Unit 6 company valuation

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A review of company valuation methods from unit 6

A review of company valuation methods from unit 6

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  • 1. Unit 6
    Company Valuation
  • 2. Methods
    There are three types of valuation
    Asset valuation
    Market multiples
    Discounted cash flow
  • 3. Asset valuation
    With this method we base our valuation of the company on the assets as shown on the balance sheet
    We can use:
    Book value, or
    Adjusted book value
  • 4. Asset valuation
    Book value
    As the title suggests we value the company based on the net assets as shown on the balance sheet
    Strengths: Easy
    Weaknesses: Only useful where accounting book value = market value
    Omits missing assets and liabilities from valuation eg goodwill, contingent liabilities
  • 5. Asset valuation
    Adjusted book value
    Books values are adjusted to market value
    Strength: Removes weakness where book assets do not equal market value
    Can be easy for assets with ready market values (eg securities)
    Weakness: Not all assets easily valued (egsecondhand factory equipment, goodwill)
  • 6. Asset valuation
    Adjusted book value
    Note that when adjusting book values, sometimes one has to “revalue” debt
    In unit 7 you will learn how to price a bond – ie value debt. For now consider the following:
    Fixed assets 140
    Current assets 25
    Current liabilities (10)
    Debt (50)
    Net assets 105
  • 7. Asset valuation
    Adjusted book value
    Note that when adjusting book values, sometimes one has to “revalue” debt
    In unit 7 you will learn how to price a bond – ie value debt. For now consider the following:
    Fixed assets 140 160
    Current assets 25 35
    Current liabilities (10) (10)
    Debt (50)(50)
    Net assets 105 135
    So we revalue each of the assets. But what about debt?
  • 8. Asset valuation
    Adjusted book value
    Consider two scenarios – which company will have the higher valuation?
    A B
    Fixed assets 160 Fixed assets 160
    Current assets 35 Current assets 35
    Current liabilities (10) Current liabilities (10)
    Debt (@7%) (50) Debt (@12%) (50)
    Net assets 135 Net assets 135
  • 9. Asset valuation
    Adjusted book value
    Consider two scenarios – which company will have the higher valuation?
    A B
    Fixed assets 160 Fixed assets 160
    Current assets 35 Current assets 35
    Current liabilities (10) Current liabilities (10)
    Debt (@7%) (50) Debt (@12%) (50)
    Net assets 135 Net assets 135
    This more expensive debt has to make B less valuable than A
  • 10. Market multiples
    There are many listed in unit 6. We shall just consider a few.
    Market value
    Price to book
    Price earnings
    EV to EBITDA
  • 11. Market multiples
    Market value
    The price quoted on the market gives us an idea of what others believe is the valuation.
    Market capitalisation = number of shares x share price = value of the company on the stock exchange
    So can we buy a company off the stock exchange at its market capitalisation?
  • 12. Market multiples
    Market value
    No. Market takeovers are ALWAYS at a premium (up to 25% of the previously quoted price).
    Consider British Airways. Its price as I write this is 198p giving a market cap of £2.3 bn. If my bonus came through and I decided to invest £10m in BA that would get me 0.4%.
    In other words my significant investment does not get me ANY control – all I am buying is a right to a dividend (as set by the Board). I do not get any:
    management rights
    right to be a director
    right to see classified documents
    set strategy etc
  • 13. Market multiples
    Market value
    But if I acquire 100% (indeed anything over 50%) I get control.
    Now I have the right to:
    Set strategy
    Get free flights
    Put myself on the Board at whatever salary I decide
    Set dividend policy
    See all of the companies records and documents, etc
    But – these extra rights have to be paid for. This extra amount (over the normal share price) is called the “control premium”
  • 14. Market multiples
    Price to book
    This is a multiple that takes for a similar quoted company the ratio of:
    Price per share / book value per share
    Book value and share price differ because of a number of reasons
    This multiple assumes that the difference is broadly in the same proportion for all similar companies.
  • 15. Discounted Cash Flow
    Number of ways
    One popular is to try and estimate the dividends from the company and treat them like any other ‘project appraisal’ ie do a DCF, using the cost of equity as the discount rate
  • 16. Discounted Cash Flow
    A very simple approximation
    Gordon’s Growth Model
    Price = D1 / (R – G)
  • 17. End