The document discusses methods for valuing companies in mergers and acquisitions, focusing on the discounted cash flow approach. It provides an overview of key DCF concepts including forecasting free cash flows, estimating a terminal value, and determining the weighted average cost of capital discount rate. In an M&A setting, the document notes that stand-alone valuations may establish a target's minimum value, while synergies from a merger should be incorporated. The discount rate should reflect the risk of the target's cash flows, using either its cost of capital or an adjusted rate if the acquirer changes leverage. Enterprise value is the sum of debt and equity values.
This document defines and explains various common financial terms and ratios used in business. It provides concise definitions for terms like assets, liabilities, balance sheet, profit and loss, cashflow, costs of goods sold, depreciation, dividends, and more. The definitions are intended to help non-financial business people understand basic financial concepts and terminology.
The document discusses the proposed merger between Hewlett-Packard (HP) and Compaq. It provides market share data for HP and Compaq in various product segments like servers, PCs, and laptops to show the combined company would have leadership in most areas. Both supporters and opponents of the merger are mentioned. Supporters argue it will create synergies and cost savings, while opponents believe there are limited technology benefits and increased risk. The valuation process included comparing stock price performance and multiples, as well as analyzing premiums paid in similar tech mergers.
This document discusses financial statement analysis for credit decisions. It describes the three main financial statements - the balance sheet, income statement, and cash flow statement. It then discusses different types of financial statement analysis including vertical analysis, horizontal analysis, and ratio analysis. Finally, it discusses analyzing a company's ongoing business concern by examining factors like working capital, cash flow, receivables, inventory, and management skills. The overall goal of financial statement analysis is to assess a company's financial health, performance, and ability to repay debts.
The main components of working capital are cash, receivables, and inventory. Cash is the most liquid current asset and includes funds held in bank accounts. Firms hold cash for transactional, precautionary, and speculative motives. The objectives of cash management are to maintain an optimal cash balance to meet payment obligations while minimizing costs. Common cash management strategies involve maintaining minimum cash levels, controlling cash inflows and outflows, and investing cash surpluses. Proper inventory management also aims to balance holding sufficient stock without excessive investment.
The recent economic growth coupled with uncertainties has resulted in the stakeholder's curiosity and interest in Valuations of their respective investee Companies and also the estimated Valuations of the Targets available for Sale which has led to a greater demand for Business Valuation services.
Since as of now there are no Regulated standards for Valuation in India, numerous conceptual controversies still remain, even among the most prominent practitioners. With a view to give an overview of the Valuation concepts in general and the practical issues in particular, www.corporatevaluations.in, an online venture of Corporate Professionals Capital, SEBI Registered Merchant Banker has prepared this report on "Insight of Valuation". Hope you find it useful. Suggestions for improvement are invited @ info@corporatevaluations.in
The document discusses various methods for valuing companies, including cost-based methods like book value and replacement cost, income-based methods like earnings capitalization and discounted cash flow, and market-based methods. It notes that valuation depends on factors like management, performance, projections, industry, and the transaction context. The valuation process involves considering financial and non-financial factors, using multiple models, and arriving at a valuation range. Special situations like multi-business companies, M&A, and cyclic businesses require tailored applications of valuation models.
The document summarizes key concepts in business valuation for closely held companies. It discusses approaches to valuation including asset-based, market, and income approaches. Specifically, it covers the discounted cash flow method for valuation and how to determine discount and capitalization rates. Issues like control premiums, minority discounts, and discount for lack of marketability are also addressed.
This document provides a business valuation for ABC Company as of January 3, 2013. The valuation was prepared by Brian S. Mazar of American Fortune Business Valuation for John R. Smith, the owner of ABC Company. The valuation considers income, market, and asset approaches to estimate the fair market value of ABC Company at $2,875,491. Certain portions of the full valuation report are encrypted for the client's exclusive use. The valuation is provided for informational purposes only and should not be used to defend the valuation with other parties without an intermediate or comprehensive report.
This document defines and explains various common financial terms and ratios used in business. It provides concise definitions for terms like assets, liabilities, balance sheet, profit and loss, cashflow, costs of goods sold, depreciation, dividends, and more. The definitions are intended to help non-financial business people understand basic financial concepts and terminology.
The document discusses the proposed merger between Hewlett-Packard (HP) and Compaq. It provides market share data for HP and Compaq in various product segments like servers, PCs, and laptops to show the combined company would have leadership in most areas. Both supporters and opponents of the merger are mentioned. Supporters argue it will create synergies and cost savings, while opponents believe there are limited technology benefits and increased risk. The valuation process included comparing stock price performance and multiples, as well as analyzing premiums paid in similar tech mergers.
This document discusses financial statement analysis for credit decisions. It describes the three main financial statements - the balance sheet, income statement, and cash flow statement. It then discusses different types of financial statement analysis including vertical analysis, horizontal analysis, and ratio analysis. Finally, it discusses analyzing a company's ongoing business concern by examining factors like working capital, cash flow, receivables, inventory, and management skills. The overall goal of financial statement analysis is to assess a company's financial health, performance, and ability to repay debts.
The main components of working capital are cash, receivables, and inventory. Cash is the most liquid current asset and includes funds held in bank accounts. Firms hold cash for transactional, precautionary, and speculative motives. The objectives of cash management are to maintain an optimal cash balance to meet payment obligations while minimizing costs. Common cash management strategies involve maintaining minimum cash levels, controlling cash inflows and outflows, and investing cash surpluses. Proper inventory management also aims to balance holding sufficient stock without excessive investment.
The recent economic growth coupled with uncertainties has resulted in the stakeholder's curiosity and interest in Valuations of their respective investee Companies and also the estimated Valuations of the Targets available for Sale which has led to a greater demand for Business Valuation services.
Since as of now there are no Regulated standards for Valuation in India, numerous conceptual controversies still remain, even among the most prominent practitioners. With a view to give an overview of the Valuation concepts in general and the practical issues in particular, www.corporatevaluations.in, an online venture of Corporate Professionals Capital, SEBI Registered Merchant Banker has prepared this report on "Insight of Valuation". Hope you find it useful. Suggestions for improvement are invited @ info@corporatevaluations.in
The document discusses various methods for valuing companies, including cost-based methods like book value and replacement cost, income-based methods like earnings capitalization and discounted cash flow, and market-based methods. It notes that valuation depends on factors like management, performance, projections, industry, and the transaction context. The valuation process involves considering financial and non-financial factors, using multiple models, and arriving at a valuation range. Special situations like multi-business companies, M&A, and cyclic businesses require tailored applications of valuation models.
The document summarizes key concepts in business valuation for closely held companies. It discusses approaches to valuation including asset-based, market, and income approaches. Specifically, it covers the discounted cash flow method for valuation and how to determine discount and capitalization rates. Issues like control premiums, minority discounts, and discount for lack of marketability are also addressed.
This document provides a business valuation for ABC Company as of January 3, 2013. The valuation was prepared by Brian S. Mazar of American Fortune Business Valuation for John R. Smith, the owner of ABC Company. The valuation considers income, market, and asset approaches to estimate the fair market value of ABC Company at $2,875,491. Certain portions of the full valuation report are encrypted for the client's exclusive use. The valuation is provided for informational purposes only and should not be used to defend the valuation with other parties without an intermediate or comprehensive report.
Okay, let's break this down step-by-step:
* Offer price per share is $48
* Mix is 20% cash, 80% stock
* To calculate the exchange ratio, we take the stock portion as a percentage of the total consideration
* Stock portion is 80% of $48, which is 0.8 * $48 = $38.40
* Cash portion is 20% of $48, which is 0.2 * $48 = $9.60
* Total consideration is $38.40 stock + $9.60 cash = $48
* To get the exchange ratio, we take the stock portion ($38.40) and divide it by the acquirer's stock price.
This document provides an introduction to a course on financial management. It outlines the syllabus which will cover topics such as financial statements, ratio analysis, working capital management, time value of money, capital budgeting, and cost of capital. The document explains what will be included in each section of the syllabus. It also presents some introductory information on key financial concepts like the balance sheet, income statement, assets, liabilities, and cash flow statements. Rules for the course emphasize the importance of group work and that the lecturer acts as a facilitator rather than teacher.
This document covers various topics related to valuation and forecasting for startups and growth companies. It discusses exit analysis for Nordic VCs, financial fundamentals like income statements and balance sheets, financial performance metrics and ratios, financial planning approaches, valuation methods like discounted cash flow analysis, and the VC method which often comes down to negotiation.
The report estimates the fair market value of Sample business at $20,000. It analyzed the business's financial data, risk factors, and used a proprietary valuation process to determine the value. The scope was limited to client-submitted data and risk ratings. The report disclaims responsibility and advises consulting advisors, as the value is an estimate that could differ from an actual transaction price.
Bba 2204 fin mgt week 12 working capitalStephen Ong
The document discusses working capital and current asset management. It covers several key topics:
1. Understanding working capital management and the tradeoff between profitability and risk.
2. Describing the cash conversion cycle, its funding requirements, and strategies for managing it such as inventory turnover and accounts receivable collection.
3. Discussing inventory management techniques including the ABC classification system and economic order quantity model.
4. Explaining credit management procedures such as evaluating changes in credit standards and terms.
The valuation of banks poses particular challenges due to the nature of their businesses. Specifically, it can be difficult to define debt and reinvestment needs, making the estimation of cash flows more complex. Banks are also heavily regulated, and the effects of regulatory requirements must be considered in valuation. Common valuation methods for banks include the dividend discount model, Gordon growth model, free cash flow method, and enterprise value method. Relative valuation using price-to-earnings and price-to-book value ratios is also employed. Asset-based valuation and excess return models provide alternatives. Regulatory capital ratios must also be incorporated into any bank valuation.
The document discusses various methods for valuing firms during mergers and acquisitions. It describes balance sheet, dividend discount, and cash flow valuation models. It also outlines the steps in a valuation, including analyzing historical performance, forecasting performance, estimating the cost of capital, and calculating and interpreting results. Finally, it analyzes the proposed merger between HP and Compaq using relative stock prices, comparable companies, premium analyses, and pro forma earnings impacts.
