Business Valuations

Question 1

Reasons for valuing businesses and financial asset

Answer 1

For tax reasons – inheritance, capital gains and income taxes can all require business and financial asset values.
 For legal purposes – if business and financial asset are being used as loan collateral or as part of an estate valuation in matrimonial disputes
 For commercial reasons – if business and financial asset are being bought or sold or if a business is being floated on a stock market. This is the mostly likely reason for performing a valuation in this paper.

Question 2

Information requirements for valuation

Answer 2

Size of holding
Details of the parties involved and the circumstances of the transaction
Copies of the Articles of Association, specifically any clauses related to such transactions
Details of past transactions
Recent published accounts
Financial projections and market
Valuations of similar listed companies

Question 3

Size of holding: the more significant the holding the greater the value per share

Answer 3

The size of the holding on its own does not give the full picture. If you own 10% of a company and the remaining 90% is all owned by one individual; your 10% is not significant. However if you own 10% and the next biggest shareholder owns 1%, your 10% is very significant.

Question 4

Details of the parties involved and the circumstances of the transaction

Answer 4

The parties and circumstances are likely to be unique for each such transaction and so this information will not necessarily be that helpful.

Question 5

Copies of the Articles of Association, specifically any clauses related to such transactions

Answer 5

The Articles of Association can be changed by the shareholders and so may not be relevant.

Question 6

Details of past transactions

Answer 6

Many factors change over time and so past transactions do not
necessarily reflect current circumstances

Question 7

Recent published accounts

Answer 7

These could both be out of date and could have been prepared with this transaction in mind.

Question 8

Financial projections and market

Answer 8

These will always be partly based on subjective judgements and opinions and may not be that realistic.

Question 9

Valuations of similar listed companies

Answer 9

Identifying similar listed companies can be difficult and even when successful, listing increases the value of a company.

Question 10

Methods of valuation

Answer 10

Asset
Income
Cashflow

Question 11

To get an estimate of the minimum potential valuation, the net asset value as it appears on the statement of financial position can be a quick and easy starting point. Care needs to be taken to identify the correct net assets figure

Answer 11

(strictly this is non-current assets plus net current assets less any long-term liabilities).

Question 12

A realisable value would give a X of price if there was a sell off or asset stripping intention. However, realisable values would need to be given in the question and would generally be lower than market values since the reason for sale would probably be known (e.g. football clubs in financial trouble selling off key players for less than their true worth).

Answer 12

better indication

Question 13

Intangibles are/arent icluded within a company valuation?

Answer 13

Are not

Question 14

Advantages / disadvantages of asset based valuation

Answer 14

Advantages
Quick and simple
Gives a starting point/benchmark.

Disadvantages
Not as good at valuing the on-going earnings/profit potential of the business.
Does not consider valuation of assets not shown on the statement of financial position such as intangible assets.

Question 15

Income based valuations = P/E Model

Answer 15

Share price / earnings per share

Market value of all ordinary shares = Pe ratio x Current ernings (PAT usually)

Question 16

Earnings =

Answer 16

PAT less preference dividends

Question 17

Advantages / disadvantages of P/E Model

Answer 17

Advantages
Quick to calculate
Considers future potential
Useful for valuing unquoted companies

Disadvantages
Adjustments may be required for PE ratio

Question 18

Earnings yield

Answer 18

Earnings / MV of shares

or

EPS / Share price

Question 19

Neglected stocks / shares

Answer 19

Small or new companies that are undiscovered, where their stocks are often undervalued as. they havent been found yet. An example of a market imperfection.

Question 20

Cash flow based valuations

Answer 20

Cash based methods are also useful for valuing the on-going business, with DCF appropriate for controlling interests and dividend based methods more suitable for smaller (i.e. minority) shareholdings since they are only valuing the entitlement to a future stream of dividends.

Question 21

Advantages / disadvantages of cash flow models

Answer 21

Advantages
Considers future potential.
Can be used to value any business.

Disadvantages
Future cash flows will be estimates only. Requires a cost of capital to be estimated.
Determining the time horizon for future cashflows is
problematic. If constant growth is assumed after a point, then a large part of the valuation will be based on a very simplified estimate.

Question 22

Advantages / disadvantages of dividend valution model

Answer 22

Advantages
Considers future cash flows to shareholder.
Relevant for minority interests.

Disadvantages
Requires a cost of equity to be estimated. Spurious results arise for businesses that don’t pay
dividends (zero value) or where growth (g) > cost of equity (ke) (negative value).
Assumes dividends grow at a constant rate forever.
Companies that may have growth but haven’t paid dividends will be valued lwoer than they should be

Question 23

Market Efficiency

Answer 23

No individual dominates the market
Transaction costs are not significant
Share prices change ‘quickly’ to reflect information about a company

Question 24

Weak form efficiency

Answer 24

Share prices reflect all information available from past changes in the price i.e. all past information which has now become a fact (e.g. past share price movements, results from audited sets of accounts).
 Hence, the market cannot be beaten by technical analysis (the study of past share price movements), as share prices already reflect the information that technical analysis uses to predict share prices.

Question 25

Semi-strong form efficiency

Answer 25

Share prices reflect all information available from past changes in the price and any publicly available current information i.e. all past and present publicly available information.
 Hence, the market cannot be beaten by reading the news or published accounts, as all publicly available information is already reflected in share prices.
 Major stock markets are close to semi-strong efficiency. This is tested by monitoring the speed with which markets react to new publicly available information.

Question 26

Strong form efficiency

Answer 26

Share prices reflect all information available from past changes in the price and any publicly available current information and any inside information i.e. all information.

Question 27

Behavioural Finance

Answer 27

Behavioural finance proposes psychology-based theories to explain stock market anomalies. Within behavioural finance, it is assumed that the information structure and the characteristics of market participants systematically influence individuals’ investment decisions as well as market outcomes.