Valuation

ValuationApplications and Processes

IntroductionWhat is value of particular things?

The answers usually determine success/failure in achieving investment objectives

Value DefinitionsWhat is Value?

Meaning of value can vary in different contexts. Different context leads to different objective, and affect the selection of a valuation approach

Value DefinitionsIntrinsic ValueValue of an asset given a hypothetically complete understanding of the assets investment characteristics

Value DefinitionsGoing Concern ValueValue which has the assumption that the company will continue its business activities into foreseeable future to produce and sell its goods/service

Value DefinitionsLiquidation ValueValue if an asset were dissolved and sold individually

Value DefinitionsFair Market ValueThe price at which an asset would change hands between buyer and seller and both of them informed well about all material aspect of the asset

Value DefinitionsInvestment ValueValue to a specific buyer taking account of potential synergies and based on the investors requirements and expectations.

Application of ValuationSelecting StocksAssuming Market ExpectationsEvaluate Corporate EventsConsidering Fairness OpinionsEvaluating Business Strategies & ModelsCommunicating with analysts and shareholdersAppraising Private BusinessShare Based Payment (Compensation)

The Valuation ProcessUnderstanding The BusinessForecasting Company PerformanceSelecting the Appropriate Valuation ModelApplying the valuation conclusions

1. Understanding The BusinessIndustry and Competitive AnalysisIntra Industry RivalryNew EntrantsSubstitutesSupplier PowerBuyer Power

Analysis of Financial ReportingRatio Analysis

2. Forecasting Company Performance1. Top-down forecasting performanceForecast from international/national/ regional macroeconomics forecast to industry forecasts and then to individual company/asset forecast

2. Bottom-up Forecasting performanceAggregates forecast at a micro level to larger scale forecasts, under specific assumption

3. Selecting the Appropriate Valuation ModelAbsolute Valuation ModelModel that specifies an assets intrinsic value, usually using present value model/ discounted cash flow modelRelative Valuation ModelModel that estimate an assets value relative to that of another asset, usually using price-to-earning ratio (P/E)Total Entity Valuation ModelModel that sums the estimated values of each of the companys business

4. Applying Valuation ConclusionSectionPurposeContentCommentsTable of ContentsShow Reports organizationNarrative DescriptionSummary and Investment ConclusionCommunicate the Large PictureCommunicate Major Specific conclusions of the analysisRecommend an investment course of actionCompany Business descriptionMajor developmentsEarnings ProjectionsValuation SummaryInvestment ActionSummary of first until last step of valuation processBusiness SummaryPresent the company in more detailCommunicate a detailed understanding of the companys economics and situationProvide & Explain specific forecastCompany description to divisional levelIndustry analysisCompetitive analysisPeriodically performanceFinancial forecastReflects the 1st and 2nd steps of valuation process

4. Applying Valuation ConclusionSectionPurposeContentCommentsRisksAlert of the risk factors in investing in the companyPossible Negative Industry developmentsPossible Negative regulatory and legal developmentPossible negative company developmentRisks in the forecastOther risks

Valuation should have enough information to determine how the analyst is defining and assessing the riskValuationCommunicate a clear & careful valuationDescriptions of valuation models usedConclusionsPro Forma TablesOrganize and present data to support the analysis in the business summaryBusiness summary, conclusion, recommendations.

Lets Face The Real WorldMake Your Own Business and make a valuation of it

Make Your own business1. Define your business Product/Service

Make Your own business2. Define your Reasons/Motivation and Purpose/Goal

How Much Investment do you need?3. Estimate your needs of funds as an initial investment?

4. Describe your investment usage (Machinery, working capital, rent, building, equipment, R&D, etc)

Capitalize your business5. Define your source of funds

Own Equity, Shareholders equity, Bank Loan, etc

ExampleProduct: Kulit Singkong CrispyWhy? -> Pioneer & Niche Product, easy to produce, potential market, healthy & natural food, etc-Investment needed Rp. 2.500.000,-Rp. 2.500.000 obtained from :Own equity Rp. 1.000.000,- Other equity Rp. 500.000,-Bank Loan Rp. 1.000.000,-Investment Breakdown

InvestmentAmountPriceTotalGerobak1 unit750 k1000 kPan2 unit70 k140 kStove2 unit250 k500 kPress Machine1 unit200 k200 kCooking Equipment1 pack980 k660kTotal2500k

6. Write down your first balance sheetAssetLiabilities & EquitiesCurrent AssetCash2.500.000LiabilitiesBank Loan1.000 .000Fixed AssetEquitiesOther equitiesOwn equities500 .0001.000 .000Total2.500.000Total2.500.000