The document provides an overview of working capital, including definitions, concepts, and management. It defines working capital as the capital required for financing short-term assets like cash, inventory, and receivables. There are two concepts of working capital - the balance sheet concept focuses on current assets and liabilities, while the operating cycle concept looks at cash flows through purchasing, production, and sales cycles. Proper management of working capital is important, as both excess and inadequate working capital can hurt a business. Factors like industry, sales, and inventory turnover affect working capital needs. Forecasting and estimating working capital requirements involves considering items like materials, production timelines, credit terms, and cash flows.
The document discusses company valuation methods and common errors in valuations. It describes four main groups of valuation methods: balance sheet-based methods, income statement-based methods, mixed methods, and cash flow discounting methods. Balance sheet methods value a company based on its assets and liabilities, but do not consider future cash flows. Income statement methods use multiples of financial metrics like EBITDA. Mixed methods combine elements of balance sheet and income statements. Cash flow discounting methods, considered most accurate, value a company based on the present value of its future cash flows. The document also lists common errors seen in over 1,000 valuations, such as inaccurate financial projections.
Mr. Chander Sawhney, Partner & Head – Valuation & Deals, Corporate Professionals shared his thoughts as a guest Speaker on Valuation Principles & Techniques in Ind AS at a seminar organised by Gurgaon Branch of ICAI on 3rd September, 2016.
IndAS113 prescribes Fair Valuation definition, Techniques, Application and its Hierarchy. About 75% of the Balance Sheet Size is expected to change due to Fair Value Accounting (#IndAS109 #Financial Instruments, #IndAS102 #Share based payments, #IndAS16 Property Plant Equipments (PPE), #IndAS103 #Business combination etc. shall be impacted using #FairValue. Time to get ready, Plan Prepare and Align with the new requirements...
About Corporate Professionals Valuation Practice
Corporate Professionals Capital Pvt. Ltd. is a SEBI Registered (Cat-1) Merchant Banker and has a successful track record of providing a broad range of M&A and Transaction Advisory Services. Our Dedicated Team has more than 10 years of rich Valuation experience and we have executed more than 500 Corporate Valuations for clients of International Repute across different Context, Industries and Boundaries.
To know more about Our Valuation offerings and how we can help you, please visit us at www.corporatevaluations.in or download our Valuation profile @ http://www.corporatevaluations.in/VALUATION_PROFILE.pdf
The document discusses fundamental principles of value creation including lessons on value creation, Fred's Hardware case study, discounted cash flow approach, drivers of cash flow and value, and economic profit. It provides examples of how companies can create value by investing capital at returns above their cost of capital. The value of a company is based on expected future cash flows discounted at the required rate of return. Growth, return on invested capital, and cost of capital are key drivers of corporate value.
The business valuation process involves establishing the standard of value, purpose and valuation date through an engagement letter. It then requires gathering company and industry data, analyzing and normalizing financial statements, and implementing accepted valuation methods like the income, market and asset methods. The process concludes with drafting and reviewing a narrative report that determines the fair value or price of a business.
Corporate Valuations “Techniques & Application”: A compilation of research oriented valuation articles.
Contents: Business valuation, Relative valuation, Sum of the parts valuation and value creation, ESOP valuation, Discounted Cash Flow Valuation, Enterprise Valuation etc.
Financial statement analysis involves analyzing a company's financial statements to assess its performance and financial position. It is done by both internal managers and external parties such as investors and creditors. Key aspects of financial statement analysis include ratio analysis, trend analysis, and comparative analysis. Ratio analysis calculates and analyzes financial ratios to evaluate aspects such as liquidity, asset efficiency, debt levels, profitability, and investor returns. Trend analysis examines changes in financial metrics over several periods. Comparative analysis compares financial results to other companies or years. The overall goal is to evaluate the company's financial health and identify strengths and weaknesses.
The document discusses various concepts related to valuation, including:
- Going-concern value, which is the value of a company as a continuing operation, versus liquidation value.
- Book value, which is a company's net assets calculated by total assets minus liabilities.
- Market value, which is the estimated value of a company based on its current share price and market capitalization.
- Bond valuation, which uses techniques like discounted cash flow to determine the fair value of a bond based on its future cash flows.
- Discounted cash flow (DCF) analysis, which discounts future cash flows to arrive at a present value used to evaluate investment opportunities.
- Intrinsic
This document provides an overview of financial statement analysis and ratio analysis. It defines key financial statements like the income statement, balance sheet, and statement of cash flows. It also explains the purpose of ratio analysis is to evaluate a firm's performance, liquidity, profitability, and financial stability by calculating and comparing various financial ratios over time and against industry benchmarks. Common ratios covered include liquidity, leverage, activity, and profitability ratios. Ratio analysis is a useful tool but requires comparing ratios to standards and accounting for company and industry differences.
Introduction to Business Valuation, Fair Market Value, reasons and elements of business valuation, methodologies of business valuation, case study on net asset value.
This document provides an overview of key concepts in financial management. It discusses topics such as the functions and goals of finance, time value of money principles, financial statement analysis techniques, and ratio analysis. The main points covered are:
- Financial management deals with procuring and effectively managing funds. Its ultimate goal is to maximize shareholder wealth.
- The time value of money, risk-return tradeoff, and greater value placed on cash are basic principles of finance.
- Ratio analysis is used to evaluate a company's liquidity, activity, stability/debt, and profitability. Ratios provide insights into performance and risk.
Corporate Finance unit 3 : Advanced financial managementGanesha Pandian
This document provides an overview of the topics covered in the Advanced Financial Management unit. It discusses appraising risky investments using risk-adjusted discount rates and certainty equivalents of cash flows. Other topics include sensitivity analysis, simulation methods like Monte Carlo simulation, and using decision trees to evaluate investment decisions under uncertainty. Real options, which provide flexibility to modify projects over time, are also introduced.
Valuation & Financial Re-organization
This document provides contact details for valuation services at IndiaCP and outlines an upcoming business leadership program on valuation. It discusses what valuation is, key concepts like value vs price and the difference between transactions and valuations. It covers standard valuation approaches like income, asset and market approaches. It also discusses valuation methodologies, factors considered, and regulatory contexts where valuation is required in India like for the Reserve Bank of India, Income Tax, and SEBI.
This document discusses the overreliance on EBITDA as a measure of firm profitability and valuation. It explores how EBITDA fails to accurately reflect real operating costs like recurring working capital needs and capital expenditures. While EBITDA was rarely used before the 1980s leveraged buyout boom, its use expanded as it inflated valuations and debt capacity. However, EBITDA does not correlate with cash flow for most firms as it does not account for important expenses. The document concludes that more thorough analysis is needed beyond EBITDA to determine a firm's fair valuation.
Okay, let's break this down step-by-step:
* Offer price per share is $48
* Mix is 20% cash, 80% stock
* To calculate the exchange ratio, we take the stock portion as a percentage of the total consideration
* Stock portion is 80% of $48, which is 0.8 * $48 = $38.40
* Cash portion is 20% of $48, which is 0.2 * $48 = $9.60
* Total consideration is $38.40 stock + $9.60 cash = $48
* To get the exchange ratio, we take the stock portion ($38.40) and divide it by the acquirer's stock price.
This document provides an introduction to a course on financial management. It outlines the syllabus which will cover topics such as financial statements, ratio analysis, working capital management, time value of money, capital budgeting, and cost of capital. The document explains what will be included in each section of the syllabus. It also presents some introductory information on key financial concepts like the balance sheet, income statement, assets, liabilities, and cash flow statements. Rules for the course emphasize the importance of group work and that the lecturer acts as a facilitator rather than teacher.
This document covers various topics related to valuation and forecasting for startups and growth companies. It discusses exit analysis for Nordic VCs, financial fundamentals like income statements and balance sheets, financial performance metrics and ratios, financial planning approaches, valuation methods like discounted cash flow analysis, and the VC method which often comes down to negotiation.
The report estimates the fair market value of Sample business at $20,000. It analyzed the business's financial data, risk factors, and used a proprietary valuation process to determine the value. The scope was limited to client-submitted data and risk ratings. The report disclaims responsibility and advises consulting advisors, as the value is an estimate that could differ from an actual transaction price.
Bba 2204 fin mgt week 12 working capitalStephen Ong
The document discusses working capital and current asset management. It covers several key topics:
1. Understanding working capital management and the tradeoff between profitability and risk.
2. Describing the cash conversion cycle, its funding requirements, and strategies for managing it such as inventory turnover and accounts receivable collection.
3. Discussing inventory management techniques including the ABC classification system and economic order quantity model.
4. Explaining credit management procedures such as evaluating changes in credit standards and terms.
The valuation of banks poses particular challenges due to the nature of their businesses. Specifically, it can be difficult to define debt and reinvestment needs, making the estimation of cash flows more complex. Banks are also heavily regulated, and the effects of regulatory requirements must be considered in valuation. Common valuation methods for banks include the dividend discount model, Gordon growth model, free cash flow method, and enterprise value method. Relative valuation using price-to-earnings and price-to-book value ratios is also employed. Asset-based valuation and excess return models provide alternatives. Regulatory capital ratios must also be incorporated into any bank valuation.
The document discusses various methods for valuing firms during mergers and acquisitions. It describes balance sheet, dividend discount, and cash flow valuation models. It also outlines the steps in a valuation, including analyzing historical performance, forecasting performance, estimating the cost of capital, and calculating and interpreting results. Finally, it analyzes the proposed merger between HP and Compaq using relative stock prices, comparable companies, premium analyses, and pro forma earnings impacts.
The document provides an overview of working capital, including definitions, concepts, and management. It defines working capital as the capital required for financing short-term assets like cash, inventory, and receivables. There are two concepts of working capital - the balance sheet concept focuses on current assets and liabilities, while the operating cycle concept looks at cash flows through purchasing, production, and sales cycles. Proper management of working capital is important, as both excess and inadequate working capital can hurt a business. Factors like industry, sales, and inventory turnover affect working capital needs. Forecasting and estimating working capital requirements involves considering items like materials, production timelines, credit terms, and cash flows.
The document discusses company valuation methods and common errors in valuations. It describes four main groups of valuation methods: balance sheet-based methods, income statement-based methods, mixed methods, and cash flow discounting methods. Balance sheet methods value a company based on its assets and liabilities, but do not consider future cash flows. Income statement methods use multiples of financial metrics like EBITDA. Mixed methods combine elements of balance sheet and income statements. Cash flow discounting methods, considered most accurate, value a company based on the present value of its future cash flows. The document also lists common errors seen in over 1,000 valuations, such as inaccurate financial projections.
