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8/18/2019 Appraoches to Valuation
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Objectives
• To understand the various approaches to
valuation
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What is the need for business
valuation?
Company PriceProduct Price
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Rs 12!""""
Rs !"""
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Conte#t of $aluation
• Raisin% capital for a $enture
• &nitial Public Offerin%
• 'c(uisitions
• )ivestitures
• P*+ )isinvestment• ,mployee *toc- Option plan
• Portfolio .ana%ement
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'pproaches to $aluation
Valuation Models
Asset Based Valuation
Discounted Cashflow Models
Relative Valuation Contingent Claim Models
LiquidationValue
ReplacementCost
Equity ValuationModels
Firm ValuationModels
Cost of capitalapproach
APVapproach
Excess ReturnModels
Stable
Two-stage
Three-stageor n-stage
Current
Normalized
Equity
Firm
Earnings Book Value
Revenues Sectorspecific
Sector
Market
Option todelay
Option toexpand
Option toliquidate
Patent UndevelopedReserves
Youngfirms
Undevelopedland
Equity introubledfirm
Dividends
Free Cashflowto Firm
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'sset /ased $aluation
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• ' type of business valuation that focuses ona company0s net asset value or the fairmar-et value of its total assets minus itstotal liabilities
'sset /ased $aluation
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When to use 'sset based
valuation?
• *cenario 1
3 4irms 5ho value drivers lar%ely depends on tan%ible
assets ,#ample mines minerals oil Cell phone
to5ers• *cenario 2
3 4irm 5hose assets are separable and mar-etable
,#ample Real estate companies
• *cenario 6 3 )eterminin% the value of firms under%oin% li(uidation
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O78CThe company %re5 its %lobal footprints 5ithac(uisition of oil and %as assets and no5 has projects in 19 countries
operations in 29 countries and a commercial presence in over !" countries
):40s primary business is development of
residential commercial and retail properties4rom developin% 22 major colonies in )elhi):4 is no5 present across 1! states2;cities in &ndia
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'sset based $aluation .ethods
/oo- value
.ethodReplacement
Cost
.ar-et $alue
.ethod
:i(uidation
value
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• The boo- value of an asset refers to the amount at
5hich an asset is sho5n in the balance sheet of a
firm
/oo- value < &nitial ac(uisition cost 3 accumulated depreciation
/oo- $alue of an asset/oo- $alue of an asset
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/oo- $alue of a business
Book value of a business refers to total boo-
value of all valuable assets =e#cludin% fictitious
assets such as accumulated losses and deferred
revenue e#penditures li-e advertisement preliminary e#penses cost of issue of securities
not 5ritten off> less all e#ternal liabilities
=includin% preference share capital>
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.ar-et value
• .ar-et value refers to the price at 5hich an asset
can be sold in the mar-et
• The mar-et value can be applied 5ith respect to
tan%ible assets only intan%ible assets =in
isolation> more often than not do not have anysale value
• .ar-et value of a business refers to the a%%re%ate
mar-et value =as per stoc- mar-et (uotation> of all
e(uity shares outstandin%
• The mar-et value is relevant to listed companies
only
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Replacement $alue
• Replacement value is the potential amount that
one 5ill have to spend at current rates to replacethe e#istin% assets of a company
Replacement Cost
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Replacement Cost
S.no Company
Adjustedreplacement cost (FY
12)in crores
Market Cap Potential upside %
1 ndia cements !"## 2$"# 2#.&
2 Madras cement "## '"1' .2
' ata Steel 121### $#""& 1&!.*
$ +indalco *2### 2'$$* 121.
* ,S- ner/y 1*# #11 &.*
" ,P Associates '#$## 1$"' 1#!
S.no Company
Adjustedreplacement cost (FY
1*)in crores
Market Cap Potential upside %
1 rasim $$!## 22$' &&.2
2 ndia Cements 1### 2$"# ''&
' Madras Cement &# '"1' 1!$
$ Sree cement 1&### &1&! 1#"."
* ata Steel 1!&"## $#""& '$1."" +indalco "#### 2'$$* 1**.&
! ,S- ner/y 1&$## #11 1$2.2
,P Po3er 4entures 2'2## &2*2 1*#.
& Poeni5 Mills "2## 2*"# 1$2.2
1# ,aypee n6ratec 1"1## "'!* 1*2.*
11 M7 n6ra 1!"## "&& 1#2.'
12 ,P associates $$1## 1$"' 2##.'1' 78 n6rastructure ## '&' 12.*
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$aluation of &ndus To5ers
One of the lar%est Cell phone to5ers in &ndia
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With 119;!; to5ers in 1! circles across the country &ndus hasthe 5idest covera%e in &ndia
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Liquidation Value
• :i(uidation value represents the price at 5hich eachindividual asset can be sold if business operations are
discontinued in the 5a-e of li(uidation of the firm
• &n operational terms the li(uidation value of a business ise(ual to the sum of =i> realisable value of assets and =ii>
cash and ban- balances minus the payments re(uired to
dischar%e all e#ternal liabilities
• &n %eneral amon% all measures of value the li(uidation
value of an asset@or business is li-ely to be the least
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'sset/ased 'pproach to $aluation'sset/ased 'pproach to $aluation
Assets-based method focuses on determining the value of
Net assets = (Total assets (excluding fictitious assets) Total external
obligations) (!)
