BASICS OF VALUATION

Contents
•Introduction to Valuation
•Methods of Valuation
•Why should you go for Valuation?
•Valuer Viewpoint
•Check points in Valuation
•How to ensure better Valuation
•International Valuation Standards

INTRODUCTION TO VALUATION

VALUE & VALUATION
Valuation is the process of determining the economic value of a business or company
Valuation of a company reflects the performance of the company – both its past performance as well as expectations of its future performance.
Value of a business can be arrived at by using objective analysis, but the transaction is finalized at the negotiated price at which the Seller is willing to sell and the Buyer is willing to buy.

VALUE & VALUATION
Valuation is the process of determining the economic value of a business or company
Valuation of a company reflects the performance of the company – both its past performance as well as expectations of its future performance.
Value of a business can be arrived at by using objective analysis, but the transaction is finalized at the negotiated price at which the Seller is willing to sell and the Buyer is willing to buy.

VALUE & VALUATION
Valuation is the process of determining the economic value of a business or company
Valuation of a company reflects the performance of the company – both its past performance as well as expectations of its future performance.
Value of a business can be arrived at by using objective analysis, but the transaction is finalized at the negotiated price at which the Seller is willing to sell and the Buyer is willing to buy.

How is Business Valuation Done
•There are dozens of valuation models, but only two valuation approaches: intrinsic and relative.
The intrinsic value of an asset is determined by the cash flows that the asset is expected to generate over its life, keeping in mind the certainty of such cash flows. Assets with high and predictable cash flows should be worth more than assets with low and volatile cash flows. In relative valuation, assets are valued by looking at how similar assets are priced by the market and performing a comparative analysis. When you determine what to pay for a property, you do so by comparing the prices of similar properties in the market.

An investor needs to do very few things right as long as he or she avoids big mistakes.
Warren Buffett
Watch the costs and the profits will take care of themselves Andrew Carnegie

Valuation and Its Facts
•VALUE VARIES WITH PERSON, PURPOSE AND TIME
•Value has different meaning when it comes to different person or place or time. Its very subjective.
•PRICE IS NOT THE SAME AS VALUE
•Price of the business is not equal to value of the business
•TRANSACTION CONCLUDES AT NEGOTIATED PRICES
•Valuation prices are important to determine but depending on the seller and buyer the transaction takes place at negotiated prices

METHODS OF
VALUATION

Approaches to Valuation

INCOME BASED METHOD

Profit Earning Capitalisation Value Method (PEVC)
•Capitalization refers to the return on investment that is expected by an investor for taking on the risk of operating the business (the riskier the business, the higher the required return).
•The earnings figure to be capitalized should reflect the true nature of the business, such as the last three years average, current year or projected year excluding the impact of any extraordinary items not expected to accrue in future.
PECV = Future Maintainable Profit after Tax/Capitalization Rate

DISCOUNTED FREE CASH FLOW METHOD DCF is a method of valuing a company, typically a going concern by estimating the cash flows & adjusting it for the time value of money.
In this method, all future cash flows of the company are estimated and discounted by an appropriate discount rate (to cover riskiness or expectation) to give their present values (PVs).
Weighted Average Cost of Capital (WACC)
WACC is the calculation of a firm’s cost of capital. Each category of capital is proportionately weighted. The categories include: • Common Stock • Preferred Stock • Bonds • Any other Long Term Debt

DISCOUNT RATE – WEIGHTED AVERAGE COST OF CAPITAL
WACC =
(Kd x D) + (Ke x E) (D + E)
Where:
D = Debt part of capital structure
E = Equity part of capital structure
Kd = Cost of Debt (Post tax)
Ke = Cost of Equity
In case of following FCFE, Discount Rate is Ke and Not WACC

ASSET BASED METHOD

ASSET BASED METHOD
The asset approach to business valuation is based on the principle of substitution:
no rational investor will pay more for the business assets than the cost of procuring
assets of similar economic utility. The value of asset-based analysis of a business is
equal to the sum of its parts.
In considering an asset-based approach, the valuation professional must consider
whether the shareholder whose interest is being valued would have any authority
to access the value of the assets directly.
1. NET ASSET VALUE/BOOK VALUE METHOD
2. LIQUIDATION VALUE METHOD
3. REPLACEMENT VALUE METHOD

MARKET BASED METHOD

Market Based Method
•In this method, value is determined by comparing the asset with similar assets. Example – Comparing a company against its peer group companies which are in the same industry of the same product line and scale. This is also known as Relative Valuation Method.

TYPES OF MARKET BASED METHOD
Comparable Companies Market Multiples Method (CCM)
Comparable Transaction Multiples Method (CTM
Market Value Method (For Quoted Securities)

COMPARABLE COMPANY MARKET MULTIPLES METHOD
Comparable Company Market Multiple uses the valuation ratio 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 a measure of financial performance or Book Value:
•Earnings/Revenue Multiples
•Book Value Multiples
•Industry Specific Multiples
•Multiples from Recent M&A Transactions
This technique hinges upon the efficient market theory which indicates that the price of exchanged securities reflects all readily available information, as well as the supply and demand effects of educated and rational buyers and sellers.

COMPARABLE TRANSACTIONS MULTIPLE METHOD
•A Comparable transaction is one of the conventional methods to value a company for sale. The main approach of the method is to look at similar or comparable transactions where the acquisition target has a similar business model and similar client base to the company being evaluated. MARKET VALUE METHOD (FOR QUOTED SECURITIES)
•The Market Price Method evaluates the value on the basis of prices quoted on the stock exchange. Average of quoted price is considered as indicative of the value perception of the company by investors operating under free market conditions.