Mr. Chander Sawhney, Partner & Head – Valuation & Deals, Corporate Professionals shared his thoughts as a guest Speaker on Valuation Principles & Techniques in Ind AS at a seminar organised by Gurgaon Branch of ICAI on 3rd September, 2016.
IndAS113 prescribes Fair Valuation definition, Techniques, Application and its Hierarchy. About 75% of the Balance Sheet Size is expected to change due to Fair Value Accounting (#IndAS109 #Financial Instruments, #IndAS102 #Share based payments, #IndAS16 Property Plant Equipments (PPE), #IndAS103 #Business combination etc. shall be impacted using #FairValue. Time to get ready, Plan Prepare and Align with the new requirements...
About Corporate Professionals Valuation Practice
Corporate Professionals Capital Pvt. Ltd. is a SEBI Registered (Cat-1) Merchant Banker and has a successful track record of providing a broad range of M&A and Transaction Advisory Services. Our Dedicated Team has more than 10 years of rich Valuation experience and we have executed more than 500 Corporate Valuations for clients of International Repute across different Context, Industries and Boundaries.
To know more about Our Valuation offerings and how we can help you, please visit us at www.corporatevaluations.in or download our Valuation profile @ http://www.corporatevaluations.in/VALUATION_PROFILE.pdf
The document discusses fundamental principles of value creation including lessons on value creation, Fred's Hardware case study, discounted cash flow approach, drivers of cash flow and value, and economic profit. It provides examples of how companies can create value by investing capital at returns above their cost of capital. The value of a company is based on expected future cash flows discounted at the required rate of return. Growth, return on invested capital, and cost of capital are key drivers of corporate value.
The business valuation process involves establishing the standard of value, purpose and valuation date through an engagement letter. It then requires gathering company and industry data, analyzing and normalizing financial statements, and implementing accepted valuation methods like the income, market and asset methods. The process concludes with drafting and reviewing a narrative report that determines the fair value or price of a business.
Corporate Valuations “Techniques & Application”: A compilation of research oriented valuation articles.
Contents: Business valuation, Relative valuation, Sum of the parts valuation and value creation, ESOP valuation, Discounted Cash Flow Valuation, Enterprise Valuation etc.
Financial statement analysis involves analyzing a company's financial statements to assess its performance and financial position. It is done by both internal managers and external parties such as investors and creditors. Key aspects of financial statement analysis include ratio analysis, trend analysis, and comparative analysis. Ratio analysis calculates and analyzes financial ratios to evaluate aspects such as liquidity, asset efficiency, debt levels, profitability, and investor returns. Trend analysis examines changes in financial metrics over several periods. Comparative analysis compares financial results to other companies or years. The overall goal is to evaluate the company's financial health and identify strengths and weaknesses.
The document discusses various concepts related to valuation, including:
- Going-concern value, which is the value of a company as a continuing operation, versus liquidation value.
- Book value, which is a company's net assets calculated by total assets minus liabilities.
- Market value, which is the estimated value of a company based on its current share price and market capitalization.
- Bond valuation, which uses techniques like discounted cash flow to determine the fair value of a bond based on its future cash flows.
- Discounted cash flow (DCF) analysis, which discounts future cash flows to arrive at a present value used to evaluate investment opportunities.
- Intrinsic
This document provides an overview of financial statement analysis and ratio analysis. It defines key financial statements like the income statement, balance sheet, and statement of cash flows. It also explains the purpose of ratio analysis is to evaluate a firm's performance, liquidity, profitability, and financial stability by calculating and comparing various financial ratios over time and against industry benchmarks. Common ratios covered include liquidity, leverage, activity, and profitability ratios. Ratio analysis is a useful tool but requires comparing ratios to standards and accounting for company and industry differences.
Introduction to Business Valuation, Fair Market Value, reasons and elements of business valuation, methodologies of business valuation, case study on net asset value.
This document provides an overview of key concepts in financial management. It discusses topics such as the functions and goals of finance, time value of money principles, financial statement analysis techniques, and ratio analysis. The main points covered are:
- Financial management deals with procuring and effectively managing funds. Its ultimate goal is to maximize shareholder wealth.
- The time value of money, risk-return tradeoff, and greater value placed on cash are basic principles of finance.
- Ratio analysis is used to evaluate a company's liquidity, activity, stability/debt, and profitability. Ratios provide insights into performance and risk.
Corporate Finance unit 3 : Advanced financial managementGanesha Pandian
This document provides an overview of the topics covered in the Advanced Financial Management unit. It discusses appraising risky investments using risk-adjusted discount rates and certainty equivalents of cash flows. Other topics include sensitivity analysis, simulation methods like Monte Carlo simulation, and using decision trees to evaluate investment decisions under uncertainty. Real options, which provide flexibility to modify projects over time, are also introduced.
Valuation & Financial Re-organization
This document provides contact details for valuation services at IndiaCP and outlines an upcoming business leadership program on valuation. It discusses what valuation is, key concepts like value vs price and the difference between transactions and valuations. It covers standard valuation approaches like income, asset and market approaches. It also discusses valuation methodologies, factors considered, and regulatory contexts where valuation is required in India like for the Reserve Bank of India, Income Tax, and SEBI.
This document discusses the overreliance on EBITDA as a measure of firm profitability and valuation. It explores how EBITDA fails to accurately reflect real operating costs like recurring working capital needs and capital expenditures. While EBITDA was rarely used before the 1980s leveraged buyout boom, its use expanded as it inflated valuations and debt capacity. However, EBITDA does not correlate with cash flow for most firms as it does not account for important expenses. The document concludes that more thorough analysis is needed beyond EBITDA to determine a firm's fair valuation.
This document discusses the overreliance on EBITDA as a measure of firm profitability and valuation. It explores how EBITDA fails to accurately reflect real operating costs like recurring working capital needs and capital expenditures. While EBITDA was rarely used before the 1980s leveraged buyout boom, its use expanded as it inflated valuations and debt capacity. However, EBITDA does not correlate with cash flow for most firms as it does not account for important expenses. The document concludes that more thorough analysis is needed beyond EBITDA to determine a firm's fair valuation.
Company X provides a document outlining key concepts in value based management including metrics like NOPAT, FCF, ROIC, WACC, and EVA. It discusses these concepts over 3 pages and provides examples of calculations for Company X in 2014-2016. Key metrics like ROIC increased substantially from 20.39% in 2014 to 60.31% in 2016 while WACC also increased from 15.19% to 24.35% over this period, leading to an expanding ROIC-WACC spread and indicating improved value creation.
Cost of capital, Cost of debt, Cost of equity, Cost of preference shares, Wei...Dayana Mastura FCCA CA
This document discusses weighted average cost of capital (WACC) which is a calculation of a firm's cost of capital considering the costs of the different components of the firm's capital structure (debt, equity, preference shares). It defines WACC and explains its importance as the minimum return a firm needs to earn on new projects/investments to break even. The document also outlines how to calculate WACC and the costs of each capital component (cost of equity using CAPM, cost of debt, cost of preference shares). It discusses how WACC is used as a benchmark for projects, in determining leverage limits, for valuation, and in discounting cash flows in a DCF analysis.
The document defines key financial terms:
- Weighted Average Cost of Capital (WACC) is a calculation of a firm's overall cost of capital that weights each category of capital (debt, equity, etc.) based on its proportion of total capital. A higher WACC means a firm is riskier and less valuable.
- Investment appraisal evaluates potential investments using methods like return on investment, net present value, and payback period. It is important for capital budgeting decisions.
- Transfer pricing refers to prices charged between related entities for goods/services and impacts how profits are allocated between tax jurisdictions.
- International Financial Reporting Standards (IFRS) are set by the IASB and establish uniform accounting standards
1) The document discusses working capital management strategies and how they can impact return on capital employed (ROCE). It analyzes data from annual working capital surveys.
2) While a shorter cash conversion cycle should theoretically increase ROCE by reducing capital tied up, the survey data does not show a clear relationship between changes in the cash conversion cycle and changes in ROCE.
3) The document then examines a company that has seasonal demand and discusses strategies for maintaining flexible working capital levels to maximize equity value across seasons while balancing cash availability and opportunity costs.
Working capital represents a company's liquidity and is calculated as current assets minus current liabilities. It reflects a company's ability to pay off short-term debt obligations and covers operational expenses. Positive working capital is needed to ensure companies can continue operating without issues. The management of working capital involves managing inventory levels, accounts receivable, accounts payable, and cash to optimize current assets and liabilities and free up cash flow. Companies aim to reduce their working capital cycle by collecting from customers quicker or stretching out payments to suppliers in order to free up more cash.
Working capital represents a company's short-term operating liquidity and is calculated as current assets minus current liabilities. It indicates whether a company has sufficient short-term resources to meet upcoming operational expenses and debt obligations. Positive working capital is important to ensure companies can continue operating and meet near-term financial obligations. Managing working capital involves optimizing components like inventory, accounts receivable, payables, and cash to efficiently fund daily operations.
The document discusses factors influencing investment vehicle (SPV) decisions for structuring project funding. An SPV is a legal entity set up to manage risk, cost of capital, and control structure for a project. Investors in securitized instruments seek credit enhancements to reduce risk. Credit enhancements include internal mechanisms like credit tranching (senior/subordinate structures) and over-collateralization, as well as external guarantees or letters of credit. The document outlines various types of internal credit enhancements used in SPVs like credit tranching, over-collateralization, cash collateral accounts, spread accounts, and triggered amortization.
The document discusses accounting standards issued by the Institute of Chartered Accountants of India (ICAI). It provides information on the Accounting Standards Board established by ICAI and its role in preparing accounting standards for proper recognition, measurement, treatment, presentation and disclosure of accounting transactions in financial statements of organizations. The document also covers the scope and objectives of various individual accounting standards.
The document provides an overview of discounted cash flow (DCF) valuation. It discusses the history of DCF dating back to ancient times and its popularity after the 1929 stock market crash. It defines DCF valuation as estimating a company's value based on discounting its predicted future cash flows. The key steps in DCF valuation are estimating future cash flows, determining an appropriate discount rate, and calculating the present value of the future cash flows. DCF valuation requires numerous assumptions about cash flows, growth rates, and discount rates.
Ratio AnalysisFinancial ratios can be used to examine various as.docxcatheryncouper
Ratio Analysis
Financial ratios can be used to examine various aspects of the financial position and performance of a business and are widely used for planning and control purposes.
