ch-32 business valuation

8/19/2019 Ch-32 Business Valuation

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Chapter 32Chapter 32

Business ValuationBusiness Valuation


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Approaches/Methods ofApproaches/Methods of

ValuationValuation

There are four approaches to valuation of

business (with focus on equity share

valuation!

" Assets based

2 #arnin$s based

3 Mar%et value based

& 'air value ethod


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)rice #arnin$s ()/# *atio)rice #arnin$s ()/# *atio

The )/# ratio (also %nown as the )/# ultiple is the ethod ost widelyused by finance ana$ers+ investent analysts and equity shareholdersto arrive at the ar%et price of an equity share, The application of thisethod priarily requires the deterination of earnin$s per equity share

(#)-, The #)- is coputed as per #quation

#)- . et earnin$s available to equity shareholders durin$ the

period/uber of equity shares outstandin$ durin$ the period, (0

The #)- is to be ultiplied by the )/# ratio to arrive at the ar%et price ofequity share (M)-,

M)-. #)- 1 )/# ratio (

The )/# ratio ay be derived $iven the M)- and #)-,

)/# ratio . M)-/#)- ((


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#4aple

Copany has future aintainable profits after ta4es as *s, 5 la%hs

(i The copany has "+66+666 ""7 )reference shares of *s "66 each+

fully paid8up,(ii The copany has &+66+666 #quity shares of *s "66 each+ fully paid8 up,

(iii )/# ratio is 5 ties,

-olution

9eterination of Mar%et )rice of #quity -hare

'uture aintainable profits after ta4es

Less: )reference dividends ("+66+666 × *s ""

#arnin$s available to equity8holders

9ivided by nuber of equity shares

#arnin$s per share (*s la%h/& la%h

Multiplied by )/# ratio (ties

Mar%et price per share (*s ",0 1 5

Value of Business is M)- x no, of outstandin$ shares

*s 5+66+666

""+66+666

+66+666

&+66+666

",0

5

*s "3&

*s 03+66+666


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Coputation of 'ree8CashCoputation of 'ree8Cash

'lows to the fir'lows to the fir After tax operating earnings (including interest cost)

Plus: Depreciation & Other non-cash items

Less: Investment in long-term assetsLess: Investment in operating net or!ing capital"""""""""""""""""""""""

Operating free cash flos (O#$#)

Plus: After-tax non-operating income%$#

Plus: Decrease in non-operating assets"""""""""""""""""""""""""""""""

'ree Cash flows to the fir ('C''


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Alternatively+ the value of equity can be deterined directly by discountin$the free cash flows available to equityholders ('C'# after eetin$interest+ preference dividends and principal payents+ the discount ratebein$ k

e+ that is+

( )∑∞

= +=

&tt

'

t'

!&

investorsallto#$###irmof (alue

( )∑∞

= +=

&tt

e

t'

!&

erse)uit*holdto#$##+)uit*of (alue


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Mar%et Value Based Approach to Valuation

,he mar!et value (reflected in the stoc! mar!et uotations) is the

most idel* used approach to determine the value of a .usiness/ inparticular of large listed firms0

,he mar!et value indicates the price the investors are illing to pa*

for the firm1s earning potentials and the corresponding ris!0

,

his method is particularl* useful in deciding sap ratios in the caseof merger decisions0

,2suall*/ 3 months average of stoc! prices or the average of high &

lo values of stoc!s during a *ear can .e ta!en0

,4ar!et value per share x no0 of outstanding shares 5 value of

.usiness


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'air Value Method

,#air value method is not an independent method of share valuation0

,he method uses the average%eighted average of to or more of the

a.ove methods0

,herefore/ such a method helps in smoothening out ide variations

caused .* different methods and indicates the 6.alanced1 figure ofvaluation0


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;0 Price%+arnings (P%+ atio) method:;0 Price%+arnings (P%+ atio) method:

alue of .usiness 5 $o1s expected future maintaina.le profits xalue of .usiness 5 $o1s expected future maintaina.le profits x

Industr*1s average P%+ atioIndustr*1s average P%+ atio

Valuation *elative to :ndustryValuation *elative to :ndustry

Avera$esAvera$es


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9iscounted Cash 'low9iscounted Cash 'low

Valuation ModelsValuation Models00 Discounted Dividend 4odel (to-stage groth model)Discounted Dividend 4odel (to-stage groth model)

3030 Discounted $ash-#lo 4odel ($ontinuing alueDiscounted $ash-#lo 4odel ($ontinuing alue

method)method)9090 Discounted I 4ethod (Instead of cost of capitalDiscounted I 4ethod (Instead of cost of capital

(!)/ I is used to discount the cash flos and(!)/ I is used to discount the cash flos and

determine the present valuedetermine the present value

;0;0 Discounted +A methodDiscounted +A method


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Valuation based on Co;sValuation based on Co;s

fundaentalsfundaentals;0 P%+ 4ultiple:;0 P%+ 4ultiple:

4ar!et price per share4ar!et price per share == O+ @ g"" O+ @ g""

+P>+P> O+ x (!-g)O+ x (!-g)

0 Price%?oo! alue multiple:0 Price%?oo! alue multiple:

4ar!et price per share4ar!et price per share 55 O+ @ g" O+ @ g" x O+ x O+

?oo! value per share O+ x (!-g)?oo! value per share O+ x (!-g)


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#4aple

-upree :ndustries has an equity ar%et capitalisation of *s 3+&66

crore in current year, Assue further that its equity share capital is *s

2+666 crore and its retained earnin$s are *s 66 crore, 9eterine the

MVA and interpret it,

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MVA . (*s 3+&66 core = *s 2+66 crore . *s 566 crore,

The value of *s 566 crore iplies that the ana$eent of -upree:ndustries has created wealth/value to the e4tent of *s 566 crore forits equity shareholders,

@ell ana$ed copanies+ havin$ $ood $rowth prospects+ andperceived so by the investors+ have positive MVA, :nvestors ay bewillin$ to pay ore than the net worth, :n contrast+ copaniesrelatively less %nown or en$a$ed in businesses that do not holdfuture $rowth potentials ay have ne$ative MVA,


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#4aple

ypothetical iited has equity ar%et capitalisation of *s 66 crore in

the current year, :ts equity share capital and accuulated losses are of

*s "+266 crore and *s 266 crore respectively, 9eterine the MVA of the

fir,

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MVA . (*s 66 crore = *s "+666 crore . (=*s "66 crore,

The fir has ne$ative MVA of *s "66 crore, The investors discount itsvalue/worth+ as it is loss incurrin$ fir,

The ar%et value added approach reflects ar%et e4pectations and isessentially a future8oriented and forward loo%in$ approach, Theinvestors+ willin$ to pay a different price (other than one su$$ested byboo% value+ are $uided by the individual copany;s future prospects+future $rowth rates+ ris% cople4ion of the fir+ industry to which thefir belon$s+ required rate of return and so on,


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Than% DouThan% Dou

ch-32 business valuation

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