Crest Sep12 Sesssion 3

Business Valuation

Session 3

AbhimanyuAugust 30, 2009

September 12, 2009 Corporate Restructuring | Session 1 2

Value and Price

• Value of a particular business or asset may be different for different parties depending upon strategic intent, synergies or for other reasons.

• Value must be clearly distinguished from price and businesses may justifiably undertake to consummate a transaction at a price which does not fall within an assessed fair value range.

• Given the valuations or valuation range / band suggested by valuers, the prerogative to decide upon a specific price is finally with the management and the Board of Directors of the Company.

• The valuation is only a tool to aid management in decision-making.

• The valuation is also time dependent.


Valuation Methods

• Asset Approach– Book Value, Adjusted Book Value, and Liquidation Value

• Income Approach– Capitalization of Earnings, Capitalization of Excess Earnings, and

Discounted Future Earnings/Cash Flows, Discounted Future EVAs.• Market Approach

– Current Market Prices, Historical Market Prices, Price to Earnings, Price to Revenue, Price to Book Value, Price to Enterprise Value

• Comparable Transactions/Relative Valuations– Comparable International and Domestic Transactions.

• Sum-of-parts Method

• Real Options Value

fatemeh

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fatemeh

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In accounting, book value or carrying value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities

fatemeh

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Liquidation value is the likely price of an asset when it is allowed insufficient time to sell on the open market, thereby reducing its exposure to potential buyers. Liquidation value is typically lower than fair market value. Unlike cash or securities, certain illiquid assets, like real estate, often require a period of several months in order to obtain their fair market value in a sale, and will generally sell for a significantly lower price if a sale is forced to occur in a shorter time period

fatemeh

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A company may have businesses that are too varied for the application of a single valuation method or ratio to all its businesses to be useful. This means, for example, that applying EV/EBITDA to total EBITDA, or using CAPM with a single beta may be not be the right approach.

fatemeh

HighLight

n corporate finance, real options analysis or ROA applies put option and call option valuation techniques to capital budgeting decisions.[1] A real option itself, is the right — but not the obligation — to undertake some business decision; typically the option to make, abandon, expand, or shrink a capital investment. For example, the opportunity to invest in the expansion of a firm's factory, or alternatively to sell the factory, is a real option.


Asset Approach

• May be important in capital intensive industries or in acquisitions where valuable non-operating assets can be stripped after the purchase of the company to recover part of acquisition cost.

• Where there are no (or very little) intangibles.• This approach is inappropriate in case of

acquisition/sale of minority interests.


Asset Approach: Premises of Value

• Sale as a going concern:– Value-in-use

• Fair market value of assets and liabilities

• Sale on a liquidation premise:– Liquidation value (value-in-exchange)

• Orderly liquidation.• Forced liquidation

• Treatment of non-recurring/ non-operating assets and liabilities in case of valuation of controlling/ minority interest.


Income Approach

• It is more often used than market/asset approaches.

• It is a preferred approach for closely held (and also widely held) knowledge based companies.

• It is also used in case of service industries.• Of course, it suffers from accounting

distortions. Hence caution is advised.


Income Approach: Methods

• Single-period Capitalization Method:– Valuation is based on the net income of one

year only and hence it can produce reliable value only if the income chosen is representative of the company’s anticipated long-term future performance.

• Multi-period Discounting Method:– Discussed under DCF method.


DCF Method: Certain Issues

• Forecast Variables• Forecast Horizon:

– Period should be long enough to portray all anticipated variations in the entity’s cash flows and until a stabilized cash flow is achieved.

• Continuing Value• Cost of Capital

– Debt cost– Equity cost– Weighted Average Cost of Capital (WACC)


Cost of Capital

• Cost of Debt:– Direct Approach.– Weighted Average Method.

• Cost of Equity: CAPM– What is the risk-free rate?

• Logic of using a long-term rate.

– What is your equity beta?– How much is the equity risk premium (ERP)?


Cost of Equity

• CAPM:– Re=Rf +β(ERP)

• Modified CAPM (used for closely held targets)– Re=Rf +β(ERP)+SCP+SCRP

• Where SCP=Small company premium and SCRP=Specific company risk premium (unsystematic risk- also known as ‘α’).

• Buildup Method (used for closely held targets)– Re=Rf +ERP+SCP+SCRP

• The size of SCRP is usually smaller when used in MCAPM than when used in buildup method.


Risk Free Rate

10 Year Govt. of India Bond Yield

4.00

5.00

6.00

7.00

8.00

9.00

10.00

Nov-04 Jul-05 Mar-06 Nov-06 Jul-07 Mar-08 Nov-08 Jul-09


Beta

0.340.800.720.82-0.520.43CNX-500

0.340.860.600.90-1.050.56NIFTYHEROHONDA

0.340.650.430.140.100.35CNX-500

0.380.650.380.170.160.38NIFTYBERGER

0.630.600.400.600.470.84CNX-500

0.790.670.370.750.601.15NIFTYITC

0.850.961.101.030.640.80CNX-500

1.061.051.141.210.911.10NIFTYRIL

1.611.191.642.122.031.39CNX-500

1.581.332.051.962.340.98NIFTYWIPRO

5-yearly03-0402-0301-0200-0199-00IndexCompany


ERP

13.149.8210-yearly average

83.7222.5411.3095.0233.841999-2000

-10.36-11.5212.031.670.511998-99

4.764.8312.2717.0317.101997-98

-15.33-10.5214.01-1.323.491996-97

-17.80-10.4715.67-2.135.201995-96

-27.44-29.3515.39-12.05-13.961994-95

47.8241.1013.3861.2054.481993-94

-73.77-68.3413.23-60.54-55.111992-93

113.99124.5113.36127.35137.871991-92

25.7735.4412.3038.0747.741990-91

ERPERPRisk freeBSE 100SENSEXYear

BSE 100SENSEXLong-term Risk Premium


Specific Company Risk Premium

• Should reflect the analysis of the competitive conditions in which the company operates. Some common company-specific risk factors:– Lack of access to capital– Ownership structure and stock transfer restrictions.– Company’s market share and the market structure of the

industry– Depth and breadth of the management– Heavy reliance on individuals with key knowledge, skills or

contracts.


Control Premium and Illiquidity Discount

• Such premium or discount should be applied in adjusting cash flows rather than in the discount factor.

• If the target is a closely held company in which a controlling interest is being acquired, do notautomatically assume that a control premium and a discount for lack of marketability must be applied to each value determined for the company.

• The correct methodology is to identify the nature of the value initially computed by each appraisal method.


Valuation: Concluding Remarks

• Valuation exercise involves more judgments than precise facts.

• The success of a valuation exercise depends on how scientific were you in your intuitive judgments.

• Hence, valuation is an artistic science.

Economy & Finance

Crest Sep12 Sesssion 3