They can be used to evaluate the financial health of a business and can be utilised by management in a wide variety of decisions involving such areas as profit planning, pricing, working-capital management, financial structure and dividend policy.
Ratio analysis provides a fairly simplistic method of examining the financial condition of a business.
A ratio expresses the relation of one figure appearing in the financial statements to some other figure appearing there.
Ratios enable comparison between businesses.
Differences may exist between businesses in the scale of operations making comparison via the profits generated unreliable.
Ratios can eliminate this uncertainty.
Other than comparison with other businesses, it is also a valuable tool in analysing the performance of one business over time.
However useful ratios are not without their problems.
Figures calculated through ratio analysis can highlight the financial strengths and weaknesses of a business but they cannot, by themselves, explain why certain strengths or weaknesses exist or why certain changes have occurred.
Only detailed investigation will reveal these underlying reasons. Ratios must, therefore, be seen as a ‘starting point’.
Financial ratio classification
The following ratios are considered the more important for decision-making purposes:
Ratios can be grouped into certain categories, each of which reflects a particular aspect of financial performance or position.
The following broad categories provide a useful basis for explaining the nature of the financial ratios to be dealt with.
Profitability.Businesses come into being with the primary purpose of creating wealth for the owners. Profitability ratios provide an insight to the degree of success in achieving this purpose. They express the profits made in relation to other key figures in the financial statements or to some business resource.
Efficiency.Ratios may be used to measure the efficiency with which certain resource have been utilised within the business. These ratios are also referred to as active ratios.
Liquidity.It is vital to the survival of a business that there be sufficient liquid resources available to meet maturing obligations. Certain ratios may be calculated that examines the relationship between liquid resources held and creditors due for payment in the near future.
Gearing.This is the relationship between the amount financed by the owners of the business and the amount contributed by outsiders, which has an important effect on the degree of risk associated with a business. Gearing is then something that managers must consider when making financing decisions.
Investment.Certain ratios are concerned with assessing the returns and performance of shares held in a particular business.
Profitabi ...
Accounts payable and accounts receivable refer to money owed to and by a business for goods and services. Accrual accounting records income and expenses when incurred rather than when payment is made. Key financial documents include the income statement, balance sheet, and cash flow statement, which provide different perspectives on a company's performance over time. Financial ratios analyze relationships between financial metrics and compare performance to peers. Profitability, leverage, liquidity, and operating efficiency ratios assess different aspects of a company's financial health.
Sip 2013 15 main report-kiran mankumbre 110914Kiran Mankumbre
This document provides an executive summary and introduction to analyzing the financial ratios of Dabur India Pvt Ltd. It discusses the objectives of the project, which are to develop a financial model of Dabur and learn about financial modeling and ratio analysis. It introduces the key types of ratios that will be analyzed, including liquidity, profitability, turnover, solvency, and overall profitability ratios. Specific ratios that will be calculated and analyzed include current ratio, quick ratio, gross profit ratio, operating ratio, net profit ratio, return on investment ratio, and return on capital employed ratio.
Prepare a witten financial analysis. .This should include calculation.pdfarrowit1
Prepare a witten financial analysis. .This should include calculations and discussion related to
the Chapter 5 appendix (Appendix 5A). See illustration 5A-1 for a summary of financial ratios.
Be sure to include (1) these ratios, (2) what they mean and (3) how you interpret them: o Current
ratio o Accounts receivable turnover o Inventory turnover o Profit margin on sales o Return on
assets o Return on stockholders\' equity o Debt to assets ratio Submit a WORD document via
D2L- Assessments - Assignments
Solution
Ans ) The ratios are not meant for a particular person or firm.People in various fields of life are
interested in ratio analysis from their own angles.The parties attached with business or firm are
creditors i.e. mony lenders, shareholders.Management uses the toolof Ratio analysisto
interpretate the information from their own angles.For example creditors are interested in
liquidity and solvency for which they will make use of current ratio , liquidity ratio,
proprietaryRatio, debt equity Ratio,capital gearing Ratio.Shareholders are interested in
profitability and long term solvency.They want to know the rate of return on their capital
employed for which they willmake use of Gross Profit Ratio, Operating Ratio, Dividend ratio
and Price Earning Ratio.Management is interested in overall efficiency of business which can be
better jud ged through Ratios like turnover to fixed assets, turnover to capital employed, stock
turnover ratio etc.So, from the above discussion it is clear that different prties uses the tool of
Ratio analysis for taking their own decisions
The particular purpose of a user is determining the particular Ratios that might be used ofr
financial analysis.Here we will discuss and calculate various ratios to do fianacial analysis.
Current Ratio = Current Assests/Current Liabilities
Current Assests= Cash + Bank+ Prepaid Insurance+Inventory+ Accounts Recievables
Current Assests=44746.5 +510+500+5000+29000=79756.5
Current Laibilites =Accounts payable
Current Laibilites= 30064.83
Current Ratio = 79756.5/30064.83= 2.7
Interpretation : Generally a current ratio of 2 times or 2:1 is cosidered to be satisfactory.Here the
current ratio of greater than 2 denotes the good liquidity position but it also indicates assest
liabilty mis match.But current ratio greater than 2 is generally preferred as compared to less than
2.
2.Account receivables turnover :It represents the number of times the cash is collected from
debtors.Lower turnover denotes poor collection and means that funds are blocked ofr longer
period of tiem and vice-versa.It also measure the liquidity of the firm.It shows how quickly
debtors (receivables) are converted into sales.The Account receivables turnover shows the
relationship between sales and debtors of the firm.
Account receivables turnover= Net Credit Annual Sales/Average trade debtors
3. Inventory turnover :This ratio indicates the number of times inventory or stock is replaced
during the year.The turnover of invent.
This document discusses several valuation methods including comparable multiples, discounted cash flow analysis, and heuristic methods. It provides an overview of comparable multiples like P/E, price to book, and enterprise value to EBITDA. It then describes using a discounted cash flow approach including estimating free cash flows, determining an appropriate time horizon, and calculating the cost of debt and equity. The document emphasizes that discounted cash flow analysis accounts for synergies and specific company characteristics better than heuristic multiples which have limitations.
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1. Elemental Economics - Introduction to mining.pdfNeal Brewster
After this first you should: Understand the nature of mining; have an awareness of the industry’s boundaries, corporate structure and size; appreciation the complex motivations and objectives of the industries’ various participants; know how mineral reserves are defined and estimated, and how they evolve over time.
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Laura Adkins-Hackett, Economist, LMIC, and Sukriti Trehan, Data Scientist, LMIC, presented their research exploring trends in the skills listed in OJPs to develop a deeper understanding of in-demand skills. This research project uses pointwise mutual information and other methods to extract more information about common skills from the relationships between skills, occupations and regions.
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Financial Assets: Debit vs Equity Securities.pptxWrito-Finance
financial assets represent claim for future benefit or cash. Financial assets are formed by establishing contracts between participants. These financial assets are used for collection of huge amounts of money for business purposes.
Two major Types: Debt Securities and Equity Securities.
Debt Securities are Also known as fixed-income securities or instruments. The type of assets is formed by establishing contracts between investor and issuer of the asset.
• The first type of Debit securities is BONDS. Bonds are issued by corporations and government (both local and national government).
• The second important type of Debit security is NOTES. Apart from similarities associated with notes and bonds, notes have shorter term maturity.
• The 3rd important type of Debit security is TRESURY BILLS. These securities have short-term ranging from three months, six months, and one year. Issuer of such securities are governments.
• Above discussed debit securities are mostly issued by governments and corporations. CERTIFICATE OF DEPOSITS CDs are issued by Banks and Financial Institutions. Risk factor associated with CDs gets reduced when issued by reputable institutions or Banks.
Following are the risk attached with debt securities: Credit risk, interest rate risk and currency risk
There are no fixed maturity dates in such securities, and asset’s value is determined by company’s performance. There are two major types of equity securities: common stock and preferred stock.
Common Stock: These are simple equity securities and bear no complexities which the preferred stock bears. Holders of such securities or instrument have the voting rights when it comes to select the company’s board of director or the business decisions to be made.
Preferred Stock: Preferred stocks are sometime referred to as hybrid securities, because it contains elements of both debit security and equity security. Preferred stock confers ownership rights to security holder that is why it is equity instrument
<a href="https://www.writofinance.com/equity-securities-features-types-risk/" >Equity securities </a> as a whole is used for capital funding for companies. Companies have multiple expenses to cover. Potential growth of company is required in competitive market. So, these securities are used for capital generation, and then uses it for company’s growth.
Concluding remarks
Both are employed in business. Businesses are often established through debit securities, then what is the need for equity securities. Companies have to cover multiple expenses and expansion of business. They can also use equity instruments for repayment of debits. So, there are multiple uses for securities. As an investor, you need tools for analysis. Investment decisions are made by carefully analyzing the market. For better analysis of the stock market, investors often employ financial analysis of companies.
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Metodos de valuacion
1. UV0112
Rev. Mar. 19, 2018
Methods of Valuation for Mergers and Acquisitions
This note addresses the methods used to value companies in a merger and acquisitions (M&A) setting. It
provides a detailed description of the discounted-cash-flow (DCF) approach and reviews other methods of
valuation, such as market multiples of peer firms, book value, liquidation value, replacement cost, market
value, and comparable transaction multiples.
Discounted-Cash-Flow Method
Overview
The DCF approach in an M&A setting attempts to determine the enterprise value, or value of the company,
by computing the present value of cash flows over the life of the company.1 Because a corporation is
assumed to have infinite life, the analysis is broken into two parts: a forecast period and a terminal value. In
the forecast period, explicit forecasts of free cash flow that incorporate the economic costs and benefits of the
transaction must be developed. Ideally, the forecast period should comprise the interval over which the firm
is in a transitional state, as when enjoying a temporary competitive advantage (i.e., the circumstances wherein
expected returns exceed required returns). In most circumstances, a forecast period of five or ten years is
used.
The terminal value of the company, derived from free cash flows occurring after the forecast period, is
estimated in the last year of the forecast period and capitalizes the present value of all future cash flows
beyond the forecast period. To estimate the terminal value, cash flows are projected under a steady-state
assumption that the firm enjoys no opportunities for abnormal growth or that expected returns equal
required returns following the forecast period. Once a schedule of free cash flows is developed for the
enterprise, the weighted average cost of capital (WACC) is used to discount them to determine the present
value. The sum of the present values of the forecast period and the terminal value cash flows provides an
estimate of company or enterprise value.
