CH13 - Business Valuation Flashcards
Perpetuity Formulas
Present value of a perpetuity = cashflow at TN (Discount factor) x 1/r (0.15)
Growing perpetuity = Cashflow (Prior Yr Discount Factor) x 1/r-g (g=growth rate expressed as a decimal)
Free Cashflow Method
Free Cashflow
Operating Profit or Forecast Profit before tax
Plus Depreciation
Less Taxation
= Operating Cash flow
Less Investment in:
Replacement of non-current assets
Incremental non-current assets
Incremental working capital
Free Cashflow
DF Factor - WACC
PV
Total PV
Short term investments (+)
Value of firm
Market value of debt (-)
Value of Equity
Free Cashflow to Equity Method
Revenue
- CoS
Gross Profit
Operating expenses
Operating Profit
Financing Costs + Loans (Debt Interest + Loans Repaid)
Forecast Profit before Tax
Taxation
Add back depreciation
Less Investment in:
Replacement of non-current assets
Incremental non-current assets
Incremental working capital
Free Cashflow
Df Ke
PV
Total PV
If just given 1 year. Take the free cashflow and then * (1+g)/(r-g)
Cashflow Methods: Adv and Disadv
Cashflow method is a good measure of performance. Some argue a better indicator than measures based on net income. Growing free cash flow is often a positive sign and also adversely.
If doing for one year – omit the change in working capital and non-current asset capital spending. The pay-off for these investments not yet included in the cashflow
- BE AWARE of any unusual events in the particular year that can impact cashflow.
Dividend Based Methods - DVM
No dividend growth – P0 = D0/Ke
Constant Dividend Growth – P0 = D(1+g)/(ke-g)
Dividend Growth into Perpetuity
PV of First n years = D0N yr AF
PV of growing dividend = D(1+g)/(ke-g) N yr DF
Dividend Based Methods: Advantages and Disadvantages
Advantages
Suitable for minority stakes – only considers dividends. In practice, model is quite accurate matched to actual share price
- Where growth is high relative to shareholders return, the share price is volatile
- Even a minor change to growth rates can cause big changes to share price which can cause crashes
Market Based Methods: When to use
In a perfectly efficient market, the market price of shares will fairly represent the cost of the company. Not happens In reality
Market Share Price – Minority stake suitable. Premium paid above the current market price to acquire a controlling interest
PE ratio method = Stock valuation based on past/future earnings
Useful for majority shareholders who can influence decisions such as dividend policy and have control in the business.
Total value of Equity = Total earnings x P/E Ratio
Value per share = EPS x P/E Ratio
PE Ratio = Share price/Earnings per share
EPS = Profit before ordinary shares(PL)/number of ordinary shares in issue (BS)
PE Ratio method - Which Earnings/Profit figure to use in EPS?
Unquoted/Private companies will not have a market-driven PE, as they don’t have shares in issue, or a share price, so an proxy P/E/industry average will be used.
If used, may need to adjust for factors like: (ADJUST 10% per reason)
Private company shares are less liquid – not as easily traded? – adjust down
The company may be more risky than the proxy – higher gearing? – adjust down
The company may have a higher projected growth level than proxy – adjust up
P/E Ratio Method – Minimum and Maximum
IF acquisition is going to occur:
(Value of Old+New+SynergyNew P/E Ratio) Minus (Value of OldOld P/E Ratio)
Earnings Yield Method – Reflects effective growth on a stable base for the future
Earnings Yield is the opposite of P/E Ratio! Simply Replace
Equity Value = Total Earnings / Earnings Yield
Value per share = EPS/ Earnings Yield
Market Based Methods: advantages and disadvantages
Advantages: Common, well understood, good for controlling interest
Disadvantages: Based on accounting profit not cash flows, hard to value an unlisted entity for a P/E Ratio, may be difficult to get a relevant level of sustainable earnings
Market to Book Ratio
Value of Company = Market to Book Ratio*Book Value of a Competitor
Disadvantages: Choosing industry average or similar firms?
Ratio the market applies is not constant throughout business cycle – only take from competitors at the same stage of maturity
Asset Based Methods
Book Value: NCA + CA Minus NCL + CL
Found easily from statements but unlikely that book values are reliable indicator of current market values.
Replacement Value: Replace NCA with Replacement value
Buyer is interested in replacement cost = the alternative cost of setting up a similar business from scratch organically
NRV – Minimum acceptable price
Disadvantage of Asset Based Methods: Lacks valuing intangible assets and goodwill, skills of employees, Specialisms
Intangible Valuation Method
Book Or Replacement cost of the real assets + (Multiplier*Annual Profit or Revenue
Calculated Intangible Value (CIV)
Calculated Intangible Value (CIV)
- Find suitable competitor and calculate Return on Assets (or use industry average)
Return on Assets = Operating Profit/Assets Employed or GIVEN - Then:
Company Operating Profit
Less: Appropriate ROA * Company Asset base
Equals: Value Spread - Post tax of Value Spread/Cost of Capital = CIV Perpetuity
- CIV Perpetuity + Asset base= Firm Value
Problems of CIV
Finding a similar company, asset portfolio, gearing
CIV actually measures the surplus intangible value our company has over that of the competitor rather than its own asset value
Which Method/Discount rate to use
Minority - DVM
Majority - P/E
Change to business risk/small change to financial: WACC
Change to financial risk/capital structure: APV metod
If using P/E Ratio = ensure it matches the same risk profile and growth prospects
Dividend Growth Method
Calculate value of known dividends. If it’s constant use the below formula:
PV of First n years = D0 (Starting Dividend)*N yr AF at Ke
If Dividend is changing each year just do PV of each!
Then find dividend growth:
(D0/DN(^(1/n)-1 = g
Then for the Value after the last known dividend -
D(last known N)*(1+g)/(Ke-g)
