Copyright © 2014 Nelson Education Ltd. 12–1
PowerPoint Presentations for
Finance for Non-Financial Managers:
Seventh Edition
Prepared by
Pierre BergeronUniversity of Ottawa
Copyright © 2014 Nelson Education Ltd. 12–2
CHAPTER 12
Business Valuation
Copyright © 2014 Nelson Education Ltd. 12–3
1. Differentiate between market value and book value.
2. Discuss valuation models.
3. Comment on what it means to scan the environment.
4. Explain how to document planning assumptions.
5. Show how to restate the statement of income and the statement of financial position.
6. Present ways to price an ongoing business.
7. Calculate the market value of publicly traded companies.
8. Determine the investment return on capital projects from an investor’s perspective.
Learning Objectives
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Book Value versus Market Value
Statement of Financial Position(based on book value)
Statement of Financial Position(based on market value)
House
Original cost $ 200,000
Accumulated
depreciation (100,000)
Book value $ 100,000 New mortgage $ 200,000
House
Market value $ 400,000 New mortgage $ 200,000
LO 1
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Valuation Models
Book value
Market value
Liquidation value
Industry multipliers
DCF method
Going-concern value
Economic value Replacement value
Assessed value
LO 2
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Scanning the Environment
Method used during the planning process to pin down planning assumptions or premises
General Past
Present
Future
Statement
of income
Statement
of financial
position
Scanning the environment
(SWOT analysis)
Documenting the planning assumptions
Restating the financial
statements
Industry
Examples of planning assumptions: GNP, labour rates, market demand, supply capability, unemployment, interest rate, price for raw materials, competitive climate, consumer profile, etc.
Price-tagging the business
LO 3
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Documenting Planning Assumptions
• Planning assumptions are used to prepare a company’s projected financial statements
LO 4
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Documenting Planning Assumptions
• Typical planning assumptions related to the statement of financial position:– Non-current assets:
• assets to be purchased, composition of non-current assets, amount to be invested in new assets, modernization, expansion, assets to be sold, depreciation and CCA rates for different non-current assets
– Current assets: • cash in bank to meet on-going activities, composition of prepaid
expenses, aging of trade receivables, estimated bad debts, inventories in raw materials, work-in-process and finished goods, holding costs, ordering costs
Continued…
LO 4
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Documenting Planning Assumptions (concluded)
– Equity: • number of shares outstanding, dividend policy
– Long-term borrowings: • amount outstanding, cost of debt, nature of
agreements– Current liabilities:
• payment policies, terms required by suppliers, amount outstanding and interest rates, nature of accruals
LO 4
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Restating Futurama’s Statement of Financial Position (Slide 3-7)
Non-current assets (at cost)Accumulated depreciationNon-current assets (net)Goodwill
Current Assets Inventories Trade receivables Prepaid expenses CashTotal Current Assets
Total Assets
Common Shares
Retained Earnings
Equity
Total Long-term borrowingsCurrent Liabilities
Trade and other payables
Notes payable Accrued expenses Taxes payableTotal current liabilities
Total Liabilities
Total equity and liabilities
$ 3,000,000400,000
170,000250,000
195,000
$ 1,340,000 140,000 1,200,000
-------
218,000
300,000
60,000
22,000
600,000
$ 1,800,000
$ 300,000
255,000
555,000
800,000
195,000
150,000
20,000
80,000
445,000
1,245,000
$ 1,800,000
Total $3,625,000
LO 5
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Restating Futurama’s Income Statement (Slide 3-8)
Revenue $ 2,500,000
Cost of sales (1,900,000)
Gross profit 600,000
Salaries (300,000)
Rent (50,000)
Depreciation (40,000)
Other expenses (15,000)
Total expenses 405,000
Profit before taxes 195,000
Income tax expense (97,500)
Profit for the year 97,500
Add back depreciation 40,000
Total cash flow $ 137,000
$ 4,000,000
$ 369,000
$ 150,000
$ 519,000
LO 5
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Book Value Method—Futurama Ltd. (Slide 3-7)
Book Value
Assets
Non-current assets $ 1,200,000
Inventories 218,000
Trade receivables 300,000
Prepaid expenses 60,000
Cash 22,000
Total assets $ 1,800,000
Equity
Liabilities
Trade and other payables 195,000
Misc. loans 1,050,000
Total Liabilities 1,245,000
Total equity and _________
liabilities $ 1,800,000
Difference between assets and liabilities
Book value
$ 555,000
LO 6
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Liquidation Value Method
Liquidation ValueAssetsNon-current assets $ 900,000Inventories 150,000Trade receivables 200,000Prepaid expenses -------Cash 22,000Total Assets $ 1,272,000
Equity
Liabilities
Trade and other payables 195,000
Misc. loans 1,050,000
Total Liabilities 1,245,000
Total equity and
liabilities $ 1,272,000
Difference between assets and liabilities if sold individually on the open market.
Liquidation value
27,000
LO 6
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Industry Multipliers
Industry multipliers are standards used to determine the value or worth of a business.
