1. BUSINE VAL
SS UATION
AP ROACH S AND M T ODS
P E EH

2. Overview of Valuation Approaches ,Methods & Procedures
The Valuation methodology is organized into a hierarchy of three
basic levels
• Approaches
• Methods
• Procedures
Valuation Approach -General course of action in which an indication
of value is to be developed
Valuation Method - a way an Approach can be implemented.
Valuation Procedures- specific calculations, data used and other
details involved in a method

3. VALUATION APPROACHES
• Income Approach – valuing the business based on
some form of economic income stream
• Market Approach or Relative approach– valuation by
reference to other transactions
• Asset-Based Approach – valuation on the basis of
assets and liabilities

4. VALUATION METHODS
Income Approach
– Discounting method
– Capitalizing method
Market Approach
– Guideline public company method (GPM)
– Guideline merged and acquired company method (GMAM)
Asset-Based Approach
– Adjusted net asset value method
– Excess earnings method

5. DCF method
DCF value = PV of CF + PV of the terminal period CF
generally two phase DCF model is adopted
discount rate is the cost of capital for the type of
investment and not the investor
capitalisation rate = discount rate - growth rate
The growth rate during the terminal period cannot exceed
the the growth rate of the economy

6. DCF method
• NPV (Net Present value under free cash flow approach is called
‘firm value ‘ or ‘enterprise value’)
• NPV (Net Present value under Equity cash flow approach called
‘equity value’)
• Gordon Model or DDGM
• Adjusted present value (APV)
• Real option

7. DCF method
The enterprise value of the company is calculated as under:
Free cash flow discounted at WACC (weighted Average Cost Of
capital) plus value of excess cash and marketable securities, cross
holding and other non operating assets (like pension fund assets,
joint venture investments etc)
Step I Determine phase I (an initial time period over which you
expect the company to maintain a competitive advantage and it is
generally 5 years and the range may be 3 to 10 years)
Step II Estimate the free cash flows (FCF): amount of cash generated
by the business before allowing for financing
Step III: Estimate the Horizontal value (HV) or Terminal value - what
will be the worth of the business at the end of that initial period
(called horizontal value or PV of phase II CF)

8. DCF method
How to Calculate Horizontal value?
It could be :
• HV = earning of the last year of the forecast period x suitable
multiple
HV = Constant perpetuity or growing perpetuity
Step IV Determine a suitable WACC (discount rate) for the
investment
Step V Discount the FCF using the WACC
Step VI Add the value of excess cash and marketable securities,
cross holding and other non operating assets.
Step VII In order to calculate the value of the equity of the company,
deduct the current amount of debt from the enterprise value
Step VI value is called the value of status quo (that is value
under existing management

9. VCP is the value of control premium that is the difference
between the value of an optimally managed firm and the
value resulting from Status Quo Valuation:
Control Premium (CP) = Value of an optimally managed firm –
VSQ

10. VSP is the positive added-value from combining two firms and
includes diversification premium. Theoretically, synergy
premium (SP) is synergy Premium (SP) = Value of the
combined firms -Value of the target firm -Value of the
Acquiring Firm

11. DCF METHOD“TEN CIRCLES OF HELL by DAMODARAN
Current year numbers: “It’s amazing how wedded we are to that one-
year, baseline number.”
Cash flows. “You can’t stop forecasting cash flows until you’re willing
to make an extraordinary assumption: that your cash flows are going to
grow at a constant rate into perpetuity,” “It’s the tail that wags every
valuation dog.”
Taxes:“We double count some, add some, ignore some.”
Growth. “We want all our businesses to grow, but ask the wrong
people—the owners and managers—and you’ll get ‘30% growth rate for
as far as the eye can see.” Don’t ever let the growth rate exceed the
risk-free rate,

12. DCF METHOD“TEN CIRCLES OF HELL by DAMODARAN
,
Discount rate. “I think we spend far too much time talking about cost of equity,
cost of capital, cost of debt—and not enough on cash flows.” Analysts
“outsource” so many of the elements of the calculation (to Ibbotson’s data,
Bloomberg data, Duff & Phelps, etc.), “that it’s frightening.”
Growth rate revisited. To grow a business, owners have to put money back
into the business, and that’s a cost of growth analysts may overlook. Instead,
the focus should be on the quality of the business’ growth.
Debt ratio revisited. “We spend a lot of time trying to get the discount rate
right,” “But given your own assumptions about the company, you should expect
the discount rate to change [over time].” Instead, “the discussion should be
about the discount rates.”