WHY SHOULD YOU
GO FOR VALUATION?

▶ Determining the consideration for acquisition/ sale of business or for purchase/sale of equity stake
▶ Determining the swap ratio for merger/demerger
▶ Corporate restructuring
▶ Sale/ purchase of intangible assets including brands, patents, copyrights, trademarks, rights
▶ Determining the value of family owned business and assets in case of family separation
▶ Determining the fair value of shares for listing on the stock exchange/going public
▶ Liquidation of company
▶ Voluntary assessment
▶ Dispute resolution
▶ Regulatory mandate

Mergers and Acquisitions Accurate business valuation is one of the most important aspects of M&A as valuations like these will have a major impact on the price that a business will be sold for. A valuation will assist the business owners in determining the value of their business and even maximizing value when considering a sale, merger, acquisition, joint venture or strategic partnership. Determining The Swap Ratio For Merger/Demerger
Swap Ratio is an exchange rate of the shares of the companies that would undergo a merger. This is calculated by the valuation of various assets and liabilities of the merging companies.
In case of a merger valuation, the emphasis is on arriving at the relative values of the shares of the merging companies to facilitate determination of the swap ratio.
Why should you go for Valuation cont.

Why should you go for Valuation cont.
CORPORATE RESTRUCTURING Valuations are an increasingly important aspect of many commercial disputes. Before deciding on how to manage a dispute , it is a good idea to understand:
•The likelihood of a successful outcome
•The currency amount involved
Liquidation of a Company
Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs.
One of the major aspects of a corporate restructuring deal is to determine the correct value of the organization.
Dispute Resolution
Valuation of a company about to be liquidated gives a fair picture of the proceeds that can be generated from the liquidation. It is determining the total worth of a company's physical assets when it goes out of business or if it were to go out of business.

VALUER VIEWPOINT
•JUSTIFYING KEY ASSUMPTIONS AND BUSINESS MODEL
•EVALUATE THE CURRENT STAGE OF THE BUSINESS CYCLE
•MAKING SENSE OF THE FINANCIAL DATA
•CHOOSING THE RIGHT VALUATION MODEL
•MINIMIZE THE IMPACT OF BIAS FROM VALUATION

CHECK POINTS IN VALUATION

Non-recurring Items/ Extraordinary Items/Other Income Impact Of Seasonal Events Intangible Asset Valuation Corporate Governance & Transparency Discounts & Premiums
Non-operating Assets/ Excess Cash Off Balance Sheet Items
Consistency In Accounting Practices Operational Environment – Legal And Tax

VALUATION – THE LAW OF DIMINISHING RETURNS

PURCHASE PRICE
ALLOCATION
It uses estimated fair values at the date of acquisition to allocate the purchase price to the assets acquired and liabilities
Goodwill is the excess of the cost of an acquired entity (including tangible and intangible assets) over the net of the amounts assigned to assets acquired and liabilities
Consideration for acquisition is paid for tangible, intangible assets and goodwill. For tangible and intangible assets it is paid in proportion to the fair value.

Why Purchase Price Allocation?
Intangible assets recognized separately from goodwill must be valued and amortized for financial reporting purposes, if appropriate
This may result in better Tax planning for undertaking the transactions of acquisition of assets and liabilities; Under Slump sale transaction, specifically the Intangible Assets can be separately accounted for by the Acquirer and Depreciation also claimed under the provisions of Indian Income Tax Law.
IFRS 3: Business Combinations, requires the allocation of the purchase price in a purchase combination to be allocated between tangible and intangible assets based on fair value.

Purchase Price Allocation (cont’d)
Tangible Assets
Appreciation in Tangible
Assets
Intangible Assets
GoodwillTotal Value of Company = Value of Tangible Assets + Intangible Assets + Goodwill.
CATEGORIES
Technology Based
Marketing Based
Customer Based
Artistic Skills

FOR BETTER VALUE CONCLUSION:
•If valuing on control basis, Valuer should prefer methods that reach control value without having to start with minority value and estimate control premium;
•If valuing on minority basis, Valuer should prefer methods that reach minority value directly without having to start with control value and estimate minority discount.

BUSINESS VALUATION STANDARDS
Business Valuation Standards are basically codes of practice that are used in business valuation. At present there is no prescribed standards for business valuation in India, in many cases the valuation lacks the uniformity and generally accepted global valuation practices. In the absence of standards of business valuation the valuation is more on an art based on the professional experience of the valuer rather than a science based on empirical studies and logics.

INTERNATIONALLY BUSINESS VALUATIONS ARE GOVERNED BY BROADLY THESE STANDARDS-
INSTITUTE OF BUSINESS APPRAISERS (IBA)
NATIONAL ASSOCIATION OF CERTIFIED VALUATION ANALYSTS (NACVA)
THE CANADIAN INSTITUTE OF CHARTERED BUSINESS VALUATORS (CICBV)
REVENUE RULING 59- 60 (USA)
ICAI VALUATION STANDARD (RECOMMENDATORY)
VALUATION STANDARDS OF AMERICAN INSTITUTE OF CPAS (AICPA)
AMERICAN SOCIETY OF APPRAISERS (ASA)

Thank You!!

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