Appraoches to Valuation

8/18/2019 Appraoches to Valuation

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Objectives

• To understand the various approaches to

valuation


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What is the need for business

valuation?

Company PriceProduct Price


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Rs 12!""""

Rs !"""


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Conte#t of $aluation

• Raisin% capital for a $enture

• &nitial Public Offerin%

• 'c(uisitions

• )ivestitures

• P*+ )isinvestment• ,mployee *toc- Option plan

• Portfolio .ana%ement


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'pproaches to $aluation

Valuation Models

Asset Based Valuation

Discounted Cashflow Models

Relative Valuation Contingent Claim Models

LiquidationValue

ReplacementCost

Equity ValuationModels

Firm ValuationModels

Cost of capitalapproach

APVapproach

Excess ReturnModels

Stable

Two-stage

Three-stageor n-stage

Current

Normalized

Equity

Firm

Earnings Book Value

Revenues Sectorspecific

Sector

Market

Option todelay

Option toexpand

Option toliquidate

Patent UndevelopedReserves

Youngfirms

Undevelopedland

Equity introubledfirm

Dividends

Free Cashflowto Firm


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'sset /ased $aluation


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• ' type of business valuation that focuses ona company0s net asset value or the fairmar-et value of its total assets minus itstotal liabilities

'sset /ased $aluation


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When to use 'sset based

valuation?

• *cenario 1

3 4irms 5ho value drivers lar%ely depends on tan%ible

assets ,#ample mines minerals oil Cell phone

to5ers• *cenario 2

3 4irm 5hose assets are separable and mar-etable

,#ample Real estate companies

• *cenario 6 3 )eterminin% the value of firms under%oin% li(uidation


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O78CThe company %re5 its %lobal footprints 5ithac(uisition of oil and %as assets and no5 has projects in 19 countries

operations in 29 countries and a commercial presence in over !" countries

):40s primary business is development of

residential commercial and retail properties4rom developin% 22 major colonies in )elhi):4 is no5 present across 1! states2;cities in &ndia


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'sset based $aluation .ethods

/oo- value

.ethodReplacement

Cost

.ar-et $alue

.ethod

:i(uidation

value


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• The boo- value of an asset refers to the amount at

5hich an asset is sho5n in the balance sheet of a

firm

/oo- value < &nitial ac(uisition cost 3 accumulated depreciation

/oo- $alue of an asset/oo- $alue of an asset


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/oo- $alue of a business

Book value of a business refers to total boo-

value of all valuable assets =e#cludin% fictitious

assets such as accumulated losses and deferred

revenue e#penditures li-e advertisement preliminary e#penses cost of issue of securities

not 5ritten off> less all e#ternal liabilities

=includin% preference share capital>


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.ar-et value

• .ar-et value refers to the price at 5hich an asset

can be sold in the mar-et

• The mar-et value can be applied 5ith respect to

tan%ible assets only intan%ible assets =in

isolation> more often than not do not have anysale value

• .ar-et value of a business refers to the a%%re%ate

mar-et value =as per stoc- mar-et (uotation> of all

e(uity shares outstandin%

• The mar-et value is relevant to listed companies

only


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Replacement $alue

• Replacement value is the potential amount that

one 5ill have to spend at current rates to replacethe e#istin% assets of a company

Replacement Cost


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Replacement Cost

S.no Company

Adjustedreplacement cost (FY

12)in crores

Market Cap Potential upside %

1 ndia cements !"## 2$"# 2#.&

2 Madras cement "## '"1' .2

' ata Steel 121### $#""& 1&!.*

$ +indalco *2### 2'$$* 121.

* ,S- ner/y 1*# #11 &.*

" ,P Associates '#$## 1$"' 1#!

S.no Company

Adjustedreplacement cost (FY

1*)in crores

Market Cap Potential upside %

1 rasim $$!## 22$' &&.2

2 ndia Cements 1### 2$"# ''&

' Madras Cement &# '"1' 1!$

$ Sree cement 1&### &1&! 1#"."

* ata Steel 1!&"## $#""& '$1."" +indalco "#### 2'$$* 1**.&

! ,S- ner/y 1&$## #11 1$2.2

,P Po3er 4entures 2'2## &2*2 1*#.

& Poeni5 Mills "2## 2*"# 1$2.2

1# ,aypee n6ratec 1"1## "'!* 1*2.*

11 M7 n6ra 1!"## "&& 1#2.'

12 ,P associates $$1## 1$"' 2##.'1' 78 n6rastructure ## '&' 12.*


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$aluation of &ndus To5ers

One of the lar%est Cell phone to5ers in &ndia


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With 119;!; to5ers in 1! circles across the country &ndus hasthe 5idest covera%e in &ndia


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Liquidation Value

• :i(uidation value represents the price at 5hich eachindividual asset can be sold if business operations are

discontinued in the 5a-e of li(uidation of the firm

• &n operational terms the li(uidation value of a business ise(ual to the sum of =i> realisable value of assets and =ii>

cash and ban- balances minus the payments re(uired to

dischar%e all e#ternal liabilities

• &n %eneral amon% all measures of value the li(uidation

value of an asset@or business is li-ely to be the least


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'sset/ased 'pproach to $aluation'sset/ased 'pproach to $aluation

Assets-based method focuses on determining the value of

Net assets = (Total assets (excluding fictitious assets) Total external

obligations) (!)

