Company Valuation

Question 1

What is the economic value of a business?

Answer 1

It is its value as a going concern

Question 2

What are intangible assets?

Answer 2

Examples include expenditure on R&D, brand values, intellectual property and goodwill.

Question 3

What is amortisation?

Answer 3

It is the depreciation of intangible assets.

Question 4

What is value in use?

Answer 4

It is the value of assets being used in a business.

Question 5

What is carrying value?

Answer 5

It is the value of assets as given in the balance sheet,

Question 6

What does the book value of a company represent?

Answer 6

It is somewhere along the spectrum between historic costs and the current market value of an organisation’s assets.

It is, therefore, is a mixture of:

• the liquidation value of the assets less the liabilities
• the replacement cost of the assets less the liabilities
• the market value of the assets less the liabilities
• the value of the business as a going concern
• the value of the business to a potential purchaser
• the sunk cost

Question 7

What is the difference between book value and economic value?

Answer 7

Book value does not provide an estimate of economic value since <b>not all assets are valued using the present value of forecast future cash flows.</b>

Question 8

What is the price to earnings ratio?

Answer 8

It is the ratio for valuing a company that measures its current share price relative to its per-share earnings.

The higher the PE ratio, the more investors are prepared to pay and hence the more bullish they are about a company’s future.

Conversely, the riskier or more volatile the expected future earnings stream, the less an investors is prepared to pay; hence a lower PE ratio.

PE ratios enable comparisons over; time, companies and across sectors and countries.

Question 9

What are off balance sheet items?

Answer 9

These are items that are not reflected in the value of shareholders funds (i.e. book value). Thus, the book value of a company can be misleading as a result.

Examples include finance related leases for vehicles, employee-related pension assets, health liabilities or share options.

Question 10

What is impairment?

Answer 10

It is the fall in the value of fixed assets, such as land, buildings, and equipment.

Question 11

What are the different methods for valuing a company?

Answer 11

There are three main ways to value a company:

• Asset valuation
• Market multiples
• Discounted Cash Flows

Question 12

What is asset valuation?

Answer 12

Asset valuation gives the book value of a company’s assets, as opposed to the market values. These can be found in the annual report and accounts.

Adjusting a book value to make it closer to economic value is a subjective exercise and depends on assumptions made in the adjustments.

Question 13

What is goodwill?

Answer 13

It is the difference in the price paid for a company and its book value and may appear on an acquiring company’s balance sheet.

Question 14

What are the <b>advantages</b> of net asset value?

Answer 14

1. It is easy to calculate
2. It comes straight from the accounts.
3. It is useful for special situations, such as companies that deal predominantly in easily valued fixed assets.

Question 15

What are the <b>disadvantages</b> of net asset value?

Answer 15

1. Relies on accounting (book) value and not economic value.
2. Accounting standards in different countries can vary
3. Accounts are often out of date and subjective as to valuation.

Question 16

What are the advantages of PE ratio?

Answer 16

1. It is commonly used.

2. Easy to calculate.

Question 17

What are the disadvantages of PE ratio?

Answer 17

1. If earnings are erratic, PE ratio should be normalised
2. It does not fully take account of the time value of money.
3. It is sensitive to accounting standards.
4. Investment requirements are overlooked.

Question 18

What are the advantages of Price-to-cash- flow?

Answer 18

1. It takes investment into account.

2. It represents real cash belonging to shareholders.

Question 19

What are the disadvantages of Price-to-cash- flow?

Answer 19

1. Confusion over definition of cash flow - 2 definitions.
2. It ignores the time value of money
3. It can be variable over time

Question 20

What does the PE ratio tell you?

Answer 20

In short, the PE ratio indicates how much money an investor can expect to invest in a company in order to receive one dollar or pound from that company’s earnings.

Question 21

What is the price-to-book ratio?

Answer 21

It is the ratio of the share price to the book value per share, or, at the company level, the ratio of the market value of the equity to the book value of shareholders’ funds.

It tells you the amount that investors are willing to pay in relation to the book value of a company. e.g 1.xx times the book value.

It is meaningless on its own and is best used to compare with similar companies in the same or different sectors and countries.

It can also be used to look back at an organisation over time.

Question 22

What is the price-to-cash flow ratio?

Answer 22

It measures the price of an organisation’s shares relative to the <b>cash flow available to shareholders</b> of which there are two primary definitions. Consequently, it can be problematic to use.

Question 23

What are the benefits of EV/EBITDA?

Answer 23

It is commonly used.

It is more stable than cashflow.

It considers the value of the whole organisation - not just the equity element.

Allows for the comparison of different companies with different financial structures inc. international comparisons.

Question 24

What are the drawbacks of EV/EBITDA?

Answer 24

Ignores capital expenditure requirements.

Ignores the differences in tax rates between companies

Book value is often used instead of market value, which distorts comparisons

Ignores the time value of money.