2. Basic Concept Business Valuation is the process of determining the "Economic Worth" of a Company based on its Business Model and External environment and supported with reasons and empirical evidence. Corporate valuation depends upon1. Purpose of valuation2. Stage of Business3. Past financials4. Expected financial results5. Industry scenario
3. Approach to Valuation Discounted free cash flow method Relative Valuation (Comparable company market multiple method) Comparable Transactions (Mergers & Acquisition) Multiple (CTM) method Price of recent investment method Net asset value method (NAV)
4. Discounted Free Cash FlowMethod Two alternative approach can be used1. Measuring the discounted cash flow to the firm2. Measuring the discounted cash flow to equityDiscounted Free Cash flow to the firm The DFCF to firm method expresses the present value of the business attributable to all claimants (like equity shareholders, debt holders, preference shareholders, warrants etc) as a function of its future cash earning capacity. This methodology work on the premise that the value of business is measured in terms of future cash flow streams, discounted to the present time at appropriate discount rate This approach seeks to measure the intrinsic ability of the business to generate cash attributable to all the claimants.
5. Discounted Free Cash FlowMethodDiscounted Free Cash flow to equity The DFCF to firm method expresses the present value of the business attributable to equity shareholders as a function of its future cash earning capacity. The value of equity is arrived at by estimating the free cash flow to equity and discounting the same at the cost of equity
6. Steps in measuring FCFF Steps for finding FCFF Earning before interest and Step 1: Arrive at EBIT* taxes Step 2: Multiply with (1-tax rate) (1-tax rate)= Operating profit after tax Step 3: Arrive at Operating profit+ Non Cash Cost after tax Step 4: Add back non cash cost- Capital expenditures (already subtracted earlier)- Increase in NCWC Step 5: Subtract Capital+ Terminal Value Expenditures Step 6: Subtract increase in NCWC Step 7: Add terminal value of the firm at the final year= Free cash flow to firm
7. Steps in measuring FCFE Steps for finding FCFFE Profit Before Tax Step 1: Arrive at PBT- Taxes Step 2: Less taxes= Profit After Tax Step 3: Arrive at PAT+ Non Cash Cost Step 4: Add back non cash cost (already subtracted earlier)- Capital expenditures Step 5: Subtract Capital- Increase in NCWC Expenditures± Changes in Debts Step 6: Subtract increase in NCWC+ Terminal Value Step7: Take into account the effect of changes in debt Step 8: Add terminal accruing to equity holder at the final year= Free cash flow to equity= Discounted Free Cash Step 8: Discount the FCFE for
8. Arriving at cost of capital Key things to remember Cost of capital for the firm should be comparable with firm with similar business and financial risk CAPM can be utilized to calculate ß debt, ß equity ß asset for publicly listed firm from the historical data. Hence beta have a historical character Return on risk free security can be estimated based on 10 year Indian Government Bond Yield Equity risk premium can be arrived from market information for the return on broad based index for a comparable period
9. Comparable company market(CCM)multiple method CCM multiple method uses the valuation ratios of a publicly traded company and applies that ratio to the company being valued The valuation ratio typically expresses the valuation as a function of measure of financial performance or book value (e.g. turnover, EBIDTA, EBIT, EPS or book value) Methodology is based on current market stock price Limitations:1. Difficulty in selecting comparable firms with similar business and financial risk (EBIDTA or Cash Flow)2. Measuring the multiple (mean or median value can be used)
10. Comparable Transactions (M&A)Method (MTM) This methodology helps in arriving the value of the company on the basis of similar deals matured in the market This provides and indicative value as it helps in reaching the value which market is providing to similar companies Can be arrived through sales multiple, EBIDTA multiples or PAT multiples
11. NAV Method NAV is the net value of all the assets of the company. If you divide it by the number of outstanding shares, you get the NAV per share. One way to calculate NAV is to divide the net worth of the company by the total number of outstanding shares. Say, a company’s share capital is Rs. 100 crores (10 crores shares of Rs. 10 each) and its reserves and surplus is another Rs. 100 crores. Net worth of the company would be Rs. 200 crores (equity and reserves) and NAV would be Rs. 20 per share (Rs. 200 crores divided by 10 crores outstanding shares). NAV can also be calculated by adding all the assets and subtracting all the outside liabilities from them. This will again boil down to net worth only. One can use any of the two methods to find out NAV.
12. Tobin’s q Tobins q was developed by James Tobin (Tobin 1969) as the ratio between the market value and replacement value of the same physical asset. Tobins q= (Market Value of Equity+ Book Value of Debt) --------------------------------------------------- --- (Book Value of Equity + Book Value of Debt)