1 This note focuses on valuing the company as a whole (i.e., the enterprise). An estimate of equity value can be derived under this approach by
subtracting interest-bearing debt from enterprise value. An alternative method not pursued here values the equity using residual cash flows, which are
computed as net of interest payments and debt repayments plus debt issuances. Residual cash flows must be discounted at the cost of equity.
This technical note was prepared by Susan Chaplinsky, Professor of Business Administration, and Michael J. Schill, Associate Professor of Business
Administration, with the assistance of Paul Doherty (MBA ’99). Portions of this note draw on an earlier note, “Note on Valuation Analysis for
Mergers and Acquisitions” (UVA-F-0557). Copyright 2000 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights
reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a
spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School
Foundation. Our goal is to publish materials of the highest quality, so please submit any errata to editorial@dardenbusinesspublishing.com.
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2. Page 2 UV0112
Review of DCF basics
Let us briefly review the construction of free cash flows, terminal value, and the WACC. It is important
to realize that these fundamental concepts work equally well when valuing an investment project as they do in
an M&A setting.
Free cash flows: The free cash flows in an M&A analysis should be the expected incremental operating cash
flows attributable to the acquisition, before consideration of financing charges (i.e., prefinancing cash flows).
Free cash flow equals the sum of net operating profits after taxes (NOPAT), plus depreciation and noncash
charges, less capital investment and less investment in working capital. NOPAT captures the earnings after
taxes that are available to all providers of capital. That is, NOPAT has no deductions for financing costs.
Moreover, because the tax deductibility of interest payments is accounted for in the WACC, such financing
tax effects are also excluded from the free cash flow, which is expressed in Equation 1.
FCF = NOPAT + Depreciation − CAPEX − NWC, (1)
where:
NOPAT is equal to EBIT (1 – t), where t is the appropriate marginal (not average) cash tax rate,
which should be inclusive of federal, state, local, and foreign jurisdictional taxes.2
Depreciation is noncash operating charges including depreciation, depletion, and amortization
recognized for tax purposes.
CAPEX is capital expenditures for fixed assets.
NWC is the increase in net working capital defined as current assets less the non-interest-bearing
current liabilities.3
The cash-flow forecast should be grounded in a thorough industry and company forecast. Care should be
taken to ensure that the forecast reflects consistency with firm strategy as well as with macroeconomic and
industry trends and competitive pressure.
The forecast period is normally the years during which the analyst estimates free cash flows that are
consistent with creating value. A convenient way to think about value creation is whenever the return on net
assets (RONA)4 exceeds the WACC.5 RONA can be divided into an income statement component and a
balance sheet component:
RONA = NOPAT/Net Assets
= NOPAT/Sales × Sales/Net Assets
In this context, value is created whenever earnings power increases (NOPAT/Sales) or when asset
efficiency is improved (Sales/Net Assets). In other words, analysts are assuming value creation whenever they
2 EBIT = earnings before interest and tax.
3 The net working capital should include the expected cash, receivables, inventory, and payables levels required for the operation of the business. If
the firm currently has excess cash (more than is needed to sustain operations), for example, the cash forecast should be reduced to the level of cash
required for operations. Excess cash should be valued separately by adding it to the enterprise value.
4 In this context, we define net assets as total assets less non-interest-bearing current liabilities or equivalently as net working capital plus net fixed
assets. A similar relationship can be expressed using return on capital (ROC). Because the uses of capital (working capital and fixed assets) equal the
sources of capital (debt and equity), it follows that RONA (return on net assets) equals ROC and, therefore, ROC = NOPAT/(Debt + Equity).
5 WACC is discussed later in this note as the appropriate discount rate used for the free cash flows.
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3. Page 3 UV0112
allow the profit margin to improve on the income statement and whenever they allow sales to improve
relative to the level of assets on the balance sheet.
Terminal value: A terminal value in the final year of the forecast period is added to reflect the present value
of all cash flows occurring thereafter. Because it capitalizes all future cash flows beyond the final year, the
terminal value can be a large component of the value of a company, and therefore deserves careful attention.
This can be of particular importance when cash flows over the forecast period are close to zero (or even
negative) as the result of aggressive investment for growth.
A standard estimator of the terminal value in the final year of the cash-flow forecast is the constant
growth valuation formula (Equation 2).
Terminal Value = FCFSteady State (WACC − g), (2)
where:
FCFSteady State is the steady-state expected free cash flow for the year after the final year of the cash-
flow forecast.
WACC is the weighted average cost of capital.
g is the expected steady-state growth rate of FCFSteady State in perpetuity.
The free-cash-flow value used in the constant growth valuation formula should reflect the steady-state
cash flow for the year after the forecast period. The assumption of the formula is that in steady state, this
cash flow will grow in perpetuity at the steady-state growth rate. A convenient approach is to assume that
RONA remains constant in perpetuity; that is, both profit margin and asset turnover remain constant in
perpetuity. Under this assumption, the analyst grows all financial statement line items (i.e., revenue, costs,
assets) at the expected steady-state growth rate. In perpetuity, this assumption makes logical sense in that if a
firm is truly in steady state, the financial statements should be growing, by definition, at the same rate.
Discount rate: The discount rate should reflect the weighted average of investors’ opportunity cost
(WACC) on comparable investments. The WACC matches the business risk, expected inflation, and currency
of the cash flows to be discounted. In order to avoid penalizing the investment opportunity, the WACC also
must incorporate the appropriate target weights of financing going forward. Recall that the appropriate rate is
a blend of the required rates of return on debt and equity, weighted by the proportion of the firm’s market
value they make up (Equation 3).
WACC = Wd kd (1 െ t) + We ke, (3)
where:
kd is the required yield on new debt: It is yield to maturity.
ke is the cost of equity capital.
Wd, We are target percentages of debt and equity (using market values of debt and equity).6
t is the marginal tax rate.
6 Debt for purposes of the WACC should include all permanent, interest-bearing debt. If the market value of debt is not available, the book value of
debt is often assumed as a reasonable proxy. The shorter the maturity of the debt and the closer the correspondence between the coupon rate and
required return on the debt, the more accurate the approximation.
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The costs of debt and equity should be going-forward market rates of return. For debt securities, this is
often the yield to maturity that would be demanded on new instruments of the same credit rating and
maturity. The cost of equity can be obtained from the Capital Asset Pricing Model (CAPM) (Equation 4).
ke = Rf + ß (Rm െ Rf), (4)
where:
Rf is the expected return on risk-free securities over a time horizon consistent with the investment
horizon. Most firm valuations are best served by using a long maturity government bond yield.
Rm − Rf is the expected market risk premium. This value is commonly estimated as the average
historical difference between the returns on common stocks and long-term government bonds. For
example, Ibbotson Associates estimated that the geometric mean return between 1926 and 2007 for
large capitalization US equities between 1926 and 2007 was 10.4%. The geometric mean return on
long-term government bonds was 5.5%. The difference between the two implies a historical market-
risk premium of about 5.0%. In practice, one observes estimates of the market risk premium that
commonly range from 5% to 8%.
ß, or beta, is a measure of the systematic risk of a firm’s common stock. The beta of common stock
includes compensation for business and financial risk.
The M&A Setting
No doubt, many of these concepts look familiar. Now we must consider how they are altered by the
evaluation of a company in an M&A setting. First, we should recognize that there are two parties (sometimes
more) in the transaction: an acquirer (buyer or bidder) and a target firm (seller or acquired). Suppose a bidder
is considering the potential purchase of a target firm and we must assess whether the target would be a good
investment. Some important questions arise in applying our fundamental concepts:
1. What are the potential sources of value from the combination? Does the acquirer have particular skills or capabilities
that can be used to enhance the value of the target firm? Does the target have critical technology or other strengths that
can bring value to the acquirer?
Potential sources of gain or cost savings achieved through the combination are called synergies. Baseline
cash-flow projections for the target firm may or may not include synergies or cost savings gained from
merging the operations of the target into those of the acquirer. If the base-case cash flows do not include any
of the economic benefits an acquirer might bring to a target, they are referred to as stand-alone cash flows.
Examining the value of a target on a stand-alone basis can be valuable for several reasons. First, it can
provide a view of what the target firm is capable of achieving on its own. This may help establish a floor with
respect to value for negotiating purposes. Second, construction of a stand-alone DCF valuation can be
compared with the target’s current market value. This can be useful in assessing whether the target is under-
or overvalued in the marketplace. Given the general efficiency of markets, however, it is unlikely that a target
will be significantly over- or undervalued relative to the market. Hence, a stand-alone DCF valuation allows
analysts to calibrate model assumptions to those of investors. By testing key assumptions relative to this
important benchmark, analysts can gain confidence that the model provides a reasonable guide to investors’
perception of the situation.
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5. Page 5 UV0112
2. What is the proper discount rate to use?
The discount rate used to value the cash flows of the target should compensate the investor/acquiring
firm for the risk of the cash flows. Commonly, the cost of capital of the target firm provides a suitable
discount rate for the stand-alone and merger cash flows. The cost of capital of the target firm is generally
more appropriate as a discount rate than the cost of capital of the acquiring firm because the target cost of
capital generally better captures the risk premium associated with bearing the risk of the target cash flows
than does the cost of capital of the acquiring firm. If the target and acquirer are in the same industry, they
likely have similar business risk. Because in principle the business risk is similar for the target and the acquirer,
either one’s WACC may be justifiably used. The use of the target’s cost of capital also assumes that the target
firm is financed with the optimal proportions of debt and equity and that these proportions will continue
after the merger.
Additional information on the appropriate discount rate can be obtained by computing the WACCs of
firms in the target’s industry. These estimates can be summarized by taking the average or median WACC. By
using the betas and financial structures of firms engaged in this line of business, a reliable estimate of the
business risk and optimal financing can be established going forward.
Sometimes an acquirer may intend to increase or decrease the debt level of the target significantly after
the merger—perhaps because it believes the target’s current financing mix is not optimal. The WACC still
must reflect the business risk of the target. A proxy for this can be obtained from the unlevered beta of the
target firm’s equity or an average unlevered beta for firms with similar business risk. The target’s premerger
unlevered beta must then be relevered to reflect the acquirer’s intended post–merger capital structure.