Net assets "er share can be obtained dividing total net assets b# the

number of equit# shares outstanding$ %t indicates the net assets

bac&ing "er equit# share (also &no'n as net 'orth "er share)$

Net assets "er share = Net assets Number of equit# shares issued

and outstanding ()

*xam"le !+ ,ollo'ing is the balance sheet of #"othetical .om"an# Limited as on /arch 0!1 current


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*xam"le !+ ,ollo'ing is the balance sheet of #"othetical .om"an# Limited as on /arch 0!1 current#ear$

2hare ca"ital

341444 !!5 6reference shares of

7s !44 each1 full# "aid-u"

!141444 *quit# shares of 7s !44 each1full# "aid-u"

6rofit and loss account

!45 8ebentures

Trade creditors

6rovision for income tax

34

!4

0

4

9!

:

:

,ixed assets

Less+ 8e"reciation

.urrent assets+

2toc&s8ebtors

.ash at ban&

6reliminar# ex"enses

7s !;4

04

!44;4

!4

!4

!


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2olution + 8etermination of Net Asset Value "er 2hare (Rs lakh)

(i) Boo& value basis ,ixed assets (net)

.urrent assets+

2toc&

8ebtors

.ash and ban&Total assets

Less: *xternal liabilities+

!45 8ebentures

Trade creditors

6rovision for taxation

!!5 6reference share ca"ital

8ividend on "reference shares(4$!! 7s 34 la&h)

Net assets available for equit#holders

8ivided b# the number of equit# shares (in lakh)

Net assets value "er share ( Rs)

7s !44

;4

!4

4

9!

:

34

3$3

7s !4

!


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(ii) /ar&et value basis

,ixed assets (net)

.urrent assets+

2toc&

8ebtors

.ash and ban&

Total assets

Less+ *xternal liabilities (as "er details given

above)+

Net assets available for equit#holders8ivided b# the number of equit# shares (in la&h)

Net assets value "er equit# share (7s)

!4

3;

!4

!04

!;9

:9

!30$3

!30$<

!$

!!?$


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(iii) Liquidation value basis

,ixed assets (net)

.urrent assets+

2toc&

8ebtors

.ash and ban&

Total assetsLess+ *xternal liabilities (listed above)+

Less+ Liquidation costs

Net assets available for equit#holders

8ivided b# the number of equit# shares (in la&h)

Net assets value "er equit# share (in 7s)

?4

34

!4

!4;

!34

3;!30$3

!;$4

:


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OPT&O7*


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Obli%ation $s Option


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*pice Aet• :o5cost carrier =:CC> *piceAet on Tuesday said it 5ould

spend B"" million to buy 6" small aircraft from CanadaD

/ombardier to enhance re%ional connectivity in the country

• &ndia has about " airports in tier&& and 5e plan to enter

these areas as there are no :CCs here

• The E;"" 7e#t8en turboprop aircraft from /ombardier canseat FG passen%ers and has lo5 noise and vibrationfree

features

• &t uses up to ;" per cent less fuel than the re%ional jet aircraft

• 2"iceet has also ordered 04 Boeing aircraft anddeliveries of the same 'ould begin b# 4!0


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Phases of development


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T,'CI&78 .,TIO)O:O8J

• Concepts

• 8uidin% principles

• Tools and Techni(ues

• ,#ercise


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)iscounted Cash 4lo5 $aluation

•Chat is itK &n discounted cash flo5 valuation the value ofan asset is the present value of the e#pected cash flo5s on

the asset

• 6hiloso"hical BasisK ,very asset has an intrinsic value

that can be estimated based upon its characteristics in

terms of cash flo5s %ro5th and ris-

• %nformation NeededK To use discounted cash flo5

valuation you need

3 to estimate the life of the asset

3 to estimate the cash flo5s durin% the life of the asset

3 to estimate the discount rate to apply to these cash

flo5s to %et present value



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• /ar&et %nefficienc#K .ar-ets are assumed to ma-e

mista-es in pricin% assets across time and are assumed tocorrect themselves over time as ne5 information comes

out about assets



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)iscounted Cashflo5 $aluationK /asis for

'pproach

Proposition 1K 4or an asset to have value the e#pected cashflo5s have to be positive some time over the life of theasset

Proposition 2K 'ssets that %enerate cash flo5s early in theirlife 5ill be 5orth more than assets that %enerate cash flo5slater the latter may ho5ever have %reater %ro5th andhi%her cash flo5s to compensate

Value =CF

t

(1+ r)t

t =1

t = n∑

Wh t i th f )C4 l ti ?