Examples of industry multipliers
MultipliersIndustries
Travel agencies
Retail businesses
Fast food
restaurants
Food distributors
.05 to .1 × annual gross sales
.75 to 1.5 × annual net profit + inventories +
equipment
.5 to .7 × monthly gross sales + inventories
.3 to .5 × annual gross sales, or .4 × monthly
gross sales + inventories
1 to 1.5 × annual net profit + inventories +
equipment
LO 6
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Discounted Cash Flow Method (10-year life span)
Discount rates Cost of capital
10%
Purchase price (outflow)
Cash inflows
Cost of capital
Hurdle rate
Net present value
Sale of the business (inflow)
Cost of capital
Hurdle rate
Hurdle rate
20%
The offer
price
$ __________
$ __________
$ __________
$ __________
$ __________
$ __________
$ __________
$ _________ X ________
$ _________ X ________
$ _______ X ________
$ _________ X ________
$ __________
- 3,625,000
519,000 6.1446 + 3,189,047
519,000 4.1926 + 2,175,907
6,000,000 .38554 +2,313,240
+ 969,0606,000,000 .16151
+ 1,877,287 - 480,033
IRR 17.2%
$ __________
- 3,625,000 $ __________3,144,967
0
If you want to make a
20% IRR
LO 6
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Going-Concern Value (using the capitalization rate)
Capitalization Value
Cash flow from operations $ 519,000
(from Slide 12-11)
Divided by capitalization rate* ÷ 20%
Going-concern value (present value) $2,595,000
*Capitalization rate represents the required rate of return for the company, which is based on a number of subjective factors and conditions at the time of the valuation.
Company will be sold as a viable business generating a cash flow of say $519,000/year forever.
Going-concern value
LO 6
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Market Value of Publicly Traded Companies
Number of shares outstanding: 50,000
Company’s net worth: $2,000,000
Book value of each share: $40.00 ($2,000,000/50,000)
Shares are trading at: $50.00
Market value of the company: $2,500,000 ($50.00 × 50,000)
LO 7
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Project Return: Investor’s Perspective
Step 1: Cash flow forecast
Step 2: Residual value of the forecast period
Step 3: Estimated market value
Step 4: Investor’s return (40% investment in the business)a) Before taxb) After tax
LO 8
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Projects: Investor’s (Venture Capitalist) Perspective
Investors are looking for a Winning Combination!
Products/Services (%)(the horse)
Management Team
(the jockey)
LO 8
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2010 2011 2012 2013 2014
Cash flow from operations $ 519 $ 800 $ 900 $1,200 $1,450
Investment in non-current assets (1,200) (400) (400) (300) (300)Incremental working capital (200) (200) (200) (200) (200)
Sub-total (1,400) (600) (600) (500) (500)
Net cash flows (881) 200 300 700 950
Discount factor @ 20% .83333 .69444 .57870 .48225 .40188Present values ($ 734) $ 139 $ 174 $ 337 $ 382
Cash Flow Forecast (Step 1)This method determines the net present value of the projected
discretionary annual cash flows.
NPV +$ 298
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Residual Value of the Forecast Period (Step 2)
Forecast of residual value in 2014
Cash flow $ 1,450
Investments (500)
Net cash flows (from Slide 12-20) 950
Capitalization rate @ 18% ($950,000 ÷ 18%) $ 5,278
×
Present value factor @ 20% .40188
Present value of the residual value $ 2,121
This step determines the residual value of the company after the forecast period is over.
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Estimated Market Value (Step 3)
Forecast of discretionary cash flow $ 298 (Slide 12-20)
Add: residual value 2,121 (Slide 12-21)
Estimated fair market $ 2,419
value of the shares
This step determines the residual value of the company after the forecast period is over.
Estimated fair market
value
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2009 2010 2011 2012 2013 2014
A. Investment return before taxes --- --- --- ---
Initial investment ($ 600) --- --- --- ---
Cash distribution to investors (Slide 12-20) $ 950 Multiplier 8.0 Total value at exit 7,600
Investor’s required share (40%) --- --- --- 3,040 Initial investment ($ 600) Total discounted cash inflow $ 600 $ 3,040
Investor’s Return—Before Tax (Step 4)This method takes into account the discounted value of the future cash flows to calculate the investor’s return.
Before-tax return to investor 38.34%
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B. After-tax return Proceeds received on exit $3,040 Initial investment (600) Capital gain on investment 2,440
Taxable portion (75%) 1,830 Investor’s tax payable (50%) 915
Gross proceeds received on exit 3,040 Investor’s tax payable 915
Net after-tax proceeds to investor $ 2,125
Investor’s Return—After Tax (Step 4)
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2009 2010 2011 2012 2013 2014
Initial investment ($ 600) --- --- --- --- ---
Total value at exit
Net after-tax proceeds to investor --- --- --- --- --- $ 2,125
Total cash flowsInitial investment ($ 600)Total cash flows $ 600 $ 2,125
After-Tax Return Calculation
After-tax return to investor 28.78%