13. DCF METHOD“TEN CIRCLES OF HELL by DAMODARAN
Garnishing valuations : “The practice of garnishing defeats the entire point of the
,
valuation,” “It puts you back to…trying to get the number that you want and puts all of
our biases into play.”
Per-share value. An issue primarily for public company valuations, which questions the
“easy” practice of determining per-share value by dividing the company’s market value
by the number of shares—but often overlooks stock options, liquid/illiquid shares, etc.
I-bankers inferno. The “darkest, deepest” layer of hell is reserved for those investment
bankers who have forgotten the “purpose of a valuation,” and in pricing an M&A deal,
will often pick the wrong company (the target company instead of the acquirer) and the
wrong discount rate (cost of debt instead of cost of equity) to arrive at the number (fees)
they want

14. Determinants of the value of a business
• History of stable growth and profits
• Product Cycle point
• Size Market share
• Industry
• Customer base -diversification
• Growth potential-topline and bottom line trends
• Competitive positioning
• Product mix
• Uniqueness
• The value of similar companies
• Strategy for continued growth and profitability
• Timing

15. Steps for business Valuation
Step I: Pre-engagement Procedures
Step II: Data Gathering
Step III: Valuation Analysis
Step IV: Selection of Valuation Methods
Step V: Determining Final Value
Step VI: Report Preparation
Step VII: Wrap-up Procedures

16. Concept of cash flow
Free cash flows (FCF)
• equal to its after tax cash flows from operations less incremental
investments made in the firm’s operating assets
• Cash flow to the firm as if there is no debt in the firm
Equity cash flow
• Cash flow to the equity shareholders
The major differences in computation of cash flows are due to
computation of taxes and treatment of debt.

17. Concept of cash flow
The other difference may arise due to extra ordinary items or
non operating items that affect ‘ PAT’ but not the
operating Income.

18. Top down approach
FCF FCFE
Cash flow EBIT EBIT
Definition Less: Tax on EBIT Less :Interest
EBIT(1-T)=NOPAT Less: Tax on EBT
Add: Depreciation Add: Depreciation
Add/less: changes in net Add/less: changes in net
operating working capital operating working capital
Less: Repayment of principal
Less: CAPEX amount of debt)
ADD: proceeds of debt issue
Less: CAPEX
IRR Project IRR Equity IRR
Appropriate WACC Cost of equity
discount
rate
PV of cash Project NPV Equity NPV
flow

19. RELATIVE VALUATION (MULTIPLES) APPROACH
• Relative valuation is more about market perception
and mood
• Under lying concept of the relative valuation is the
law of one price-similar asset should command
similar price
• A multiple is the ratio of market price variable to a
particular value driver of the firm
• This approach is relevant as it uses observable factual
evidence of “COMPS”

20. RELATIVE VALUATION (MULTIPLES) APPROACH
Key Issues:
Multiples
• are easy to use but also easy to misuse
• have very short shelf life (as compared to fundamentals)
• use requires less time & efforts
• Easier to justify and sell
• closer to the market – more value if comparable firm is
getting more value in rising market
• RGC (Risk, Growth, Cash flow) may be ignored.
• Accrual flow multiple dominates cash flow multiples

21. Types of Multiples
• Equity based multiples
• Entity or MVIC (Market Value of Invested Capital) multiples
MVIC = no. of shares x MPS
• Equity based multiples either give value of equity on market
basis or book basis
• MVIC based multiples either give value of firm on market
basis or book basis
• Must make adjustment for non-operating assets under
MVIC method

22. HOW TO USE MULTIPLES IN VALUATION
Step I: selection of value relevant measure and value
drivers
Step II: Identification of “COMPS”
Step III: Select and calculate appropriate multiple –aggregation
of multiple into single number through analysis of “COMPS” multiple
Step IV: Apply to the company
Step V: Make final adjustments for non-operating assets,
Contingent liabilities and convertibles.

23. Selection of value relevant measure
• Equity multiple or entity multiple ?
• Which value driver/ multiple to use?
• Trailing multiple or forward looking multiple?
• More number of multiples vs. less multiples- purpose
relevant multiple vs. sanity check multiples

24. Selection of value relevant measure
• Matching principle – numerator and denominator
should have consistent definition
• Capital structure – equity multiple is greatly
affected by the capital structure than entity multiple
• Difference in earning guidance and investment and
payout policy
• Stage of business life cycle
• Empirical research supports forward looking
multiples processing two years analysts forecast

25. Criteria for identification of comparable firm
• Use industry classification system or at least list
firm’s competitors
SIC: Standard Industrial classification
GICS: Global industry classification benchmark)
Go up to 3 or 4 digits classification (more
homogeneous) rather than 1 or 2 digits (broad
industry group)
Size and region
Number of comparables- 4 to 8 ideal size( plus or
minus 2

