Firm Valuation

Question 1

What are the methods in firm valuation?

Answer 1

Multiples Approach (based on other firms, relative valuation method)
Discounted Cash Flow Approach (based on the intrinsic value generated by the firm, absolute valuation method)
Contingent Valuation (based on contingent claims, real options technique)

Question 2

Can we create any multiple to proceed with the firm’s valuation?

Answer 2

Yes

Question 3

What is a multiple?

Answer 3

A multiple is ratio that has a driver and a key variable linked with that value.

Question 4

What are the main kind of multiples used?

Answer 4

• Cash-Flow based Value multiples
• Cash-Flow based Price multiples
• Asset-based multiples

Question 5

What are the advantages of multiples valuation?

Answer 5

• Includes information from other evaluation techniques in a simple way. For example, if you are using the P/E ratio to evaluate a company and most other investors evaluate the price of the comparable firm through the present value of future cash flows to equityholders, than you are incorporating this information in a simpler way. This can also be seen as Free-Riding.
• Incorporates market consensus. By using multiples, you are using consensus regarding different analysts’ evaluations.

Question 6

What are the disadvantages of multiples valuation?

Answer 6

• Assumes that all comparable firms have the same growth rates, cost of capital and business composition.
• Difficult to incorporate firm specific characteristics.
• If all analysts only did valuation based on multiples no one does the fundamental analysis.