This document provides an overview of business valuation concepts and methods. It discusses key valuation concepts like risk and return correlation and the weighted average cost of capital (WACC) formula. The document also outlines the business valuation process in 6 steps and describes several valuation approaches including income, asset, and market approaches. Specific valuation methods are explained like discounted cash flow under the income approach and net asset value method under the asset approach. Forecasting techniques and earnings/cash flow based valuation methods are also summarized.
2. INDEX
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The concept The Drivers The Process Risk & Return
Measuring
Returns
WACC
Factors
Affecting
Business Value
Risk FactorsIndustry RiskGeneral Factors
Business
Valuation
Methods
3. THE CONCEPT
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Valuation is the process of determining the “economic worth” of an asset or company under
certain assumptions & limiting conditions & subject to the data available at the valuation date.
Business valuation is a process & a set of procedures used to estimate the economic value of an
owner’s interest in a business.
Valuation is used by financial market participants to determine the price they are willing to pay
or receive to affect a sale of a business.
5. THE PROCESS
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Obtain an in-depth understanding of
the business & business ownership
interest
Step #1
Perform a thorough financial &
qualitative analysis
Step #2
Consider all three valuation
approaches
•Income approach
•Market approach
•Asset-based approach
Step #3
Consider valuation adjustments (e.g.
discounts or premiums)
Step #4
Reconcile indicated values to arrive
at a conclusion of value
Step #5
Present findings in a report
Step #6
6. THE PROCESS (CONT.)
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Understanding what is being
valued
• Understanding broad overview of
valuation requirements
• Industry analysis
• Market conditions
Valuation Methodology
Assessment
• Discounted Cash Flow
• Capitalization of Earnings
• Net tangible assets
• Quoted market price
Valuation adjustments
• Discount for lack of marketability
• Discount for minority interests
• Premium for control
• Any other case: specific
considerations
Valuation Calculations &
Report
• Valuation prepared
• Documentation in report
consistent with Taxation
Office/Audit requirements
Review process
• Assessment of market
transactions to support valuations
Presentation of the result
• Final report produced
• Discussions of major assumptions
& valuation findings
7. RISK & RETURN
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A direct correlation exists between risk & return.
The greater the risk, the greater is the potential return.
Investments with the highest returns often bears the greatest
risk can lead to financial ruins.
The risk an investor is willing to accept to maximize returns will
depend on his/her risk appetite & risk tolerance levels.
12. MEASURING RETURN: CAPM FORMULA
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Rs = Rf + ß (Rm – Rf)
Rs = Expected Return [Required return on investment]
Rf = Risk-free Return [Return that can be earned on a risk-free investment]
Rm =Average Return on all securities
ß = The Securities beta (Systematic) risk factor
13. ASSUMPTIONS OF CAPM
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All investors aim to
maximize economic
returns
All investors make
decisions based on
risks & returns
Investors are rational &
risk-averse
Investors cannot
influence prices
All investors have the
same expectations
towards input factors
for investment
decisions
All investors have
access to unlimited
funds
All investments as
liquid & be sold at
market price
No or insignificant
transaction costs
14. WEIGHTED AVERAGE COST OF CAPITAL (WACC)
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WACC
Cost of
Equity
Cost of
Debt
(after tax)
Weighted by the proportion of debt
& equity in the capital structure
18. RISK FACTORS
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External
Expectations of the economy
Existing conditions of the economy
Expectation of the industry
Existing conditions in the industry
Competitive environment
Internal
Expectation of the business
Financial position/conditions of the
business
Competitive position of the
business
Nature & size of the business
Quality & depth of management
Investment
Risk factors of the investment
Amount invested in the business
Expectation in capital appreciation
Expectation in liquidity of the
investment
Level of expected management
burden
22. GENERAL FACTORS
22
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What affects value?
Customer loyalty
Opening hours Online presence
Trading history
Sector demand
Value of
fixtures/fittings
Lease/rent
conditions
Trading location
Future potential
Condition of
property
Financial
performance
Strength of brand
suppliers
23. VALUATION METHODS
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Income based approach
Prefect to explore the intrinsic value
of any business by evaluating the
cash flows, NPV, equity method, &
economic profit model
Asset based approach
Value the business on the market
value of assets, replacement costs,
& liquidation value of the assets
Market based approach
This approachcomes in handy when
capturing the market sentiment,
considering the peers.
24. VALUATION APPROACHES & METHODS
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Going Concern Approach
Income
Capitalized
earnings
Capitalized
cash flow
Discounted
cash flow
Asset
Adjusted net
book value
Market
Comparable
public
companies
Comparable
transactions
Rules of
thumb
25. ASSET-BASED METHODS
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• Method represents the book value of the business (assets -
liabilities) based on their market values [Going Concern]Book Value Method
• Method represents the book value of the business based
on liquidation values [Disposal Values]
Liquidation Value
Method
• Method represents the book value of the business based
on the replacement values of the assets [Start-ups]
Replacement
Value Method
26. EXAMPLE OF ASSET-BASED APPROACH
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Item
Non-current Assets
Intangible Assets
Inventory
Other Assets
Equity
Non-Current Liabilities
Current Liabilities
Net Asset Value
BookValue
240,000
90,000
180,000
370,000
320,000
250,000
310,000
320,000
MarketValue
320,000
50,000
160,000
370,000
250,000
370,000
380,000
The book value of the business is JOD 320K (minimum going concern value).
The net asset value (market value of the business) is JOD 380K (Estimated selling value)
27. NET ASSET VALUE METHOD
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Advantages
• Asset accumulation method is very useful
when allocating the purchase price among
the individual business assets
• Useful to value asset-based or property
investment companies
Disadvantages
• Value of individual assets may vary
significantly depending the basis used to
value the assets
• May be difficult in valuing individual assets
as the assets may be interdependent
• Methods ignore off-balance sheet assets &
liabilities
29. VALUATION OF INTANGIBLE ASSETS
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Market Value
Based on market prices for similar
transaction concluded recently
Capitalized Income
Used for intangible assets that
generate cash or income –
capitalized at fair return or
discounted cash flow
Cost Based
Estimation of the cost to reproduce
the intangible asset
32. SEVEN STEPS IN FORECASTING
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Determine the use of the
forecast
Step #1
Select the items to be
forecasted
Step #2
Determine the time horizon
of the forecast
Step #3
Select the forecasting
model(s)
Step #4
Gather the data
Step #5
Make the forecast
Step #6
Validate & implement
results
Step #7
33. EARNINGS/CASH FLOW BASED METHOD
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Generally, the capitalization earnings/cash flow
method is appropriate for
A mature business with
relatively consistent
earnings/cash flow
A business where average
earnings/cash flow can be
reasonably estimated
throughout a business cycle
A business for which
forecasts are not available
or are not reliable