Business Valuation

       Session 3




     Abhimanyu
      August 30, 2009
Value and Price
           • Value of a particular business or asset may be different for
             different parties d...
Valuation Methods
           • Asset Approach
                 – Book Value, Adjusted Book Value, and Liquidation Value
  ...
Asset Approach
           • May be important in capital intensive industries
             or in acquisitions where valuabl...
Asset Approach: Premises of Value
           • Sale as a going concern:
                 – Value-in-use
                  ...
Income Approach
           • It is more often used than market/asset
             approaches.
           • It is a preferr...
Income Approach: Methods

           • Single-period Capitalization Method:
                 – Valuation is based on the n...
DCF Method: Certain Issues
           • Forecast Variables
           • Forecast Horizon:
                 – Period should...
Cost of Capital
           • Cost of Debt:
                 – Direct Approach.
                 – Weighted Average Method....
Cost of Equity
           • CAPM:
                 –         Re=Rf +β(ERP)
           • Modified CAPM (used for closely he...
Risk Free Rate
                                  10 Year Govt. of India Bond Yield
            10.00



             9.00
...
Beta


          Company     Index     99-00    00-01      01-02      02-03    03-04   5-yearly
          WIPRO       NIFT...
ERP
          Long-term Risk Premium                                        SENSEX       BSE 100
                       Ye...
Specific Company Risk Premium
           • Should reflect the analysis of the competitive
             conditions in which...
Control Premium and Illiquidity Discount
           • Such premium or discount should be applied in
             adjusting...
Valuation: Concluding Remarks

           • Valuation exercise involves more
             judgments than precise facts.
  ...
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Crest Sep12 Sesssion 3