Net assets "er share can be obtained dividing total net assets b# the
number of equit# shares outstanding$ %t indicates the net assets
bac&ing "er equit# share (also &no'n as net 'orth "er share)$
Net assets "er share = Net assets Number of equit# shares issued
and outstanding ()
*xam"le !+ ,ollo'ing is the balance sheet of #"othetical .om"an# Limited as on /arch 0!1 current
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*xam"le !+ ,ollo'ing is the balance sheet of #"othetical .om"an# Limited as on /arch 0!1 current#ear$
2hare ca"ital
341444 !!5 6reference shares of
7s !44 each1 full# "aid-u"
!141444 *quit# shares of 7s !44 each1full# "aid-u"
6rofit and loss account
!45 8ebentures
Trade creditors
6rovision for income tax
34
!4
0
4
9!
:
:
,ixed assets
Less+ 8e"reciation
.urrent assets+
2toc&s8ebtors
.ash at ban&
6reliminar# ex"enses
7s !;4
04
!44;4
!4
!4
!
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2olution + 8etermination of Net Asset Value "er 2hare (Rs lakh)
(i) Boo& value basis ,ixed assets (net)
.urrent assets+
2toc&
8ebtors
.ash and ban&Total assets
Less: *xternal liabilities+
!45 8ebentures
Trade creditors
6rovision for taxation
!!5 6reference share ca"ital
8ividend on "reference shares(4$!! 7s 34 la&h)
Net assets available for equit#holders
8ivided b# the number of equit# shares (in lakh)
Net assets value "er share ( Rs)
7s !44
;4
!4
4
9!
:
34
3$3
7s !4
!
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(ii) /ar&et value basis
,ixed assets (net)
.urrent assets+
2toc&
8ebtors
.ash and ban&
Total assets
Less+ *xternal liabilities (as "er details given
above)+
Net assets available for equit#holders8ivided b# the number of equit# shares (in la&h)
Net assets value "er equit# share (7s)
!4
3;
!4
!04
!;9
:9
!30$3
!30$<
!$
!!?$
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(iii) Liquidation value basis
,ixed assets (net)
.urrent assets+
2toc&
8ebtors
.ash and ban&
Total assetsLess+ *xternal liabilities (listed above)+
Less+ Liquidation costs
Net assets available for equit#holders
8ivided b# the number of equit# shares (in la&h)
Net assets value "er equit# share (in 7s)
?4
34
!4
!4;
!34
3;!30$3
!;$4
:
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OPT&O7*
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Obli%ation $s Option
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*pice Aet• :o5cost carrier =:CC> *piceAet on Tuesday said it 5ould
spend B"" million to buy 6" small aircraft from CanadaD
/ombardier to enhance re%ional connectivity in the country
• &ndia has about " airports in tier&& and 5e plan to enter
these areas as there are no :CCs here
• The E;"" 7e#t8en turboprop aircraft from /ombardier canseat FG passen%ers and has lo5 noise and vibrationfree
features
• &t uses up to ;" per cent less fuel than the re%ional jet aircraft
• 2"iceet has also ordered 04 Boeing aircraft anddeliveries of the same 'ould begin b# 4!0
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Phases of development
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T,'CI&78 .,TIO)O:O8J
• Concepts
• 8uidin% principles
• Tools and Techni(ues
• ,#ercise
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)iscounted Cash 4lo5 $aluation
•Chat is itK &n discounted cash flo5 valuation the value ofan asset is the present value of the e#pected cash flo5s on
the asset
• 6hiloso"hical BasisK ,very asset has an intrinsic value
that can be estimated based upon its characteristics in
terms of cash flo5s %ro5th and ris-
• %nformation NeededK To use discounted cash flo5
valuation you need
3 to estimate the life of the asset
3 to estimate the cash flo5s durin% the life of the asset
3 to estimate the discount rate to apply to these cash
flo5s to %et present value
)iscounted Cash 4lo5 $aluation
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• /ar&et %nefficienc#K .ar-ets are assumed to ma-e
mista-es in pricin% assets across time and are assumed tocorrect themselves over time as ne5 information comes
out about assets
)iscounted Cash 4lo5 $aluation
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)iscounted Cashflo5 $aluationK /asis for
'pproach
Proposition 1K 4or an asset to have value the e#pected cashflo5s have to be positive some time over the life of theasset
Proposition 2K 'ssets that %enerate cash flo5s early in theirlife 5ill be 5orth more than assets that %enerate cash flo5slater the latter may ho5ever have %reater %ro5th andhi%her cash flo5s to compensate
Value =CF
t
(1+ r)t
t =1
t = n∑
Wh t i th f )C4 l ti ?
