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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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