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Crest Sep12 Sesssion 3

  1. 1. Business Valuation Session 3 Abhimanyu August 30, 2009
  2. 2. Value and Price • Value of a particular business or asset may be different for different parties depending upon strategic intent, synergies or for other reasons. • Value must be clearly distinguished from price and businesses may justifiably undertake to consummate a transaction at a price which does not fall within an assessed fair value range. • Given the valuations or valuation range / band suggested by valuers, the prerogative to decide upon a specific price is finally with the management and the Board of Directors of the Company. • The valuation is only a tool to aid management in decision- making. • The valuation is also time dependent. September 12, 2009 Corporate Restructuring | Session 1 2
  3. 3. Valuation Methods • Asset Approach – Book Value, Adjusted Book Value, and Liquidation Value • Income Approach – Capitalization of Earnings, Capitalization of Excess Earnings, and Discounted Future Earnings/Cash Flows, Discounted Future EVAs. • Market Approach – Current Market Prices, Historical Market Prices, Price to Earnings, Price to Revenue, Price to Book Value, Price to Enterprise Value • Comparable Transactions/Relative Valuations – Comparable International and Domestic Transactions. • Sum-of-parts Method • Real Options Value September 12, 2009 Corporate Restructuring | Session 1 3
  4. 4. Asset Approach • May be important in capital intensive industries or in acquisitions where valuable non-operating assets can be stripped after the purchase of the company to recover part of acquisition cost. • Where there are no (or very little) intangibles. • This approach is inappropriate in case of acquisition/sale of minority interests. September 12, 2009 Corporate Restructuring | Session 1 4
  5. 5. Asset Approach: Premises of Value • Sale as a going concern: – Value-in-use • Fair market value of assets and liabilities • Sale on a liquidation premise: – Liquidation value (value-in-exchange) • Orderly liquidation. • Forced liquidation • Treatment of non-recurring/ non-operating assets and liabilities in case of valuation of controlling/ minority interest. September 12, 2009 Corporate Restructuring | Session 1 5
  6. 6. Income Approach • It is more often used than market/asset approaches. • It is a preferred approach for closely held (and also widely held) knowledge based companies. • It is also used in case of service industries. • Of course, it suffers from accounting distortions. Hence caution is advised. September 12, 2009 Corporate Restructuring | Session 1 6
  7. 7. Income Approach: Methods • Single-period Capitalization Method: – Valuation is based on the net income of one year only and hence it can produce reliable value only if the income chosen is representative of the company’s anticipated long-term future performance. • Multi-period Discounting Method: – Discussed under DCF method. September 12, 2009 Corporate Restructuring | Session 1 7
  8. 8. DCF Method: Certain Issues • Forecast Variables • Forecast Horizon: – Period should be long enough to portray all anticipated variations in the entity’s cash flows and until a stabilized cash flow is achieved. • Continuing Value • Cost of Capital – Debt cost – Equity cost – Weighted Average Cost of Capital (WACC) September 12, 2009 Corporate Restructuring | Session 1 8
  9. 9. Cost of Capital • Cost of Debt: – Direct Approach. – Weighted Average Method. • Cost of Equity: CAPM – What is the risk-free rate? • Logic of using a long-term rate. – What is your equity beta? – How much is the equity risk premium (ERP)? September 12, 2009 Corporate Restructuring | Session 1 9
  10. 10. Cost of Equity • CAPM: – Re=Rf +β(ERP) • Modified CAPM (used for closely held targets) – Re=Rf +β(ERP)+SCP+SCRP • Where SCP=Small company premium and SCRP=Specific company risk premium (unsystematic risk- also known as ‘α’). • Buildup Method (used for closely held targets) – Re=Rf +ERP+SCP+SCRP • The size of SCRP is usually smaller when used in MCAPM than when used in buildup method. September 12, 2009 Corporate Restructuring | Session 1 10
  11. 11. Risk Free Rate 10 Year Govt. of India Bond Yield 10.00 9.00 8.00 7.00 6.00 5.00 4.00 Nov-04 Jul-05 Mar-06 Nov-06 Jul-07 Mar-08 Nov-08 Jul-09 September 12, 2009 Corporate Restructuring | Session 1 11
  12. 12. Beta Company Index 99-00 00-01 01-02 02-03 03-04 5-yearly WIPRO NIFTY 0.98 2.34 1.96 2.05 1.33 1.58 CNX-500 1.39 2.03 2.12 1.64 1.19 1.61 RIL NIFTY 1.10 0.91 1.21 1.14 1.05 1.06 CNX-500 0.80 0.64 1.03 1.10 0.96 0.85 ITC NIFTY 1.15 0.60 0.75 0.37 0.67 0.79 CNX-500 0.84 0.47 0.60 0.40 0.60 0.63 BERGER NIFTY 0.38 0.16 0.17 0.38 0.65 0.38 CNX-500 0.35 0.10 0.14 0.43 0.65 0.34 HEROHONDA NIFTY 0.56 -1.05 0.90 0.60 0.86 0.34 CNX-500 0.43 -0.52 0.82 0.72 0.80 0.34 September 12, 2009 Corporate Restructuring | Session 1 12
  13. 13. ERP Long-term Risk Premium SENSEX BSE 100 Year SENSEX BSE 100 Risk free ERP ERP 1990-91 47.74 38.07 12.30 35.44 25.77 1991-92 137.87 127.35 13.36 124.51 113.99 1992-93 -55.11 -60.54 13.23 -68.34 -73.77 1993-94 54.48 61.20 13.38 41.10 47.82 1994-95 -13.96 -12.05 15.39 -29.35 -27.44 1995-96 5.20 -2.13 15.67 -10.47 -17.80 1996-97 3.49 -1.32 14.01 -10.52 -15.33 1997-98 17.10 17.03 12.27 4.83 4.76 1998-99 0.51 1.67 12.03 -11.52 -10.36 1999-2000 33.84 95.02 11.30 22.54 83.72 10-yearly average 9.82 13.14 September 12, 2009 Corporate Restructuring | Session 1 13
  14. 14. Specific Company Risk Premium • Should reflect the analysis of the competitive conditions in which the company operates. Some common company-specific risk factors: – Lack of access to capital – Ownership structure and stock transfer restrictions. – Company’s market share and the market structure of the industry – Depth and breadth of the management – Heavy reliance on individuals with key knowledge, skills or contracts. September 12, 2009 Corporate Restructuring | Session 1 14
  15. 15. Control Premium and Illiquidity Discount • Such premium or discount should be applied in adjusting cash flows rather than in the discount factor. • If the target is a closely held company in which a controlling interest is being acquired, do not automatically assume that a control premium and a discount for lack of marketability must be applied to each value determined for the company. • The correct methodology is to identify the nature of the value initially computed by each appraisal method. September 12, 2009 Corporate Restructuring | Session 1 15
  16. 16. Valuation: Concluding Remarks • Valuation exercise involves more judgments than precise facts. • The success of a valuation exercise depends on how scientific were you in your intuitive judgments. • Hence, valuation is an artistic science. September 12, 2009 Corporate Restructuring | Session 1 16

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