7. Write down your next balance sheetAssetLiabilities & EquitiesCurrent AssetCash0LiabilitiesBank Loan1.000 .000Fixed AssetGerobakPanStovePress MachineCooking equipmnt1.000.000140.000500.000200.000660.000EquitiesOther equitiesOwn equities500 .0001.000 .000Total2.500.000Total2.500.000

Variable CostDirect CostsFixed per unit of output but may vary in total as output changesThose costs that vary depending on a company's production volume; they rise as production increases and fall as production decreases

Variable CostsExamples:Direct laborDirect materialsEnergy costs (fuel, electricity, natural gas) associated with the production areaFreight costsPackagingSales commissions

Variable Costs8. Define your own variable costs

Fixed CostsBusiness expenses that are not dependent on the level of goods or services produced by the businessA cost that does not change with an increase or decrease in the amount of goods or services produced

Fixed CostsExamples:Administrative salariesDepreciationInsuranceLump sums spent on intermittent advertising programsProperty taxesRent

Fixed Costs9. Define your own Fixed costs

Variable cost for 1 package of kulit singkong 50 gram

Raw MaterialIn Rp.Cassava1,5 kg/30 pcs (@Rp700/Kg)2.100Flour kg/30 pcs2.000Seasoning/30 pcs500Oil ltr /30 pcs6.000Packaging Plastic/30 pcs200Energy (Gas)/30 pcs2.000Direct Labor (Rp.20.000 daily) / 60 pcs10.000Total Cost of Goods Material/30 pcs22.800Total Cost of Goods Material/1 pcs760

Monthly Fixed Cost Example Fixed CostIn Rp.Space Rent500.000Security Expense200.000Fixed Salary700.000Electricity50.000Marketing50.000Total Fixed Cost1.500.000

Maximum Production Capacity10. Define your maximum production Capacity using all of your resources, machine, labor, material, technology, system, etc-

Example: Maximum Production Capacity is 60 pcs/day, when working days a month is 30 days, maximum monthly production is 1.800 pcs/month

Setting up Sales PricePrice is the amount of money charged for goods or servicesWhen setting the price of a new product, businessmen must consider the competitions prices, estimated consumer demand, costs, and expenses, as well as the firms pricing objectives and strategies.

Cost Plus PricingA fixed percentage of profit will be added to the costSum of total cost and added amount percentage value will be set up as a price

Price =

Setting up Sales Price11. Set up your own product/service price

ExampleValue added expected is 30%Max Production = 60 dailyFixed cost monthly = Rp. 1.500.000,-1 month is 30 days work, so production capacity is 1.800 pcs monthly. So fixed cost / unit is Rp. 833,3Variable Cost/unit is Rp.760

Price = =

=Rp.2.276.2

Price / pcs = Rp. 2.300,-

RevenueTotal Revenue & ProfitTotal sales Equal to the selling price per unit multiplied by the quantity soldProfit is total revenue minus total cost

12. Define your maximum revenue and profit based on your maximum production = Max Production Volume x Price per unit

Maximum profit = total revenue (total vc+total fc)

ExamplePrice/unit = Rp.2.300Maximum Production Capacity = 60 pcs/daily = 1.800 monthlyMax monthly revenue = 1.800 pcs x Rp. 2.300Max monthly revenue = Rp. 4.140.000

13. Write down Your First Income StatementWhen sales hit maximum production, income statement shown below:Sales 4.140.000Variable CostCassava3 kg/60 pcs (@Rp700/Kg) 126,000 Flour kg/60 pcs 120,000 Seasoning/60 pcs 30,000 Palm Oil1 ltr /60 pcs 360,000 Packaging Plastic/60 pcs 12,000 Energy (Gas)/60 pcs 120,000 Direct Labor (Rp.20.000 daily) / 60 pcs 600,000 Cost of Goods Sold (60 pcs) * (30 days)(1.368.000)Fixed CostSpace Rent500.000Security Expense200.000Fixed Salary700.000Electricity50.000Marketing50.000Total Fixed Cost(1.500.000)EBIT (Earning Before Interest & Taxes) 1.272.000.