To unlever a firm beta, one uses the prevailing tax rate (T) and the pre–deal debt-to-equity ratio (D/E) of
the firm associated with the beta estimate (ßL) to solve Equation 5:
ßu = ßL / [1 + (1 – T) D/E]. (5)
Next, one uses the unlevered beta estimate (ßu) or average unlevered beta estimate (if using multiple firms
to estimate the unlevered beta) to relever the beta to the new intended debt-to-equity ratio (D/E*)
(Equation 6):
ß'L = ßu [1 + (1 – T) D/E*]. (6)
The result is a relevered beta estimate (ß'L) that captures the business risk and the financial risk of the
target cash flows.
The circumstances of each transaction will dictate which of these approaches is most reasonable. Of
course, if the target’s business risk somehow changes because of the merger, some adjustments must be made
to all of these approaches on a judgment basis. The key concept is to find the discount rate that best reflects
the business and financial risks of the target’s cash flows.
3. After determining the enterprise value, how is the value of the equity computed?
This is a straightforward calculation that relies upon the definition of enterprise value as the value of cash
flows available to all providers of capital. Because debt and equity are the sources of capital, it follows that
enterprise value (V) equals the sum of debt (D) and equity (E) values (Equation 7):
V = D + E. (7)
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6. Page 6 UV0112
Therefore, the value of equity is simply enterprise value less the value of existing debt (Equation 8):
E = V – D, (8)
where debt is the market value of all interest-bearing debt outstanding at the time of the acquisition. For
publicly traded targets, the value of the share price can be computed by simply dividing the equity value by
the number of shares of stock outstanding.
4. How does one incorporate the value of synergies in a DCF analysis?
Operating synergies are reflected in enterprise value by altering the stand-alone cash flows to incorporate
the benefits and costs of the combination. Free cash flows that include the value an acquirer and target can
achieve through combination are referred to as combined or merger cash flows.
If the acquirer plans to run the acquired company as a stand-alone entity, as in the case of Berkshire
Hathaway purchasing a company unrelated to its existing holdings (e.g., Dairy Queen), there may be little
difference between the stand-alone and merger cash flows. In many strategic acquisitions, however, such as
the Pfizer/Wyeth and InBev/Fujian Sedrin Brewery mergers, there can be sizable differences.
How the value of these synergies is split among the parties through the determination of the final bid
price or premium paid is a major issue for negotiation.7 If the bidder pays a premium equal to the value of the
synergies, all the benefits will accrue to target shareholders, and the merger will be a zero net-present-value
investment for the shareholders of the acquirer.
Example of the DCF Method
Suppose Company A has learned that Company B (a firm in a different industry but in a business that is
strategically attractive to Company A) has retained an investment bank to auction the company and all of its
assets. In considering how much to bid for Company B, Company A starts with the cash-flow forecast of the
stand-alone business drawn up by Company B’s investment bankers shown in Table 1. The discount rate
used to value the cash flows is Company B’s WACC of 10.9%. The inputs to WACC, with a market risk
premium of 6%, are shown in Table 2.
On a stand-alone basis, the analysis in Table 1 suggests that Company B’s enterprise value is $9.4 million.
7 The premium paid is usually measured as: (Per-Share Bid Price – Market Price for Target Shares Before Merger) ൊ Market Price for Target Shares
Before Merger.
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Table 1. Valuation of Company B as a stand-alone unit.
(Assume that Company A will allow Company B to run as a stand-alone unit with no synergies.)
Revenue growth 6.0% Steady state growth 5.9%
COGS 55% WACC 10.9%
SG&A 20% Tax rate 39%
Net working capital (NWC) 22% Year 6
Steady
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 State
Revenues ($ thousands)
COGS
Gross profit
SG&A
Depreciation
EBIT
Less taxes
NOPAT
9,750 10,000
5,500
4,500
2,000
1,000
1,500
(585)
915
10,600
5,830
4,770
2,120
1,000
1,650
(644)
1,007
11,236
6,180
5,056
2,247
1,000
1,809
(706)
1,103
11,910
6,551
5,360
2,382
1,000
1,978
(771)
1,207
12,625
6,944
5,681
2,525
1,000
2,156
(841)
1,315
13,370
1,393
Add: depreciation
Less: capital expenditures
Less: increase in NWC
= Free cash flow
Terminal value
Free Cash Flows + Terminal Value
1,000
(1,250)
(55)
610
610
1,000
(1,250)
(132)
625
625
1,000
(1,250)
(140)
713
713
1,000
(1,250)
(148)
809
809
1,000
(1,250)
(157)
908
11,305
12,213
(664)
(164)
565
Enterprise Value PV10.9% (FCF) = 9,396
NWC (22% Sales) 2,145 2,200 2,332 2,472 2,620 2,777 2,941
NPPE (+ CAPEX – Depr. each year) 10,000 10,250 10,500 10,750 11,000 11,250 11,914
Operating margin [NOPAT/Sales] 9.2% 9.5% 9.8% 10.1% 10.4% 10.4%
PPE turnover [Sales/NPPE] 0.98 1.01 1.05 1.08 1.12 1.12
RONA [NOPAT/(NWC+NPPE)] 7.3% 7.8% 8.3% 8.9% 9.4% 9.4%
Year 6 Steady-State Calculations:
Sales = Year 5 Sales × (1 + Steady-State Growth) = 12,625 × 1.059 = 13,370
NOPAT = Year 5 NOPAT × (1 + Steady-State Growth) = 1,315 × 1.059 = 1,393
NWC = Year 5 NWC × (1 + Steady-State Growth) = 2,777 × 1.059 = 2,941
NPPE = Year 5 NPPE × (1 + Steady-State Growth) = 11,250 × 1.059 = 11,914
Increase in NPPE = Capital Expenditures less Depreciation = 11,250 – 11,914 = –664
Year 5 Terminal Value = Steady-State FCF (WACC – Steady-State Growth) = 565 (0.109 – 0.059) =
11,305
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8. Bidder Target
Co. A Co. B
Bond rating A BBB
Yield to maturity of bonds—kd 7.2% 7.42%
Tax rate 39.0% 39.0%
After-tax cost of debt—kd (1 − t) 4.39% 4.53%
Beta 1.05 1.20
Cost of equity—ke 12.18% 13.08%
Debt as % of capital—Wd 20.0% 25.0%
Equity as % of capital—We 80.0% 75.0%
10-year treasury bond yield 5.88% 5.88%
Market risk premium 6.0% 6.0%
WACC 10.6% 10.9%
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Table 2. Inputs to WACC.
Now suppose Company A believes it can make Company B’s operations more efficient and improve its
marketing and distribution capabilities. In Table 3, we incorporate these effects into the cash-flow model,
thereby estimating a higher range of values that Company A can bid and still realize a positive net present
value (NPV) for its shareholders. In the merger cash-flow model of the two firms in Table 3, Company B
has added two percentage points of revenue growth, subtracted two percentage points from the
COGS8/Sales ratio, and subtracted one percentage point from the SG&A/Sales ratio relative to the stand-
alone model. We assume that all of the merger synergies will be realized immediately and therefore should fall
well within the five-year forecast period. The inputs to target and acquirer WACCs are summarized in
Table 3.
Because Company A and Company B are in different industries, it is not appropriate to use Company A’s
WACC of 10.6% in discounting the expected cash flows. Despite the fact that after the merger, Company B
will become part of Company A, we do not use Company A’s WACC because it does not reflect the risk
associated with the merger cash flows. In this case, one is better advised to focus on “where the money is
going, rather than where the money comes from” in determining the risk associated with the transaction. In
other words, the analyst should focus on the target’s risk and financing (not the buyer’s risk and financing) in
determining the appropriate discount rate. The discount rate should reflect the expected risk of the cash flows
being priced and not necessarily the source of the capital.
Notice that the value with synergies, $15.1 million, exceeds the value as a stand-alone entity by $5.7
million. In devising its bidding strategy, Company A would not want to offer the full $15.1 million and
concede all the value of the synergies to Company B. At this price, the NPV of the acquisition to Company A
is zero. The existence of synergies, however, allows Company A leeway to increase its bid above $9.4 million
and enhance its chances of winning the auction.
8 Cost of Goods Sold.
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Table 3. Valuation of Company B with synergies.
(Assume that Company B merges with Company A and realizes operational synergies.)
Revenue growth 8.0% Steady state growth 5.9%
COGS 53% WACC 10.9%
SG&A 19% Tax rate 39%
Net working capital (NWC) 22%
Year 6
Steady
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 State
Revenues ($ in thousands)
COGS
Gross profit
SG&A
Depreciation
EBIT
Less taxes
NOPAT
9,750 10,000
5,300
4,700
1,900
1,000
1,800
(702)
1,098
10,800
5,724
5,076
2,052
1,000
2,024
(789)
1,235
11,664
6,182
5,482
2,216
1,000
2,266
(884)
1,382
12,597
6,676
5,921
2,393
1,000
2,527
(986)
1,542
13,605
7,211
6,394
2,585
1,000
2,809
(1,096)
1,714
14,408
1,815
Add: depreciation
Less: capital expenditures
Less: increase in NWC
= Free cash flow
Terminal value
Free Cash Flows + Terminal Value
1,000
(1,250)
(55)
793
793
1,000
(1,250)
(176)
809
809
1,000
(1,250)
(190)
942
942
1,000
(1,250)
(205)
1,086
1,086
1,000
(1,250)
(222)
1,242
19,490
20,732
(664)
(177)
974
Enterprise Value PV10.9% (FCF) = 15,140
NWC (22% sales)
NPPE (+ CAPEX – Depr. each year)
2,145
10,000
2,200
10,250
2,376
10,500
2,566
10,750
2,771
11,000
2,993
11,250
3,170
11,914
Operating margin [NOPAT/Sales]
PPE turnover [Sales/NPPE]
RONA [NOPAT/(NWC+NPPE)]
11.0%
0.98
8.8%
11.4%
1.03
9.6%
11.9%
1.09
10.4%
12.2%
1.15
11.2%
12.6%
1.21
12.0%
12.6%
1.21
12.0%
Year 6 Steady-State Calculations:
Sales = Year 5 Sales × (1 + Steady-State Growth) = 13,605 × 1.059 = 14,408
NOPAT = Year 5 NOPAT × (1 + Steady-State Growth) = 1,714 × 1.059 = 1,815
NWC = Year 5 NWC × (1 + Steady-State Growth) = 2,993 × 1.059 = 3,170
NPPE = Year 5 NPPE × (1 + Steady-State Growth) = 11,250 × 1.059 = 11,914
Increase in NPPE = Capital Expenditures less Depreciation = 11,250 – 11,914 = –664
Year 5 Terminal Value = Steady-State FCF (WACC – Steady-State Growth) = 974 (0.109 – 0.059) =
19,490
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Considerations for Terminal Value Estimation
In the valuation of both the stand-alone and merger cash flows, the terminal value contributes the bulk of
the total cash-flow value (if the terminal value is eliminated, the enterprise value drops by about 75%). This
relationship between terminal value and enterprise value is typical of firm valuation because of the ongoing
nature of the life of a business. Because of the importance of the terminal value in firm valuation, the
assumptions that define the terminal value deserve particular attention.