26. Criteria for selection of multiple
Select comparable companies or transactions – how?
•Management Style
•Size
•Product & Customer diversification
•Technology
•Key Financial trends
•Strategic & operational strategies
•Market positioning & maturity of operation
•Geographical consideration
•Trading volume of selected companies
•Price volatility (σ)
•Distribution of multiples – across the sector & market

27. Equity Multiples
• P/E (Price Earning Ratio)
• P/B (Price to Book Ratio)
• Equity / Sales
• Equity / Cash flow
• Equity / PAT
• Equity / Book value of share

28. MVIC ( Market value of invested capital)
• MVIC / Sales
• MVIC / EBITDA
• MVIC / EBIT
• MVIC / Book value of invested capital
• MVIC/TA

29. Equity multiple
Price Earning Ratio – most commonly used multiples
• Make sure definition is consistent & uniform
PER = MPS / EPS
• Variant of PER
Current PER = Current MPS / Current EPS
Some analyst may use average price over last 6m or a year
• Trailing PER = Current MPS / EPS based on last 4 quarters.
[or, LTM: Last twelve months]
• Forward PER = Current MPS / expected EPS during next F/Y
• EPS may further be based on fully diluted basis or primary basis
• EPS may include or exclude extraordinary items

30. Equity multiple - PER
• For Growth Company forward PER will consistently give low value
than trailing PER
• Bullish valuer use forward PER to conclude that stock is
undervalued.
• Bearish valuer will consider Current PER to justify that Stock is
overvalued.
• Full Impact of dilution may not occur during next year leading to
lower EPS.
• While using industry PER be careful about outliers
• MLF (money loosing firm) creates a bias in selection
• Equity value is calculated based on existing outstanding shares but
EPS is on fully diluted basis.

31. Equity multiple – PEG (Price Earning growth)
PEG = PER / expected growth in EPS
• One mistake analyst will make to consider growth in operating
income rather than EPS
• Growth should be consistent with PER calculation
• Never use forward PER for peg as it amounts to double counting of
growth
• Lower the PEG better the stock
• If PER is high without growth prospect, PEG will be high – risky firm
• PEG does not consider risk taken in growth and sustainability of
growth.

32. Equity multiple
P/B ratio = market value of equity / book value of equity
• Book value is computed from the Financial Statement
• Price of book ratio near to 4 is highly priced stock [mean P/B ratio
of all listed firm in USA during 2006 was 2.4]
Price to Sales ratio
(Revenue multiple) = market value of equity
Revenue
• The larger the revenue multiple better it is.
• Generally there is no sectoral Revenue multiple.

33. MVIC multiple vs Equity multiple
• MVIC multiple look at market value of operating assets of the firm
(and not only for equity invested).
• MVIC multiple is not affected by Finance leverage.
• If firms under comparison are differing in their financial leverage,
put more reliance on MVIC multiple.

34. ASSET BASED APPROACH
determining a value indication of a
business, business ownership interest, or
security using one or more methods based
on the value of the assets net of liabilities
Method 1: Adjusted Net Value Method
Method2: Excess Earnings Method

35. ASSET BASED APPROACH
Adjusted Net Value Method
• Identify all assets & liabilities (recorded and unrecorded
tangible and intangible assets, liabilities & contingents)
• Determine which assets and liabilities on the balance sheet
require valuation
• Value the items identified
• Construct a value-based balance sheet using the adjusted
values
• Value of assets = adjusted value of assets - outside liabilities

36. ASSET BASED APPROACH
Excess Earnings Method Steps:
• Estimate a normalized level of operating earnings, the
operating tangible asset value, and a reasonable rate of
return to support the tangible assets
• Multiply the reasonable rate of return by the value of tangible
assets to arrive at the reasonable money return on tangible
assets
• Determine excess earnings by subtracting the return on
tangible assets from normalized earnings- if it is negative then
there is no intangible value

37. ASSET BASED APPROACH
Excess Earnings Method Steps (continued):
• Determine the capitalization rate appropriate for the
excess earnings
• Determine the value of intangible assets by dividing
the capitalization rate into the excess earnings
• Add the value of tangible assets to the value of
intangible assets

38. ASSET BASED APPROACH
Apply this approach generally where
• Company is going in liquidation
• Asset intensive companies -Significant value of assets for going
concern
• For control valuation
• Real estate companies
• Investment companies
• Finance companies
• Startup stage company
• Distressed companies