assets Debt

Working Capital Equity

Current Assets
Less Current Liabilities

Entity Value = Debt Value + Equity Value

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 Asset and Liquidation
Value
• Segment value
• Availability of secondary markets
• Appraised value

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 Multiplier Methods
• Price-to-earnings (P/E)
• Price-to-earnings-before-interest-tax-
depreciation and amortization
(P/EBITDA).
• Price-to-book (P/B)
• Price-to-sales (P/S)
• Price-to-cash flow (P/CF).

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 Multiplier Value
Value = Item value x Multiplier

For ex.: Using the P/E method:

Value = EPS forecast x Predicted

P/E multiple

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 Dividend Discount Model - DDM
A procedure for valuing the price of a stock by using
predicted dividends and discounting them back to present
value. The idea is that if the value obtained from the DDM is
higher than what the shares are currently trading at, then the
stock is undervalued.

This procedure has many variations, and it doesn't work for companies
that don't pay out dividends.

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 Discounted Cash Flow
Models
• Free cash flow represents the cash flow
generated by the company that is available for
dividends and interest payments (but may also
be used to grow the business or repurchase
shares).

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 Free Cash Flow Models
• Free cash flow = Gross Cash Flow -
Investment

• Gross Cash Flow =NOPAT + Depreciation

• NOPAT = EBIT * (1-Tax rate)

• Investment = Capex + Net Working Capital
• Capex = NPPE + Depreciation

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FCF: No Growth Model
(a) No Growth Model
FCF
V 
WACC

(Note: Denominator is the WACC,

not the return on equity)

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 Free Cash Flow: Constant
Growth
(b) Constant Growth Model

F C F 0 (1  g )
V 
WACC  g

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 FCF: Abnormal Growth
Model
(c) Abnormal Growth Model

FCF1 FCF2 FCFN CV

V    ...  
1  WACC (1  WACC ) 2 (1  WACC ) N (1  WACC ) N

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 Continuing Value
• CV is known as the continuing value (or
terminal value) and is the value of the
company at the end of the explicit
forecast period (i.e. at the end of year N).

• There are two common ways to estimate

CV:
1) Constant Growth Method
2) Multiplier Method
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 Estimating Continuing
Value
(i) Constant Growth Method
g is the constant growth rate per year in
perpetuity after year N.
g = Expected Infl + Real Growth in Econ + Fran Growth Rate

In general, g consists of three components:

– The first two can be obtained from many economic
forecasting services.
– The last is the rate at which you believe the company can
grow above that of the economy as a whole.

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Various Methods of Computing
Continuing / Terminal Value
Where:
TV = the total amount
P = the principal amount
r = interest rate
t = period of time
FCFO (1+g)
TVO == K-g
Where:
TVO = Value of the firm in year 0
FCFO = Free cash flow in year 0
k = Discount rate
g = Growth rate in E (in perpetuity)

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Various Methods of Computing
Continuing / Terminal Value

Where:

d = discount rate

g = growth rate

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 Estimating CV (Contd.)
(ii) Multiplier Method
• This approach uses the final year’s pro formas to
determine either N/Inc, EBITDA, or book value at
the end of the explicit forecast period.

• The model then assumes that the company will

trade at an industry average multiplier after year
N.

• CV = Net Inc of year N x (Industry Avg. P/E)

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Valuation Models…

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 Which approach should you
use? Depends upon the asset
being valued..

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And the analyst doing
the valuation….

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THANK YOU!

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CONCEPTS AND PRINCIPLES

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 Land and Property
• Land
– Is essential to our lives and existence
– Its importance brings into focus as it impacts the societies
and nations!
• Valuation of land as if vacant or of land and
development is an economic concept
• Property is a legal concept
– Interests
– Rights and
– Benefits

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 Land and Property
• Value is created by real estate’s
– Utility
– Capacity to satisfy the needs and wants of human societies
• Contributions are from
– General uniqueness
– Durability
– Fixity or location
– Relatively limited supply
– Specific utility of a given site

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 Land and Property
Price changes are due Principles in valuation
to •Supply and demand
•General economic •Competition
conditions
•Substitution
•Social forces
•Anticipation or
•Relative purchasing expectation
power of money
•Change
•Technology

Essentially aspects affecting the degree of utility and

productivity of a property 53