In the stand-alone Company B valuation in Table 1, we estimated the terminal value using the constant-
growth valuation model. This formula assumes that the business has reached some level of steady-state
growth such that the free cash flows can be modeled to infinity with the simple assumption of a constant
growth rate. Because of this assumption, it is important that the firm’s forecast period be extended until such
a steady state is truly expected.9 The terminal-value growth rate used in the valuation is 5.9%. In this model,
the analyst assumes that the steady-state growth rate can be approximated by the long-term risk-free rate (i.e.,
the long-term Treasury bond yield). Using the risk-free rate to proxy for the steady-state growth rate is
equivalent to assuming that the expected long-term cash flows of the business grow with the overall economy
(i.e., nominal expected growth rate of GDP). Nominal economic growth contains a real growth component
plus an inflation rate component, which are also reflected in long-term government bond yields. For example,
the Treasury bond yield can be decomposed into a real rate of return (typically between 2% and 3%) and
expected long-term inflation. Because the Treasury yield for our example is 5.9%, the implied inflation is
between 3.9% and 2.9%. Over the long term, companies should experience the same real growth and
inflationary growth as the economy on average, which justifies using the risk-free rate as a reasonable proxy
for the expected long-term growth of the economy.
Another important assumption is estimating steady-state free cash flow that properly incorporates the
investment required to sustain the steady-state growth expectation. The steady-state free-cash-flow estimate
used in the merger valuation in Table 3 is $974,000. To obtain the steady-state cash flow, we start by
estimating sales in Equation 9:10
SalesSteady State = SalesYear 5 × (1 + g) = 13,605 × 1.059 = 14,408. (9)
Steady state demands that all the financial statement items grow with sales at the same steady-state rate of
5.9%. This assumption is reasonable because in steady state, the enterprise should be growing at a constant
rate. If the financial statements did not grow at the same rate, the implied financial ratios (e.g., operating
margins or RONA) would eventually deviate widely from reasonable industry norms.
The steady-state cash flow can be constructed by simply growing all relevant line items at the steady-state
growth rate as summarized in Tables 1 and 3. To estimate free cash flow, we need to estimate the steady-
state values for NOPAT, NWC, and net property, plant, and equipment. By simply multiplying the Year 5
value for each line item by the steady-state growth factor of 1.059, we obtain the steady-state Year 6 values.11
Therefore, to estimate the steady-state change in NWC, we use the difference in the values for the last two
years (Equation 10):
9 The steady state may only be accurate in terms of expectations. The model recognizes that the expected terminal value has risk. Businesses may
never actually achieve steady state due to technology innovations, business cycles, and changing corporate strategy. The understanding that the firm
may not actually achieve a steady state does not preclude the analyst from anticipating a steady-state point as the best guess of the state of the business
at some point in the future.
10 Note that Tables 1 and 3 summarize the steady-state calculations.
11 Alternatively, we can compute NOPAT using Year 5’s NOPAT/Sales ratio of 12.6% or NWC using the same 22% of sales relation used
throughout the analysis. As long as the ratios are constant and linked to the steady-state sales value, the figures will capture the same steady-state
assumptions.
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∆NWCSteady State = NWCYear 5 − NWCSteady State = 2,993 − 3,170 = −177. (10)
This leaves depreciation and capital expenditure as the last two components of cash flow. These can be
more easily handled together by looking at the relation between sales and net property, plant, and equipment,
where NPPE is the accumulation of capital expenditures less depreciation. Table 3 shows that in the steady-
state year, NPPE has increased to 11,914. The difference of NPPE gives us the net of capital expenditures
and depreciation for the steady state (Equation 11):
∆NPPESteady State = NPPE1995 − NPPESteady State = 11,250 − 11,914 = −664. (11)
Summing the components gives us the steady-state free cash flow (Equation 12):
FCFSteady State = NOPATSteady State + ∆NPPESteady State + ∆NWCSteady State (12)
= 1,815 −664 −176
= 974.12
Therefore, by maintaining steady-state growth across the firm, we have estimated the numerator of the
terminal value formula that gives us the value of all future cash flows beyond Year 5 (Equation 13):
Terminal ValueYear 5 = FCFSteady State ൊ (WACC − g) = 974 ൊ (0.109 − 0.059) = 19,490. (13)
The expression used to estimate steady-state free cash flow can be used for alternative assumptions
regarding expected growth. For example, one might also assume that the firm does not continue to build new
capacity but that merger cash flows grow only with expected inflation (e.g., 3.9%). In this scenario, the
calculations are similar but the growth rate is replaced with the expected inflation. Even if capacity is not
expanded, investment must keep up with growth in profits to maintain a constant expected rate of operating
returns.
Finally, it is important to acknowledge that the terminal value estimate embeds assumptions about the
long-term profitability of the target firm. In the example in Table 3, the implied steady-state RONA can be
calculated by dividing the steady-state NOPAT by the steady-state net assets (NWC + NPPE). In this case,
the return on net assets is equal to 12.0% [1,815 ൊ (3,170 + 11,914)]. Because in steady state the profits and
the assets will grow at the same rate, this ratio is estimated to remain in perpetuity. The discount rate of
10.9% maintains a benchmark for the steady-state RONA. Because of the threat of competitive pressure, it is
difficult to justify in most cases a firm valuation wherein the steady-state RONA is substantially higher than
the WACC. Alternatively, if the steady-state RONA is lower than the WACC, one should question the
justification for maintaining the business in steady state if the assets are not earning the cost of capital.
Market Multiples as Alternative Estimators of Terminal Value
Given the importance attached to terminal value, analysts are wise to use several approaches when
estimating it. A common approach is to estimate terminal value using market multiples derived from
information based on publicly traded companies similar to the target company (in our example, Company B).
The logic behind a market multiple is to see how the market is currently valuing an entity based on certain
benchmarks related to value rather than attempting to determine an entity’s inherent value. The benchmark
used as the basis of valuation should be something that is commonly valued by the market and highly
12 Note that we can demonstrate that the cash-flow estimation process is consistent with the steady-state growth. If we were to do these same
calculations using the same growth rate for one more year, the resulting FCF would be 5.9% higher (i.e., 974 × 1.059 = 1,031).
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correlated with market value. For example, in the real estate market, dwellings are frequently priced based on
the prevailing price per square foot of comparable properties. The assumption made is that the size of the
house is correlated with its market value. If comparable houses are selling at $100 per square foot, the market
value for a 2,000-square-foot house is estimated to be $200,000. For firm valuation, current or expected
profits are frequently used as the basis for relative market multiple approaches.
Suppose, as shown in Table 4, that there are three publicly traded businesses that are in the same
industry as Company B: Company C, Company D, and Company E. The respective financial and market data
that apply to these companies are shown in Table 4. The enterprise value for each comparable firm is
estimated as the current share price multiplied by the number of shares outstanding (equity value) plus the
book value of debt. Taking a ratio of the enterprise value divided by the operating profit (EBIT), we obtain
an EBIT multiple. In the case of Company C, the EBIT multiple is 5.3 times, meaning that for every $1 in
current operating profit generated by Company C, investors are willing to pay $5.3 of firm value. If Company
C is similar today to the expected steady state of Company B in Year 5, the 5.3-times-EBIT multiple could be
used to estimate the expected value of Company B at the end of Year 5, the terminal value.13
Table 4. Comparable companies to target company.
Company C Company D Company E
Industry Industry Z Industry Z Industry Z
Stage of growth Mature Mature High Growth
EBIT ($ in thousands) $3,150 $2,400 $750
Net earnings 1,500 1,500 150
Equity value 14,000 11,400 3,000
Debt value 2,800 3,000 3,500
Enterprise value $16,800 $14,400 $6,500
Enterprise Value/EBIT 5.3 6.0 8.7
Equity Value/Net Earnings 9.3 7.6 20.0
To reduce the effect of outliers on the EBIT multiple estimate, we can use the information provided
from a sample of comparable multiples. In sampling additional comparables, we are best served by selecting
multiples from only those firms that are comparable to the business of interest on the basis of business risk,
economic outlook, profitability, and growth expectations. We note that Company E’s EBIT multiple of 8.7
times is substantially higher than the others in Table 4. Why should investors be willing to pay so much more
for a dollar of Company E’s operating profit than for a dollar of Company C’s operating profit? We know
that Company E is in a higher growth stage than Company C and Company D. If Company E profits are
expected to grow at a higher rate, the valuation or capitalization of these profits will occur at a higher level or
multiple. Investors anticipate higher future profits for Company E and consequently bid up the value of the
respective capital.14
Because of Company E’s abnormally strong expected growth, we decide that Company E is not a good
proxy for the way we expect Company B to be in Year 5. We choose, consequently, to not use the 8.7-times-
13 We assume in this example that current multiples are the best proxies for future multiples. If there is some reason to believe that the current
multiple is a poor or biased estimate of the future, the market multiples must be adjusted accordingly. For example, if the current profits are
extraordinarily small or large, a multiple based on such a distorted value will produce an artificial estimate of the expected future value. A more
appropriate multiple will use a nondistorted or “normalized” profit measure.
14 See Appendix for an example of the relationship between market multiples and the constant-cash-flow growth model.
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EBIT multiple in estimating our terminal value estimate. We conclude instead that investors are more likely to
value Company B’s operating profits at approximately 5.7 times (the average of 5.3 and 6.0 times). The logic
is that if investors are willing to pay 5.7 times EBIT today for operating profit of firms similar to what we
expect Company B to be in Year 5, this valuation multiple will be appropriate in the future. To estimate
Company B’s terminal value based on our average EBIT multiple, we multiply the Year 5 stand-alone EBIT
of $2.156 million by the average comparable multiple of 5.7 times. This process provides a multiple-based
estimate of Company B’s terminal value of $12.2 million. This estimate is somewhat above the constant-
growth-based terminal value estimate of $11.3 million.
