Valuation of a firm

M.Thenmozhi
Professor
Department of management Studies
Indian Institute of Technology Madras
Chennai 600 036
mtm@iitm.ac.in
Valuing a business – enterprise –
value per share -
• Company assets or its equity?
– Net assets or net worth
• Minority interest or controlling interest?
– Marketable- public company
– Private company – limited
• Going concern or liquidation?
• Enterprise value – value debt- marketable
securities = owners value
 Valuation
• Dividend Capitalisation Approach
• Asset based Approach
• Earnings Based Approach
• Comparable company approach
• Comparable transactions approach
• Discounted cash flow approach
 Valuation of equity shares
Dividend Capitalisation Approach
D1 D2 D  Dt
Ve = --------- + --------- + …+ --------- =  -------
(1+ke)1 (1+ke)1 (1+ke)  t=1
(1+ke)t
 Valuation of equity shares...
Dividend Capitalisation Approach ...
If we plan to own shares only for two years:
D1 D2 P
Ve = --------- + --------- + ----------
(1+ke)1 (1+ke)2 (1+ke)2

P2 = expected M.P. at the end of 2 years

ke = required rate of return or capitalisation rate
If perpetual
Ve = De/ke
De = dividend expected per year, ke = expected rate of return
 Valuation of equity shares...
Dividend Capitalisation Approach…
If dividend is growing:
Do(1+g) Do(1+g)2 D0(1+g) 
Ve = ------------ + ------------ + ….+ --------------
(1+ke)1 (1+ke)2 (1+ke)

Do(1+g)
= -----------
(ke-g)
Do = present dividend per share
D1 = dividend at the end of year one i.e.D o(1+g)
 Valuation of equity shares ...
Asset Based Approach
Net assets---- Book value
Net assets(or networth)
= -----------------------------
No. of shares
Net assets ---- market value
M.V. of assets - total liabilities
= -------------------------------------
No. of shares
 Valuation of equity shares ...

Earnings based approach

M.P. = E.P.S. * P/E ratio

Price earnings ratio=MPS/EPS =6

 Valuation of equity shares ...
Cash flow approach
Free cash flow = operating profit after tax (i.e. EBIT(1-t))
+ Depreciation
 other non cash items
+/- change in capital expenditure
 change in working capital
 P.V. of expected future free cash flows
V = --------------------------------------------------
No. of shares

•FMV of firm= PV(FCF years 1-10 +

Terminal Value at year 10)
 Valuation of equity shares ...
Cash flow approach...
Using growth factor:
= P.V. of FCF / r-g
----------------------
No. of shares
Comparable Company approach
Company A B C Av.

Market value of
equity /Sales
Market value of equity/
book value of equity
Market value of equity/
Net income
Market value of equity/
free cash flows
Comparable Company approach
Co. Sales x Av ratio = Firm value

Co. Book Value x Av. ratio =Firm value

of equity
Co. Net income x Av ratio = Firm value

Co.Free cash x Av. ratio =Firm value

flows
Av. Firm value
 Comparable Transactions approach

• Similar to Comparable Company approach

Discounted Cash Flow approach
• Present value of future cash flows ( yr 1 to
10)
• Present value of terminal value ( 10 th yr)
Equity Value = (Value of firm – Value of
debt) / Number of shares
 Valuing an ecommerce firm
• Gross Merchandise value multiple
– No positive cash flow
– Approx. estimate
- Gross revenue - Sales value of merchandise
• good indicator of the growth of the company
• Gross Transactions Value - sale value of
items sold
– Commission on GTV
Case study