Unit 6 company valuation

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A review of company valuation methods from unit 6

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Unit 6 company valuation

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

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