Although the importance of terminal value motivates the use of several estimation methods, sometimes
these methods yield widely varying values. The variation in estimated values should prompt questions on the
appropriateness of the underlying assumptions of each approach. For example, the differences in terminal
value estimates could be due to:
A forecast period that is too short to have resulted in steady-state performance.
The use of comparable multiples that fail to match the expected risk, expected growth, or
macroeconomic conditions of the target company in the terminal year.
An assumed constant growth rate that is lower or higher than that expected by the market.
The potential discrepancies motivate further investigation of the assumptions and information contained in
the various approaches so that the analyst can “triangulate” to the most appropriate terminal-value estimate.
In identifying an appropriate valuation multiple, one must be careful to choose a multiple that is
consistent with the underlying earnings stream of the entity one is valuing. For example, one commonly used
multiple based on net earnings is called the price–earnings, or P/E, multiple. This multiple compares the
value of the equity to the value of net income. In a valuation model based on free cash flow, it is typically
inappropriate to use multiples based on net income because these value only the equity portion of the firm
and assume a certain capital structure.15 Other commonly used multiples that are appropriate for free-cash-
flow valuation include EBITDA (earnings before interest, tax, depreciation, and amortization), free cash flow,
and total capital multiples.
Although the market-multiple valuation approach provides a convenient, market-based approach for
valuing businesses, there are a number of cautions worth noting:
1. Multiples can be deceptively simple. Multiples should provide an alternative way to triangulate toward an
appropriate long-term growth rate and not a way to avoid thinking about the long-term economics of
a business.
2. Market multiples are subject to distortions due to market misvaluations and accounting policy. Accounting
numbers further down in the income statement (such as net earnings) are typically subject to greater
distortion than items high on the income statement. Because market valuations tend to be affected by
business cycles less than annual profit figures, multiples can exhibit some business-cycle effects.
Moreover, business profits are negative; the multiples constructed from negative earnings are not
meaningful.
3. Identifying closely comparable firms is challenging. Firms within the same industry may differ greatly in
business risk, cost and revenue structure, and growth prospects.
15 Only in the relatively rare case of a company not using debt would the P/E ratio be an appropriate multiple.
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4. Multiples can be computed using different timing conventions. Consider a firm with a December 31 fiscal year
(FY) end that is being valued in January 2005. A trailing EBIT multiple for the firm would reflect the
January 2005 firm value divided by the 2004 FY EBIT. In contrast, a current-year EBIT multiple
(leading or forward EBIT multiple) is computed as the January 2005 firm value divided by the 2005
EBIT (expected end-of-year 2006 EBIT).16 Because leading multiples are based on expected values,
they tend to be less volatile than trailing multiples. Moreover, leading and trailing multiples will be
systematically different for growing businesses.
Transaction multiples for comparable deals
In an M&A setting, analysts look to comparable transactions as an additional benchmark against which to
assess the target firm. The chief difference between transaction multiples and peer multiples is that the former
reflects a “control premium,” typically 30% to 50%, that is not present in the ordinary trading multiples. If
one is examining the price paid for the target equity, transactions multiples might include the Per-Share Offer
Price Target Book Value of Equity per Share, or Per-Share Offer Price Target Earnings per Share. If one
is examining the total consideration paid in recent deals, one can use Enterprise Value EBIT. The more
similarly situated the target and the more recent the deal, the better the comparison will be. Ideally, there
would be several similar deals in the past year or two from which to calculate median and average transaction
multiples. If there are, one can glean valuable information about how the market has valued assets of this
type.
Analysts also look at premiums for comparable transactions by comparing the offer price to the target’s
price before the merger announcement at selected dates, such as 1 day or 30 days before the announcement.
A negotiator might point to premiums in previous deals for similarly situated sellers and demand that
shareholders receive “what the market is paying.” One must look closely, however, at the details of each
transaction before agreeing with this premise. How much the target share price moves upon the
announcement of a takeover depends on what the market had anticipated before the announcement. If the
share price of the target had been driven up in the days or weeks before the announcement on rumors that a
deal was forthcoming, the control premium may appear low. To adjust for the “anticipation,” one must
examine the premium at some point before the market learns of (or begins to anticipate the announcement
of) the deal. It could also be that the buyer and seller in previous deals are not in similar situations compared
with the current deal. For example, some of the acquirers may have been financial buyers (leveraged buyout
[LBO] or private equity firms) while others in the sample were strategic buyers (companies expanding in the
same industry as the target.) Depending on the synergies involved, the premiums need not be the same for
strategic and financial buyers.
Other Valuation Methods
Although we have focused on the DCF method, other methods provide useful complementary
information in assessing the value of a target. Here, we briefly review some of the most popularly used
techniques.
16 Profit figures used in multiples can also be computed by cumulating profits from the expected or most recent quarters.
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Book value
Book-value valuation may be appropriate for firms with commodity-type assets valued at market, stable
operations, and no intangible assets. Caveats are the following:
This method depends on accounting practices that vary across firms.
It ignores intangible assets such as brand names, patents, technical know-how, and managerial
competence.
It ignores price appreciation due, for instance, to inflation.
It invites disputes about types of liabilities. For instance, are deferred taxes equity or debt?
Book-value method is backward-looking. It ignores the positive or negative operating prospects of the
firm and is often a poor proxy for market value.
Liquidation value
Liquidation value considers the sale of assets at a point in time. This may be appropriate for firms in
financial distress or, more generally, for firms whose operating prospects are highly uncertain. Liquidation
value generally provides a conservative lower bound to the business valuation. Liquidation value will depend
on the recovery value of the assets (e.g., collections from receivables) and the extent of viable alternative uses
for the assets. Caveats are the following:
It is difficult to get a consensus valuation. Liquidation values tend to be highly appraiser-specific.
It relies on key judgment: How finely one might break up the company? Group? Division? Product
line? Region? Plant? Machines?
Physical condition, not age, will affect values. There can be no substitute for an on-site assessment of
a company’s real assets.
It may ignore valuable intangible assets.
Replacement-cost value
In the 1970s and early 1980s, an era of high inflation in the United States, the U.S. Securities and
Exchange Commission required public corporations to estimate replacement values in their 10-K reports.
This is no longer the case, making this method less useful to U.S. firms, but it is still useful to international
firms, for which the requirement continues. Caveats are the following:
Comparisons of replacement costs and stock market values ignore the possible reasons for the
disparity: overcapacity, high interest rates, oil shocks, inflation, and so on.
Replacement-cost estimates are not highly reliable, often drawn by simplistic rules of thumb.
Estimators themselves (operating managers) frequently dismiss the estimates.
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Market value of traded securities
Most often, this method is used to value the equity of the firm (E) as Stock Price Outstanding Shares.
It can also be used to value the enterprise (V) by adding the market value of debt (D) as the Price per Bond
Number of Bonds Outstanding.17 This method is helpful if the stock is actively traded, followed by
professional securities analysts, and if the market efficiently impounds all public information about the
company and its industry. It is worth noting the following:
Rarely do merger negotiations settle at a price below the market price of the target. On average,
mergers and tender offers command a 30% to 50% premium over the price one day before the
merger announcement. Premiums have been as high as 100% in some instances. Often the price
increase is attributed to a “control premium.” The premium will depend on the rarity of the assets
sought after and also on the extent to which there are close substitutes for the technology, expertise,
or capability in question; the distribution of financial resources between the bidder and target; the
egos of the CEOs involved (the hubris hypothesis); or the possibility that the ex ante target price was
unduly inflated by market rumors.
This method is less helpful for less well-known companies that have thinly or intermittently traded
stock. It is not available for privately held companies.
The method ignores private information known only to insiders or acquirers who may see a special
economic opportunity in the target company. Remember, the market can efficiently impound only
public information.
Summary Comments
The DCF method of valuation is superior for company valuation in an M&A setting because it:
Is not tied to historical accounting values. It is forward-looking.
Focuses on cash flow, not profits. It reflects noncash charges and investment inflows and outflows.
Separates the investment and financing effects into discrete variables.
Recognizes the time value of money.
Allows private information or special insights to be incorporated explicitly.
Allows expected operating strategy to be incorporated explicitly.
Embodies the operating costs and benefits of intangible assets.
Virtually every number used in valuation is measured with error, either because of flawed methods to
describe the past or because of uncertainty about the future. Therefore:
No valuation is “right” in any absolute sense.
It is appropriate to use several scenarios about the future and even several valuation methods to limit
the target’s value.
17 Since the market price of a bond is frequently close to its book value, the book value of debt is often used as a reasonable proxy for its market
value. Conversely, it is rare that book value per share of equity is close enough to its market price to serve as a good estimate.
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Adapt to diversity: It may be easier and more accurate to value the divisions or product lines of a target,
rather than to value the company as a whole. Recognize that different valuation methods may be appropriate
for different components.
Avoid analysis paralysis: Limit the value quickly. Then if the target still looks attractive, try some
sensitivity analysis.
Beyond the initial buy/no buy decision, the purpose of most valuation analysis is to support negotiators.
Knowing value boundaries and conducting sensitivity analysis enhances one’s flexibility to respond to new
ideas that may appear at the negotiating table.
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Appendix
Methods of Valuation for Mergers and Acquisitions
Description of Relationship between Multiples of Operating Profit and Constant Growth Model
One can show that cash-flow multiples such as EBIT and EBITDA are economically related to the
constant growth model. For example, the constant growth model can be expressed as follows:
FCF
V
WACC g .
Rearranging this expression gives a free-cash-flow multiple expressed in a constant growth model:
V 1
FCF WACC g .
This expression suggests that cash-flow multiples are increasing in the growth rate and decreasing in the
WACC. In the following table, one can vary the WACC and growth rate to produce the implied multiple.
WACC
8% 10% 12%
Growth
0% 12.5 10.0 8.3
2% 16.7 12.5 10.0
4% 25.0 16.7 12.5
6% 50.0 25.0 16.7
This document is authorized for use only in Magarian, Sandra's Valuaci?n y t?picos avanzados en finanzas - UBS at Universidad Argentina De La Empresa (UADE) from Mar 2020 to Sep
2020.