Common questions we come across quite frequently… • Why do we need to Value a business? • How can we value a Company or business? • What is the right way to value a company?
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Why do we need to Value a business? •
Value of an asset is important to determine its worth.
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Value of an asset might be different for different people.
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For Example, if we have a piece of land, it may have a different value for a farmer who would grow crops on it and for a real estate Company which would want to develop and then resell it.
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How can we value a Company or business? Valuation methods
Asset based Valuation
Market based Valuation
Cash Flow based Valuation
Book Value Method
Multiples Method
Discounted cash flow / Intrinsic Value Method
Replacement Value Method
Transaction Value Method
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Book Value Method •
In this method, we look at the latest reported balance sheet of a Company and calculate the net worth/ Book Value based on Company reported numbers.
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Book Value or Net worth of a Company is Sum of Total Assets minus Short and Long-term Liabilities.
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Net Asset Value = Total Assets – Total Liabilities
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Book Value= Total Assets – Total Liabilities
Advantages
Book Value Method – Advantages and Limitations
- Balance sheets are prepared based on historical costs; therefore, the book value of assets may not give the true value of the business/ assets. - Accounting policy may differ across companies/ regions.
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Limitations
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- Net asset value/ Net worth can be calculated quickly based on reported balance sheet. - Net worth is also available in data bases like Bloomberg and Capital IQ.
Replacement value method •
This method is similar to the Book value method.
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The difference is that in this method we take the replacement value of assets instead of book value.
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Replacement value means the price that one must pay to get the asset replaced.
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This method therefore is based on current costs and not historical costs.
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Advantages
Replacement Value method – Advantages and Limitations
- It is usually difficult to get the current/ replacement cost of every asset as the price information may not be readily available. - Calculating value based on replacement costs may also be tedious and time-consuming process.
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Limitations
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- This method is based on replacement costs/ current costs and not historical costs of assets. Therefore, gives a better view on value of a Company.
Multiples method This is a market-based valuation approach. It is quite often used by equity analysts/ investment bankers. In this method, we value a company based on multiples of similar listed companies. Multiples used can differ by circumstance. For Example. We can use EV/Sales or Price/ Sales multiple for startups or loss-making entities Earnings based multiples like EV/EBITDA, EV/NOPAT or P/E multiple are generally used method for profitable businesses. Asset based multiples like Price/Book, EV/Invested capital are used for financial Companies or Companies which are highly capital intensive. • It is also known as relative valuation or Comparable company valuation. • • •
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Advantages
Multiples method – Advantages and Limitations
- Multiples method is simple and provides a quick estimation of value of a business.
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- It may not be easy to find companies with similar businesses.
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Limitations
- We get a ball-park range using different multiples (earnings multiples/ asset-based multiples)
- This method values a business based on current market valuation. It does not consider other factors like performance on growth, return on invested capital, forward expectations etc.
Transaction value method • This method is similar to Multiples based valuation approach. • It is used to value a business or a segment of a company usually in mergers and acquisitions. • In this method, we take the transaction value multiples for past deals (like Transaction value/EBITDA, Transaction value/ Revenues etc.) to estimate the value of the business or segment being looked into.
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Advantages
Transaction value method – Advantages and Limitations
- This method values a business based on prior transactions. It does not consider other factors like performance on growth, return on invested capital, forward expectations etc. - It may not be easy to find similar type of recent deals.
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Limitations
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- This method is simple and provides a quick estimation of value of a business. - We can get a range using different type of multiples (Transaction value/revenue, Transaction value/EBITDA)
Discounted cash flow method •
This method is also known as intrinsic value method.
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DCF method includes estimation of cash flow generated by a business over long term and then discount the cash flows to present time.
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STEPS TO PERFORM A DCF VALUTION 1
2
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Analyze historical performance
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Present value of cash flows till perpetuity (over long term) is the intrinsic value of the Company. Estimating future cash flows requires a good understanding of the industry, business and economy.
Understand the business
4 5
Project Future cash flows Calculate Terminal Value
Discount the Cash Flows using WACC
Discounted cash flow method – Advantages and Limitations
- DCF method calculates the intrinsic value of the business based on future cash flows. - It is quite detailed - Helps do sensitivity analysis - Helps build scenarios (by changing assumptions)
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- DCF Valuation is Complex and time consuming. - Dependent on multiple assumptions (growth, margins, capex etc.) - Terminal value represents large portion of Total business value - Calculating cost of capital may not be straight forward
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