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Valuation
Special Case
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Cyclical Firmsn Volatile; dependent on economy;
n Base Year Earnings
n
Adjust base year for cyclical effectsn Adjust expected growth rate to reflect economic
cycle
n Used normalised earnings for base year
n Volatilityn Handle volatility through the discount rate
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Firm’s in Distressn Hope
n Use normalised earnings from happier terms
n Make detailed cash flow estimates for transition period -
from illness to healthn No Hope
n Liquidation Value = Liquidation value of Assets - Value of Debt
n Option Pricing Model . In Firms with high leverage wherethe value of the firm is lower than the debt equity can be
considered as out of money call option on the underlyingfirm and can be so valued.
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Firms with Product Optionsn Value = Value of assets in place + future
possibilities
n
Three approachesn Value the product option in the open market and
add it to the DCF valuation.
n Use a higher growth rate capturing the impact of the product option
n Use option pricing models
n Beware double counting
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Private Firmsn Estimating Discount Rate
n comparable firms
n accounting betas
n estimate the beta by regressing earnings withthe market index of earnings
n use financial fundamentals
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Private Firms - Cash Flowsn Cash Flows
n Difficulty in estimating management compensationand return on capital
n Substantially less information
n Past history unreliable
n Estimating Cash Flows
n Management Expenses
n
Tax Ratesn Increase in expenses, legal, record keeping etc
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Valuation of Public Enterprisesn Monopolies
n Prelude to introduction of competition in the field
n Special Status helps access markets
n Manpowern Productivity
n Size and Efficiency
n Middle Management Strong/ Top ManagementWeak
n
Technical Manpower Quality Highn Benefits and Hidden liabilities
n Real Estate
n Access to Markets
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Building Up Discount Ratesn 20 Year Long Bond Yield to Maturity
n + Long horizon equity risk premium
n
+ (if applicable) small stock premiumn + additional risk premium
n = discount rate
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Minority Interestn Relationship between the interest being
valued and the total enterprise.
n Key Questionn How much control does the minority interest
have?
n It reflects lack of control
n The base from which it is subtracted is itsproportionate share in the total entity value
including all rights of control
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Marketability Discountn It is the liquidity of the interest
n How quickly can it be converted into cash
n The base is the value of an entity which isotherwise comparable
n Mean Discount (1990): 42% Max 342.3%Duracell
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Illustration:
Value of NonMarketrableMinority Share
Rs. 3.60 / share
MarketabilityDiscount
40% discount forlack of Mktbility
Value of MinorityShare if FreelyTraded
Rs. 6 per share
Control Premium/
Minority Discount
40% minority
interest discount
Value of ControlShare
Rs.10/share
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Control Premia in the US
47%Financial Services
32%Retail44%WholeSale
33%Electricity and Gas
26%Communication
24%Transport
47%Manufacturing
23%Construction
43%Mining
PremiaI ndustry
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Other Methods of Valuation
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Adjusted Book Value Methodn Adjust all assets and liabilities from historical
cost to current value
n Fair market value on a going concern basis
n Identify, value and bring on to the balancesheet all off balance sheet assets andliabilities
n Intangible assets never recorded and contingentliabilities
n Subtract recast liabilities from assets
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Excess Earnings Methodn Capitalize the excess earnings after
n
Adjusting for WACC
n Taxes
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