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Corporate valuation

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Published on Feb 27, 2013

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1. Corporate Valuation: Principles and Practices2. Basic Concept Business Valuation is the process of determining the "Economic Worth" of a Company based on its Business Model andExternal environment and supported with reasons and empirical evidence. Corporate valuation depends upon1. Purpose of valuation2. Stageof Business3. Past financials4. Expected financial results5. Industry scenario

3. Approach to Valuation Discounted free cash flow method Relative Valuation (Comparable company market multiple method)Comparable Transactions (Mergers & Acquisition) Multiple (CTM) method Price of recent investment method Net asset value method(NAV)4. Discounted Free Cash FlowMethod Two alternative approach can be used1. Measuring the discounted cash flow to the firm2. Measuringthe discounted cash flow to equityDiscounted Free Cash flow to the firm The DFCF to firm method expresses the present value of thebusiness attributable to all claimants (like equity shareholders, debt holders, preference shareholders, warrants etc) as a function of its futurecash earning capacity. This methodology work on the premise that the value of business is measured in terms of future cash flow streams,

discounted to the present time at appropriate discount rate This approach seeks to measure the intrinsic ability of the business to generatecash attributable to all the claimants.5. Discounted Free Cash FlowMethodDiscounted Free Cash flow to equity The DFCF to firm method expresses the present value of thebusiness attributable to equity shareholders as a function of its future cash earning capacity. The value of equity is arrived at by estimating thefree cash flow to equity and discounting the same at the cost of equity6. Steps in measuring FCFF Steps for finding FCFF Earning before interest and Step 1: Arrive at EBIT* taxes Step 2: Multiply with (1-tax

rate) (1-tax rate)= Operating profit after tax Step 3: Arrive at Operating profit+ Non Cash Cost after tax Step 4: Add back non cash cost-Capital expenditures (already subtracted earlier)- Increase in NCWC Step 5: Subtract Capital+ Terminal Value Expenditures Step 6: Subtractincrease in NCWC Step 7: Add terminal value of the firm at the final year= Free cash flow to firm7. Steps in measuring FCFE Steps for finding FCFFE Profit Before Tax Step 1: Arrive at PBT- Taxes Step 2: Less taxes= Profit After TaxStep 3: Arrive at PAT+ Non Cash Cost Step 4: Add back non cash cost (already subtracted earlier)- Capital expenditures Step 5: SubtractCapital- Increase in NCWC Expenditures± Changes in Debts Step 6: Subtract increase in NCWC+ Terminal Value Step7: Take into accountthe effect of changes in debt Step 8: Add terminal accruing to equity holder at the final year= Free cash flow to equity= Discounted Free Cash

Step 8: Discount the FCFE for

8. Arriving at cost of capital Key things to remember Cost of capital for the firm should be comparable with firm with similar business andfinancial risk CAPM can be utilized to calculate ß debt, ß equity ß asset for publicly listed firm from the historical data. Hence beta have ahistorical character Return on risk free security can be estimated based on 10 year Indian Government Bond Yield Equity risk premium canbe arrived from market information for the return on broad based index for a comparable period9. Comparable company market(CCM)multiple method CCM multiple method uses the valuation ratios of a publicly traded company and

applies that ratio to the company being valued The valuation ratio typically expresses the valuation as a function of measure of financialperformance or book value (e.g. turnover, EBIDTA, EBIT, EPS or book value) Methodology is based on current market stock priceLimitations:1. Difficulty in selecting comparable firms with similar business and financial risk (EBIDTA or Cash Flow)2. Measuring the multiple(mean or median value can be used)10. Comparable Transactions (M&A)Method (MTM) This methodology helps in arriving the value of the company on the basis of similardeals matured in the market This provides and indicative value as it helps in reaching the value which market is providing to similarcompanies Can be arrived through sales multiple, EBIDTA multiples or PAT multiples

11. NAV Method NAV is the net value of all the assets of the company. If you divide it by the number of outstanding shares, you get theNAV per share. One way to calculate NAV is to divide the net worth of the company by the total number of outstanding shares. Say, acompany’s share capital is Rs. 100 crores (10 crores shares of Rs. 10 each) and its reserves and surplus is another Rs. 100 crores. Net worthof the company would be Rs. 200 crores (equity and reserves) and NAV would be Rs. 20 per share (Rs. 200 crores divided by 10 croresoutstanding shares). NAV can also be calculated by adding all the assets and subtracting all the outside liabilities from them. This will againboil down to net worth only. One can use any of the two methods to find out NAV.

12. Tobin’s q Tobins q was developed by James Tobin (Tobin 1969) as the ratio between the market value and replacement value of thesame physical asset. Tobins q= (Market Value of Equity+ Book Value of Debt) --------------------------------------------------- ---(Book Value of Equity + Book Value of Debt)

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