F3 - 8. Business Valuations

Question 1

What are the 4 most common reasons for valuing a business?

Answer 1

1. Seeking a stock market flotation, so a share price assessment
2. Considering buying another business
3. Looking to sell part of the business
4. Banks deciding on a lending decision

Question 2

What are the 4 main categories of business valuation method?

Answer 2

1. Asset based (with or without intangibles)
2. Earnings based
3. Cash flow based
4. Share price x number of shares (if quoted)

Question 3

What are the 3 options for asset based valuations, and when are theybest used?

Answer 3

1. Historic cost/ NBV (min selling price)
2. Replacement cost (cost of starting up like for like)
3. Realisable value (min selling price)

Question 4

What are the 2 main advantages of using asset based valuations?

Answer 4

1. Quick and simple to estimate
2. Gives minimum starting point

Question 5

What are the 3 main disadvantages of using asset based valuations?

Answer 5

1. Doesnt consider on-going earnings/profit potential
2. Doesnt consider intangible asset value
3. Reliant on accounting conventions

Question 6

How do you value a company using it’s P/E ratio?

Answer 6

P/E ratio x sustainable earnings

Question 7

If valuing an unquoted company, what P/E can be used?

Answer 7

That of a similar unquoted business, possibly adjusted downwards

Question 8

What are the 3 main advantages of earnings based valuations?

Answer 8

1. Quick
2. Considers future potential
3. Useful for valuing unquoted companies

Question 9

What are the 3 main disadvantages of earnings based valuations?

Answer 9

1. Adjustments needed to P/E and earnings
2. Based on profits not cash flow
3. Decision on which P/E to use in takeover - own or targets?

Question 10

What are the 2 cash flow based valuation methods and when are they each most useful?

Answer 10

1. PV of future cashflows (controlling interest)
2. PV of future dividends received (smaller shareholding)

Question 11

Which cashflows and discount rate are used to calculate the market value of a company’s equity?

Answer 11

Free cashflow to shareholders (after debt interest and debt), cost of equity

Question 12

Which cashflows and discount rate are used to calculate the market value of a company’s equity and debt?

Answer 12

Free cashflow to all investors (before interest and debt), WACC

Question 13

What are the 3 main advantages of cashflow based valuations?

Answer 13

1. Considers future potential
2. Can be used for any business (quoted or unquoted)
3. Considers time value of money

Question 14

What are the 3 main disadvantages of cashflow based valuations?

Answer 14

1. Cash flows are estimates
2. Need to estimate cost of capital

Question 15

What are the 4 main types of intangible asset?

Answer 15

1. Intellectual capital
2. Digital assets
3. Brands
4. Customer loyalty

Question 16

What are the 3 categories of intellectual capital?

Answer 16

1. Human (knowledge, skills)
2. Intellectual assets (reports, drawings etc)
3. Intellectual property (patents, copyrights etc)

Question 17

What 2 things does the valuation of digital assets heavily depend on?

Answer 17

1. Usage rights
2. Impact of regulation changes

Question 18

What are the 3 methods of valuing intangible assets?

Answer 18

1. Market value
2. Cost to develop
3. Income expected (/relief from royalites)

Question 19

How is the Calculated Intangible Value calculated, to be added on to the value of tangible assets?

Answer 19

Find the excess pre tax return by taking the industry return on assets * year end tangible assets from the profit before tax;
Estimate the PV of this excess, post tax

Question 20

What are the 4 main characteristics of an efficient market?

Answer 20

1. Share prices are fair
2. No individual dominates the market
3. Transaction costs are not significant
4. Share prices change quickly to reflect information

Question 21

In a market with semi-strong efficiency, when does the share price change in relation to company decisions?

Answer 21

As soon as they are publically announced