Topic 15: Business valuation Flashcards
What is and Why do we need business valuations?
It determines the value of a business and this is also used to cover valuing the equity of a company and valuing of other financial instruments.
They are need for Listing on the share market as the share price is based on the businesses value, an acquisition so the bidder knows the value and same as if a company is sell a subsidiary, it needs to know how much its worth. Disposal of investment e.g. sell the shares for the right price.
What are the 4 valuation methods to value a business?
Market capitalisation - Market value of a quoted company.
Asset based valuation - the net assets of a business is worth something so that’s a starting value as it cant go below that.
Earnings based valuation - based of P/E Valuation formula.
Earnings based approach - EPS/Share price.
Cashflow based Approach - Dividends growth, discounted cashflow technique.
What are the three bases for asset based valuations?
Historical cost - Net book value - liabilities. its is affected by accounting policies.
Realisable value - How much the assets would be sold for now and paid off liabilities, its always the lowest price to see the minimum value of equity.
Replacement Value - How much it would be to replace the asset and how much would it cost.
What are usefulness for the asset based valuations?
Positives:
Ease - Company always have historical data and are always in the same format so its easy to understand.
Replacement costs gives you the maximum value and it is reflected in the financial statements.
Realisable - gives the minimum price if a company wants to get rid.
Negatives:
Historical costs - Meaningless as it is subject to accounting policies.
Determining Values - Hard to know true value as markets can change and waiting periods can affect price, some people want quick sales.
Ignores Goodwill - Its intangible value from brand loyalty, competence of workforce and these can be very valuable.
Ignores the future - Ignores future potential on these assets.
What is the earnings based approach and explain?
P/E Valuation:
We use Price/Earnings to value companies not listed by taking the P/E of a similar company and applying it to our company.
Value of equity per share = Suitable P/E ratio x EPS of company being valued.
Total value of equity = suitable P/E Ratio x total earnings of company being valued.
The earnings available to shareholders (The pot dividends are taken from) is the total earnings of a company.
What is the usefulness for earnings based valuations and against?
Positives:
Based on earnings - this is better than using dividends as it is not controlled by the controlling stake of the business.
Incorporates value of goodwill - Which asset based valuations doesn’t do because the P/E ratio of the suitable company will have goodwill incorporated.
Negatives:
Suitable P/E - Can be difficult to know which company is best to use.
Earnings volatility - Earnings can be unpredictable.
Marketability of shares - it is hard to know how much to reduce the P/E ratio by.
What is the earnings yield approach? and how to add growth?
Value of equity = (Equity x (1+G))/(Earnings yield-G).
What is the growth model and its terms?
on the formula sheet
G = Growth rate
Do= dividends just paid
RE = required rate of return
Po = market value.
What is the usefulness of the dividends growth model and arguments against.
Positives:
Principle - Values future dividends at a discount.
Based on dividends - Useful when valuing a non controlling interest in a company.
Negatives:
G = Assuming growth rate can be established as its not a exact science as its based on past dividends and assuming dividends will grow into perpetuity.
Constant
Constant KE - Assumes that cost of equity does not change which is not realistic because risk can change and long term gearing can change.
G VS Ke - Assumes growth rate is lower than the cost of equity which may be true, even though it is more unlikely growth can be higher than cost of equity.
What is the discounted cashflow valuation?
It determines value by using its present value of it’s future cashflow discounted at its weighted average cost of capital.
Value of equity = value of company - Value of debt.
Value of a company is the present value of its future cashflows discounted at WACC which is also value of equity - value of debt.
What is the usefulness of discounted cashflows method to value a business and problems with DCF
Positives:
Principle - it uses future cashflow that are discounted at the cost of capital so its future cashflow based and not past cahflow based
Its cash based as profit is affect by accounting policies,
Reflects investors required rate of return.
Suitable - it can be used on a controlling and non-contralling stake.
Negatives:
Assumptions - There are alot fo assumptions to be made e.g future cashflows, growth rate and appropriate discount rate.
What is the key principle when calcuating the value of debt?
The market value of debt = present value of future cashflows from the debt DISCOUNTED at The investors required rate of return.
Present value of future cashflows from debt is the cashflows generated by debt either from interest or redemptions.
The investors required rate of return is the yield on teh debt (Viewing from the investors POV).
What is the yield on debt equal to?
Pre tax cost of debt.
When we work out market value of debt we ignore Tax.
How to calculate the value of Irredeemable debt? and the terms?
Po=I/Kd pre tax
Po = Market value of debt (ex-int)
I = Annual interest in $ (Coupon rate x $100 Nominal Value)
Kd pre tax = Pre tax cost of irrecoverable debt or investors yield on debt.
IGNORE TAX
What is the difference when calculating MV of debt and cost of debt?
MV is Pre tax
Cost is post tax
