MODULE 4 CORPORATE VALUATION

MODULE – 4
CORPORATE VALUATION
Corporate Valuation / Business valuation is a process and a set of procedures
used to estimate the economic value of an owner's interest in a
business. Valuation is used by financial market participants to determine the price
they are willing to pay or receive to affect a sale of a business.
The process of determining the economic value of a business or company.
Business valuation can be used to determine the fair value of a business for a
variety of reasons, including sale value, establishing partner ownership and
divorce proceedings. Often times, owners will turn to professional business
valuators for an objective estimate of the business value.

Reasons for a business valuation

There are many reasons and circumstances requiring a business valuation, some
pleasant and some not so pleasant.

 Business succession planning is a common reason to obtain a business

valuation. The business succession parties could be a partner, employee or
other party close to the business or an outside business wishing to acquire
the business.
 Business valuation requirements under not so pleasant conditions would be
a divorce, multiple owner disaccord or shareholder oppression.
 Regulatory bodies sometimes require a business valuation, real property
valuation and personal property valuation. Sometimes all three are needed.
Examples include gifting, estate, income taxes, property taxes and financial
accounting standards under generally accepted accounting principles
(GAAP) or international guidelines.

Basis of Business Value

A set of key assumptions defining how business value is to be measured.

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A basis of value in business valuation encompasses the foundational elements of

business value measurement such as expected transactional environment,
objectives of parties interested in business valuation and the purpose of appraisal.
The most important bases of business value are:
 Market value
 Investment value
 Fair value
 Special value

Market Value

Current estimate of the business selling price. Usually determined by business

valuation methods under the market approach.
One of the main reasons to do business valuation is to estimate the business
selling price.
If you are a business owner, you would be interested to know what price your
business can sell for. If you are looking to buy a business, the selling prices of
similar businesses give you an idea of what you would need to spend to acquire a
business.
In either case, the business market value is the current indication of the
potential business selling price.
You can use market-based business valuation methods to get a current estimate
of the business market value. These business valuation methods work because
they rely on direct comparisons to selling prices of businesses that resemble your
business or your acquisition target.
Business Market Value Estimation

Investment Business Value

The measure of business value used to determine what a business is worth to a

particular investor or business owner.

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Different people may have different goals for owning and running a business. In
addition, people may perceive the risks associated with business ownership
differently. These differences may affect what these business people believe a
company is worth.
The fair market value standard measures what a business is worth to a
hypothetical average investor. The investment value standard lets you determine
the value to a real business person with specific business ownership objectives.

Fair Value Basis

When referring to the valuation of a business or business assets, the fair

value basis is defined as a potential transfer price between a specific buyer and
seller, both parties possessing full knowledge of all the relevant facts to make
their decision in accordance with their respective objectives.

Special value

Special value is what a particular investor or group of investors believe the assets
to be worth due to some unique advantages to be realized from the asset
acquisition.
Special value is quite different from the business market value which disregards
any special or synergistic benefits to the investor and requires only the presence
of hypothetical willing buyer and seller parties. Indeed, the difference between
the market value and special value is what creates interest on the part of these
synergistic investors.

APPROACHES TO VALUATION:

1. Discounted Cash Flow Method

2. Relative Valuation Method
3. Comparable Transaction Method
4. Net Asset Method

Discounted Cash Flow Method

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Discounted cash flow (DCF) is a popular method used in feasibility

studies, corporate acquisitions and stock market valuation. This method is based
on the theory that an asset's value is equal to all future cash flows derived from
that asset. These cash flows must be discounted to the present value at
a discount rate representing the cost of capital, such as the interest rate.

A discounted cash flow (DCF) is a valuation method used to estimate the

attractiveness of an investment opportunity. DCF analysis uses future free cash
flow projections and discounts them to arrive at a present value estimate, which
is used to evaluate the potential for investment. If the value arrived at through
DCF analysis is higher than the current cost of the investment, the opportunity
may be a good one.

Calculated as:

DCF is also known as the Discounted Cash Flows Model.

There are several variations when it comes to assigning values to cash flows and
the discount rate in a DCF analysis. But while the calculations involved are
complex, the purpose of DCF analysis is simply to estimate the money an investor
would receive from an investment, adjusted for the time value of money. 

The time value of money is the assumption that a dollar today is worth more than
a dollar tomorrow. For example, assuming 5% annual interest, $1.00 in a savings
account will be worth $1.05 in a year. Due to the symmetric property (if a=b,
then b=a), we must consider $1.05 a year from now to be worth $1.00 today.

Relative Valuation Method

A relative valuation model is a business valuation method that compares a firm's

value to that of its competitors to determine the firm's financial worth.

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There are many different types of relative valuation ratios, such as price to free
cash flow, enterprise value (EV), operating margin, price to cash flow and price-to-
sales (P/S).

One of the most popular relative valuation multiples is the price-to-earnings (P/E)
ratio. It is calculated by dividing stock price by earnings per share (EPS). A
company with a high P/E ratio is trading at a higher price of earnings than its
peers and is considered overvalued. Likewise, a company with a low P/E ratio is
trading at a lower price of EPS and is considered undervalued. This framework can
be carried out with any multiple of price to gauge relative market value.

In addition to providing a gauge for relative value, the P/E ratio allows analysts to
back into the price that a stock should be trading at based on its peers. For
example, if the average P/E for the specialty retail industry is 20x, it means the
average price of stock from a company in the specialty retail industry trades at 20
times its EPS.

Assume company A trades for Rs.50 in the market and has EPS of Rs.2. The P/E
ratio is calculated by dividing Rs. 50 by Rs. 2, which is 25x. This is higher than the
industry average of 20x, which means Company A is overvalued. If company A
were trading at 20 times its EPS, the industry average, it would be trading at a
price of Rs. 40, which is the relative value. In other words, based on the industry
average company A is trading at a price that is Rs.10 higher than it should be,
representing an opportunity to sell.

Comparable Transaction Method

A comparable transaction is a method of valuing a company that is for sale.

Comparable transactions considers the past sales of similar companies as well as
the market value of publicly traded firms that have an equivalent business
model to the company being valued. To get a more accurate valuation, more than
one comparable transaction should be used. This method of valuation can help
identify the current value and potential growth for a company.

Comparable transactions look at multiples such as the EV/EBITDA ratio, among

others, to determine a value. The difficulty with this approach is the limited
availability of financial data regarding past transactions between private
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companies. A comparable transaction approach is generally used in conjunction

with other valuation techniques including the discounted cash flow and
other comparable company analysis techniques.

Net Asset Method

An asset-based approach is a type of business valuation that focuses on a

company's net asset value(NAV), or the fair-market value of its total assets minus
its total liabilities, to determine what it would cost to recreate the business. There
is some room for interpretation in the asset approach in terms of deciding which
of the company's assets and liabilities to include in the valuation, and how to
measure the worth of each.

The real value of assets in an asset-based approach for valuing a business may be
much greater than simply adding up the recorded assets. For example, a
company’s balance sheet may not include major assets such as internally
developed products and proprietary methods of conducting business. If the
company’s owner did not pay for the assets, they did not get recorded on the cost
basis balance sheet. In addition, many businesses have special products or
services that make them unique. Pricing those offerings as part of selling a
business may be difficult due to their intangible value.

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