1. There are 2 methods of valuation of a business
1. Assets based method which focuses on net value of
assets.
2. Earnings based method correlates the firm’s value to
its potential future earnings or cash flow generating
capacity

2.  Assets based approach to valuation
 Value of assets determined to arrive at equity share
valuation
 NAV per share could be arrived on
1. Book value basis
2. Market value basis
3. Liquidation value basis

3.  Earnings Based approach to valuation
1. Earnings measure based on accounting –
capitalisation method
2. Price Earnings Ratio
3. Earnings measure on cash flow basis(DCF method)
4. Earnings measure on free cash flow basis(FCFF)

4.  Earnings Based approach to valuation
1. Earnings measure based on accounting –
capitalisation method
Valuation of a firm is based on:
Future maintainable profits
Capitalisation rate applicable to such earnings
Past profits of a firm say for a period of 3 years are
averaged out .Apart from averaging ,adjustments in
extraordinary items have to be made to arrive at a
reliable future maintainable profits.

5.  Earnings Based approach to valuation
 Price earnings ratio
 Most commonly used by finance managers,
investment analysts and equity shareholders to
arrive at the market price of an equity share.
 Earnings /profits are after deducting taxes,
preference dividend and after adjusting for
exceptional and extraordinary items
 MPS=EPS *P/E Ratio

6.  Earnings Based approach to valuation
1. Earnings measure based on Cash flow basis(DCF
Approach)
Used to evaluate capital expenditure proposals in
terms of their potential for creating NPV for the
firm.
Value of a business id equal to the present value of
expected future cash flows to the firm, discounted at
a rate that reflects the riskiness of the cash flows.

7.  Earnings measure on free cash flow basis(FCFF)
1. This method reflects the cash flows generated by a
company’s operations for all the providers of
capital(debt and equity)
2. This method takes into account after tax non
operating income as well as adjustments for non
operating assets.

8.  Calculation of Free Cash Flows
After tax operating earnings
Plus: Depreciation, amortisation and other non cash items
Less: Investment in long term assets
Less Investment in operating net working capital
=Operating free cash flows
Plus: After tax non operating income
Plus: Decrease in non operating Assets,eg investment securities
=Free cash flows to Firm(FCFF)

9. The value of the firm: Present value of FCFF
FCFFs are available to all the capital providers of a
corporate enterprise, the discount rate applied would
be the weighted cost of capital.
The equity valuation can be deducted by subtracting the
total external liabilities from the value of the firm.

10. Value of a firm= present value of cash flows during
explicit forecast period + continuing value of the firm
Continuing value of a firm=Free cash flow (T+1)
k0 - g
g = expected growth rate in normal level of net
operating profits less adjusted taxes
k0 = weighted average cost of capital