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What is the use of )C4 valuation?
• ,stimatin% .er%er 8ains and Costs 3 *uppose that you are the finance mana%er of firm '
and you 5ant of analyHe the possible purchase of
firm / What is the first thin% you loo- for ?
3 &s there any economic %ain from mer%er ?
• ,conomic %ain arises only if the t5o firms are 5orth more
to%ether than apart
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Io5 do you calculate economic %ain?
8ain < P$'/ = P$' L P$/ > < P$'/
Cost of ac(uirin% /
Cost < Cash paid P$/
7et Present value < 8ain Cost
< P$'/ = Cash paid P$/ >
7P$ < 5ealth 5ith mer%er 5ealth 5ithout mer%er
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• 4irm ' has a value of Rs 2"" million and / hasa value of Rs !" million .er%in% the t5o
5ould allo5 cost savin%s 5ith a present value of
Rs 2! million Calculate the =7P$>,conomic
%ain from the mer%er'ssume firm / is bou%ht
for cash Rs 9! million
Io5 do you calculate economic %ain?
)i t d C h 4l $ l ti
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)iscounted Cash 4lo5 $aluation
,(uity $aluation 4irm valuation
Cash flo5s to e(uity
)iscount rate
=cost of e(uity>
Cash flo5s to firm
)iscount rate
=W'CC>
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& ,(uity $aluation
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&,(uity $aluation
• The value of e(uity is obtained by discountin% e#pected
cashflo5s to e(uity ie the residual cashflo5s aftermeetin% all e#penses ta# obli%ations and interest and
principal payments and reinvestment needs at the cost of
e(uity ie the rate of return re(uired by e(uity investors
in the firm
5here
C4 to ,(uityt < ,#pected Cashflo5 to ,(uity in period t
- e < Cost of ,(uity
Value of Equity =
CF to Equityt(1+ k e )
tt=1
t=n
∑
4C4,1 4C4,2 4C4,6 4C4,; 4C4,! 4C4,n
" 1 2 6 ; ! n
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&& 4irm $aluation
• .ost of ca"ital a""roachK The value of the firm is
obtained by discountin% e#pected cashflo5s to the firmie the residual cashflo5s after meetin% all operatin%e#penses and ta#es but prior to debt payments at the5ei%hted avera%e cost of capital 5hich is the cost of thedifferent components of financin% used by the firm5ei%hted by their mar-et value proportions
Value of Firm =CF to Firm t
(1+ WACC)t
t =1
t= n
∑
" 1 2 6 ; ! n
4C441 4C442 4C446 4C44; 4C44! 4C44n
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8eneric )C4 $aluation .odel
Cash flowsFirm: Pre-debt cash
flowEquity: After debtcash flows
Expected GrowthFirm: Growth inOperating EarningsEquity: Growth inNet Income/EPS
CF1 CF2 CF3 CF4 CF5
Forever
Firm is in stable growth:Grows at constant rateforever
Terminal Value
CFn.........
Discount RateFirm:Cost of Capital
Equity: Cost of Equity
ValueFirm: Value of Firm
Equity: Value of Equity
DISCOUNTED CASHFLOW VALUATION
Length of Period of High Growth
• 'ssume that you are analyHin% a company 5ith the follo5in% cash
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flo5s for the ne#t five years 'ssume also that the cost of e(uity is
1692! N and that the firm can borro5 lon% term at 1" N = The ta#
rate for the firm is !" N > The current mar-et value of e(uity is Rs
1"F6 and the value of debt outstandin% is Rs G""• year C4 to e(uity interest =1t> C4 to firm
• 1 !" ;" "
• 2 9" ;" 1""
• 6 9G ;" 1"G
• ; F92" ;" 1192"
• ! G6; ;" 126;
• Ter $al 19"6 2696• Calculate the value of the firm usin% ,(uity valuation and 4irm
valuation approaches
*xam"le 3
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"
2u""ose a firm has em"lo#ed a total ca"ital of 7s !1444 la&h ("rovided equall# b# !4"er cent debt and ; la&h equit# shares of 7s !44 each)1 its cost of equit# is !3 "er centand it is subDect to cor"orate tax rate of 34 "er cent$ The "roDected free cash flo's to
all investors of the firm for ; #ears are give in the table+
@ear-end !
0
3
;
7s 044 la&h
44
;44
!;4
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(ii) Valuation of ,irm1 Based on E 4
@ear-end ,.,, 6V factor(4$!4)
Total "resentvalue
!
0
3;
Total "resent valuevaluation of firm
Less value of debt
Value of equit#
7s 044
44
;44
!;4
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(iii) Valuation of *quit#1 Based on E e
@ear-end ,.,, to
all
investors
After tax
"a#ment to
debtholders
,.,* to
equit#holder
s
6V
factor
(4$!3)
Total
"resent
value
!
03
;
Total "resent value
7s 044
44
;44!;4