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What is the use of )C4 valuation?

• ,stimatin% .er%er 8ains and Costs 3 *uppose that you are the finance mana%er of firm '

and you 5ant of analyHe the possible purchase of

firm / What is the first thin% you loo- for ?

3 &s there any economic %ain from mer%er ?

• ,conomic %ain arises only if the t5o firms are 5orth more

to%ether than apart


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Io5 do you calculate economic %ain?

8ain < P$'/ = P$' L P$/ > < P$'/

Cost of ac(uirin% /

Cost < Cash paid P$/

7et Present value < 8ain Cost

< P$'/ = Cash paid P$/ >

7P$ < 5ealth 5ith mer%er 5ealth 5ithout mer%er


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• 4irm ' has a value of Rs 2"" million and / hasa value of Rs !" million .er%in% the t5o

5ould allo5 cost savin%s 5ith a present value of

Rs 2! million Calculate the =7P$>,conomic

%ain from the mer%er'ssume firm / is bou%ht

for cash Rs 9! million

Io5 do you calculate economic %ain?

)i t d C h 4l $ l ti


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,(uity $aluation 4irm valuation

Cash flo5s to e(uity

)iscount rate

=cost of e(uity>

Cash flo5s to firm

)iscount rate

=W'CC>


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& ,(uity $aluation


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&,(uity $aluation

• The value of e(uity is obtained by discountin% e#pected

cashflo5s to e(uity ie the residual cashflo5s aftermeetin% all e#penses ta# obli%ations and interest and

principal payments and reinvestment needs at the cost of

e(uity ie the rate of return re(uired by e(uity investors

in the firm

5here

C4 to ,(uityt < ,#pected Cashflo5 to ,(uity in period t

- e < Cost of ,(uity

Value of Equity =

CF to Equityt(1+ k e )

tt=1

t=n

∑

4C4,1 4C4,2 4C4,6 4C4,; 4C4,! 4C4,n

" 1 2 6 ; ! n


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&& 4irm $aluation

• .ost of ca"ital a""roachK The value of the firm is

obtained by discountin% e#pected cashflo5s to the firmie the residual cashflo5s after meetin% all operatin%e#penses and ta#es but prior to debt payments at the5ei%hted avera%e cost of capital 5hich is the cost of thedifferent components of financin% used by the firm5ei%hted by their mar-et value proportions

Value of Firm =CF to Firm t

(1+ WACC)t

t =1

t= n

∑

" 1 2 6 ; ! n

4C441 4C442 4C446 4C44; 4C44! 4C44n


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8eneric )C4 $aluation .odel

Cash flowsFirm: Pre-debt cash

flowEquity: After debtcash flows

Expected GrowthFirm: Growth inOperating EarningsEquity: Growth inNet Income/EPS

CF1 CF2 CF3 CF4 CF5

Forever

Firm is in stable growth:Grows at constant rateforever

Terminal Value

CFn.........

Discount RateFirm:Cost of Capital

Equity: Cost of Equity

ValueFirm: Value of Firm

Equity: Value of Equity

DISCOUNTED CASHFLOW VALUATION

Length of Period of High Growth

• 'ssume that you are analyHin% a company 5ith the follo5in% cash


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flo5s for the ne#t five years 'ssume also that the cost of e(uity is

1692! N and that the firm can borro5 lon% term at 1" N = The ta#

rate for the firm is !" N > The current mar-et value of e(uity is Rs

1"F6 and the value of debt outstandin% is Rs G""• year C4 to e(uity interest =1t> C4 to firm

• 1 !" ;" "

• 2 9" ;" 1""

• 6 9G ;" 1"G

• ; F92" ;" 1192"

• ! G6; ;" 126;

• Ter $al 19"6 2696• Calculate the value of the firm usin% ,(uity valuation and 4irm

valuation approaches

*xam"le 3


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"

2u""ose a firm has em"lo#ed a total ca"ital of 7s !1444 la&h ("rovided equall# b# !4"er cent debt and ; la&h equit# shares of 7s !44 each)1 its cost of equit# is !3 "er centand it is subDect to cor"orate tax rate of 34 "er cent$ The "roDected free cash flo's to

all investors of the firm for ; #ears are give in the table+

@ear-end !

0

3

;

7s 044 la&h

44

;44

!;4


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(ii) Valuation of ,irm1 Based on E 4

@ear-end ,.,, 6V factor(4$!4)

Total "resentvalue

!

0

3;

Total "resent valuevaluation of firm

Less value of debt

Value of equit#

7s 044

44

;44

!;4


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(iii) Valuation of *quit#1 Based on E e

@ear-end ,.,, to

all

investors

After tax

"a#ment to

debtholders

,.,* to

equit#holder

s

6V

factor

(4$!3)

Total

"resent

value

!

03

;

Total "resent value

7s 044

44

;44!;4

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Appraoches to Valuation