Mmi finance 5


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Mmi finance 5

  1. 1. Chapter V VALUING A BUSINESS
  2. 2. <ul><li>First setp in valuating a business is to decide what is to be valuated: </li></ul><ul><li>Do we want to valuate the company’s assets or its equity? </li></ul><ul><li>Shall we valuate the business as a going concern or in liquidation? </li></ul><ul><li>Are we to value a minority interest in the business or controlling interest? </li></ul>Valuating a Business
  3. 3. <ul><li>When a company acquires another, it can do so by purchasing either the seller’s assets or its equity. When the buyer purcases the seller’s equity, it must assume the seller’s liabilities. </li></ul><ul><li>Example: if you purchase a house for 100 thou EUR cash and assumption of the seller’s 400 thou EUR mortgage, you say you buy the house for 500 thou EUR, with 100 thou EUR down. </li></ul><ul><li>Most acquisition involving companies of any size are structured as an equity purchase . However, never lose sight of the fact that the true cost is the cost of equity + value of liabilities </li></ul>Valuating a Business – Assets or Equity?
  4. 4. <ul><li>Companies can generate value for owners in 2 states: in liquidation or as growing concerns </li></ul><ul><li>Liquidation value is the cash generated by terminating the business and selling its assets individually </li></ul><ul><li>Going-Concern value is the present worth of expected future cash flows generated by a business </li></ul>Valuating a Business – Dead or Alive?
  5. 5. <ul><li>Market value ≠ Book value </li></ul><ul><li>Why? </li></ul><ul><ul><li>Financial statements (that give a value of the shareholder’s equity) are transaction based. For example, an asset for 1 mil EUR in 1950 and used by the accountant in the balance sheet, may have no relevance today (inflation, the asset is obsolete) </li></ul></ul><ul><ul><li>Companies tipicaly have many assets and liabilities that do not appear on the balance sheet, but affect future income (patents and trademarks, loyal customers, technology, better management) </li></ul></ul><ul><li>When a company is publicly listed, it is a simple matter to calculate its market value </li></ul><ul><li>#of shares x market price per share </li></ul>Valuating a Business – Market value vs. book value
  6. 6. <ul><li>Absent market prices, the most direct way to estimate going-concern value is by calculating the present value of expected future cash flows going to owners and creditors. </li></ul><ul><li>When this number exceeds the acquisition price, the purchase has a possitive net present value and is therefore attractive. Converselly, when the net present value of the future cash flows is less than the acquisition price, th epurchase is unattractive </li></ul><ul><li>Fair market value </li></ul><ul><li>FMV of firm = PV{expected cash flows to owners and creditors} </li></ul><ul><li>Maximum price one should pay for a business = present value of expected future cash flows to capital suppliers discounted at an risk adjusted discount rate; discounted rate should be target company’s weighted –average cost per capital </li></ul>Valuating a Business – Discounted Cash flow
  7. 7. <ul><li>Value of equity = Value of firm – Value of debt </li></ul><ul><li>Therefore, in order to value a company’s equity, we need to estimate firm value and subtract debt. </li></ul><ul><li>Market value and book value of debt are usually the same an can be taken from the balance sheet </li></ul>Valuating a Business – Discounted Cash flow
  8. 8. <ul><li>Terminal value </li></ul><ul><li>Because a firm can have an infinitely long life expectancy, we can not estimate cash flow for hundreds of years </li></ul><ul><li>We think of the company’s future as composed of 2 periods: first (5-15 years) we presume company has a unique cash flow patern and growth trajectory – we estimate annual free cash flows; second – after the firs period company becomes stable, slow growth business – we estimate a single terminal value reprsenting the worth of all subsequent free cash flows </li></ul><ul><li>FMV of firm = PV(FCF years 1-10 + Terminal Value at year 10) </li></ul><ul><li>Where </li></ul><ul><li>FCF = EBIT (1- Tax)+ Depreciation – Capital expenditures – Working Capital </li></ul>Valuating a Business – Discounted Cash flow
  9. 9. <ul><li>In boom times, the newspaper companies would sell at: </li></ul><ul><li>10 x multiple of EBITDA </li></ul><ul><li>Today, multiple of EBITDA decreased. The highest multiple is at internet companies. Please check on Yahoo finance for Yahoo, Google. </li></ul>Valuating a Business – Discounted Cash flow