Interest and TaxesAssume your loan has 1% interest monthlyAnd government charged you 10% for tax14. Prepare your new income statement, so you can get earning after interest and tax

Income Statement with interestInterest = 1% x Rp.1.000.000,- = Rp.10.000,-Sales 4.140.000Variable CostCassava3 kg/60 pcs (@Rp700/Kg) 126,000 Flour kg/60 pcs 120,000 Seasoning/60 pcs 30,000 Oil1 ltr /60 pcs 360,000 Packaging Plastic/60 pcs 12,000 Energy (Gas)/60 pcs 120,000 Direct Labor (Rp.20.000 daily) / 60 pcs 600,000 Cost of Goods Sold (60 pcs) * (30 days)(1.368.000)Fixed CostSpace Rent500.000Security Expense200.000Fixed Salary700.000Electricity50.000Marketing50.000Total Fixed Cost(1.500.000)EBIT (Earning Before Interest & Taxes) 1.272.000.Interest10.000EBT (Earning Before Taxes)1.262.000

Income Statement with interest & taxes

Sales 4.140.000Variable CostCassava3 kg/60 pcs (@Rp700/Kg) 126,000 Flour kg/60 pcs 120,000 Seasoning/60 pcs 30,000 Oil1 ltr /60 pcs 360,000 Packaging Plastic/60 pcs 12,000 Energy (Gas)/60 pcs 120,000 Direct Labor (Rp.20.000 daily) / 60 pcs 600,000 Cost of Goods Sold (60 pcs) * (30 days)(1.368.000)Fixed CostSpace Rent500.000Security Expense200.000Fixed Salary700.000Electricity50.000Marketing50.000Total Fixed Cost(1.500.000)EBIT (Earning Before Interest & Taxes) 1.272.000.Interest 1% from Rp.1.000.000,-10.000EBT (Earning Before Taxes)1.262.000Taxes 10%126.200EAT (Earning After Taxes)1.135.800

Equity (Shares)Assume your equity to common share (stock)Divide its value to Rp.1.000 ,- per shareSo you can get outstanding share15. calculate your outstanding sharesExample Liabilities & EquitiesLiabilitiesBank Loan1.000 .000EquitiesOther equitiesOwn equities500 .0001.000 .000Total2.500.000

Total Value = 1.500.000

Divide by 1.000

So value per share is Rp. 1.000/shareAnd shares outstanding is 1.500 share

Earning Per ShareThe portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.16. Calculate your earning per share by dividing earning after tax with share outstandingEPS = EAT/Share outstanding

Example EAT = Rp. 1.135.800,-Share Outstanding = 1.500EPS = Rp. 1.135.800,-/1.500 = Rp.757,2,-

Questions Review1. Define your business Product/Service2. Describe your reasons why you choose the product/service as your main core business?3. Estimate your needs of funds as an initial investment?4. Describe your investment usage5. Define your source of funds6. Write down your first balance sheet7. Write down your next balance sheet8. Define your own variable costs9. Define your own Fixed costs10. Define your maximum production Capacity11. Set up your own product/service price12. Define your maximum revenue and profit based on your maximum production 13. Write down Your First Income Statement14. Prepare your new income statement, so you can get earning after interest and tax15. calculate your outstanding shares and value per share

Test Your Valuation SkillUnderstanding The BusinessForecasting Company PerformanceSelecting the Appropriate Valuation ModelApplying the valuation conclusions

Valuation ModelAbsolute Valuation ModelModel that specifies an assets intrinsic value, usually using present value model/ discounted cash flow modelCalculate BEP, PBP, NPV, PI, IRR (discount rate = 1%/month)

Valuation TechniqueCriteriaPBP24 monthsPI>1NPVPositiveIRRMore than K=1%

Valuation ModelRelative Valuation ModelModel that estimate an assets value relative to that of another asset, usually using price-to-earning ratio (P/E) and Ratio Analysis

4. Applying Valuation ConclusionSectionPurposeContentCommentsTable of ContentsShow Reports organizationNarrative DescriptionSummary and Investment ConclusionCommunicate the Large PictureCommunicate Major Specific conclusions of the analysisRecommend an investment course of actionCompany Business descriptionMajor developmentsEarnings ProjectionsValuation SummaryInvestment ActionSummary of first until last step of valuation processBusiness SummaryPresent the company in more detailCommunicate a detailed understanding of the companys economics and situationProvide & Explain specific forecastCompany description to divisional levelIndustry analysisCompetitive analysisPeriodically performanceFinancial forecastReflects the 1st and 2nd steps of valuation process

4. Applying Valuation ConclusionSectionPurposeContentCommentsRisksAlert of the risk factors in investing in the companyPossible Negative Industry developmentsPossible Negative regulatory and legal developmentPossible negative company developmentRisks in the forecastOther risks

Valuation should have enough information to determine how the analyst is defining and assessing the riskValuationCommunicate a clear & careful valuationDescriptions of valuation models usedConclusionsPro Forma TablesOrganize and present data to support the analysis in the business summaryBusiness summary, conclusion, recommendations.