ASSIGMENT

OF
BUSINESS ANALYSIS
AND
VALUATION

Submitted to: Submitted by:

Ms. MONIKA Mehak(1215740)
Tamanna Sharma(1212019)
Vishakha Chauhan(1212000)
Diksha Kaliraman(1215736)
MBA(final)
VALUE IS DEFINED AS PURCHASING POWER.

VALUE: Value is the worth of a thing a bundle of benefits, it can be tangible or intangible
or it can be change in the market.

VALUATION: Valuation is the process of determining the current worth of an asset or a

company; there are many techniques used to determine value. An analyst placing a value on a
company looks at the company's management, the composition of its capital structure, the
prospect of future earnings and market value of assets.

ELEMENTS OF BUSINESS VALUATION

Three Elements of Business Valuation Business valuation refers to the process and set of
procedures used to determine the economic value of an owners interest in a business. The
three elements of Business Valuation are:

(1) Economic Conditions: As we see in Portfolio Management Theory, wherein we adopt

the Economy-Industry-Company (E-I-C) approach, in Business Valuation too, a study
and understanding of the national, regional and local economic conditions existing at the
time of valuation, as well as the conditions of the industry in which the subject business
operates, is important. For instance, while valuing a company involved in sugar
manufacture in India in January 2013 the present conditions and forecasts of Indian
economy, industries and agriculture need to be understood before the prospects of Indian
sugar industry and that of a particular company are evaluated.

(2) Normalization of Financial Statements: This is the second element that needs to be
understood for the following purposes: (a) Comparability adjustments: to facilitate
comparison with other organizations operating within the same industry. (b) Non-
operating adjustments: Non-operating assets need to be excluded. (c) Non-recurring
adjustments: Items of expenditure or income which are of the non-recurring type are to
be excluded to provide comparison between various periods. (d) Discretionary
adjustments: Wherever discretionary expenditure had been booked by a company, they
are scrutinised to be adjusted to arrive at a fair market value.
 (3) Valuation Approach: There are three common approaches to business valuation -
Discounted Cash Flow Valuation, Relative Valuation, and Contingent Claim Valuation.
Within each of these approaches; there are various techniques for determining the fair market
value of a business. Valuation models fall broadly into four variance based respectively on
assets, earning, dividend and discounted cash flows, typically using a Capital Asset Pricing
Model to calculate a discount rate.

BUSINESS VALUATION APPROACHES

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(I) Asset-based approach

The asset-based approach has many other common names such as the asset accumulation
method, the net asset value method, the adjusted book value method and the asset build-up
method. The purpose of the model is to study and revaluate the companys assets and
liabilities obtaining the substance value which also is the equity.

(II) Income-based approach

The income approach is commonly called Discounted Cash Flow (DCF) . It is accepted as an
appropriate method by business appraisers. This approach constitutes estimation of the
business value by calculating the present value of all the future benefit flows which the
company are expected to generate.
Mathematically it can be expressed as the following formula:
PV = FV / (1 + i)n
Where,
PV = Present Value
FV = Future Value
i = discount rate reflecting the risks of the estimated future value
n = raised to the nth power, where n is the number of compounding periods

(III) Market-based approach

The market approach determines company value by comparing one or more aspects of the
subject company to the similar aspects of other companies which have an established market
value.

BUSINESS VALUATION MODELS

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Wide ranges of models are used in valuation ranging from the simple to the sophisticated. In
general terms, there are three models to valuation.
(1) Discounted cash flow valuation: It relates to the value of an asset to the present value of
expected future cash flows on that asset. DCF method is an easy method of valuation.
This approach has its foundation in the present value rule, where the value of any asset is the
present value of expected future cash flows that the asset generates. To use discounted cash
flow valuation, you need
To estimate the life of the asset
To estimate the cash flows during the life of the asset
To estimate the discount rate to apply to these cash flows to get present value

Value

Where,
=
n = Life of the asset
CF = Cash flow in period t
r = Discount rate reflecting the riskiness of the estimated cash flows
The cash flows will vary from asset to asset.

Inputs to Discounted Cash Flow Models

(a) Discount Rates

In valuation, we begin with the fundamental notion that the discount rate used on a cash flow
should reflect its riskiness. In case of higher risk, cash flows to be discounted with higher
discount rates. There are two ways of viewing risk. The first is purely in terms of the
likelihood that an entity will default on a commitment to make a payment,
The second way of viewing risk is in terms of the variation of actual returns around expected
returns. The actual returns on a risky investment can be very different from expected returns.

(b) Expected Cash Flows

In the strictest sense, the only cash flow an equity investor gets out of a publicly traded firm
is the dividend; models that use the dividends as cash flows are called dividend discount
models. A broader definition of cash flows to equity would be the cash flows left over after
the cash flow claims of non-equity investors in the firm have been met (interest and principal
payments to debt holders and preferred dividends) and after enough of these cash flows has
been reinvested into the firm to sustain the projected growth in cash flows. This is the free
cash flow to equity (FCFE), and models that use these cash flows are called FCFE discount
models.
The cashflow to the firm is the cumulated cash flow to all claimholders in the firm. One way
to obtain this cashflow is to add the free cash flows to equity to the cash flows to lenders
(debt) and preferred stockholders. A far simpler way of obtaining the same number is to
estimate the cash flows prior to debt and preferred dividend payments, by subtracting from
the after-tax operating income the net investment needs to sustain growth. This cash flow is
called the free cash flow to the firm (FCFF) and the models that use these cash flows are
called FCFF models.
(c) Expected Growth
While estimating the expected growth in cash flows in the future, analysts confront with
uncertainty most directly. There are three generic ways of estimating growth. One is to look
at a companys past and use the historical growth rate posted by that company. The peril is
that past growth may provide little indication of future growth. The second is to obtain
estimates of growth from more informed sources. For some analysts, this translates into using
the estimates provided by a companys management whereas for others it takes the form of
using consensus estimates of growth made by others who follow the firm.

ADVANTAGES OF DCF MODEL:

a) Understanding of business
b) To look for fundamentals
c) Not based on perception

LIMITATION OF DCF MODEL:

a) Cyclic firm
b) Firm with unutilized assets
c) Firms in the process of restructuring
d) Private firms
e) Biasness

This model is only suitable for Long-term investments.

(2) Relative valuation : It estimates the value of an asset by looking at the pricing of
comparable assets relative to a common variable such as earnings, cash flows, book
value or sales. The profit multiples used are (a) Earnings before interest, tax,
depreciation and amortisation (EBITDA), (b) Earning before interest and tax (EBIT), (c)
Profits before tax (PBT) and (d) Profit after tax (PAT).
KEY COMPONENTS-
a) Comparable Assets
b) Standardised Price

ADVANTAGES OF RELATIVE VALUATION:

a) Simple to calculate
b) Quick Estimation
c) Tailor made solution

DISADVANTAGES OF RELATIVE VALUATION:

a) Misuse or Manipulation
b) Define only undervalued & overvalued not defines the reason
 STEPS IN RELATIVE VALUATION:

(3) Contingent Claim valuation: It uses option pricing models to measure the value of
assets that have share option characteristics. Some of these assets are traded financial
assets like warrants, and some of these options are not traded and are based on real
assets. Projects, patents and oil reserves are examples. The latter are often called real
options.

Key benefits of carrying out earnings based valuation and/or contingent valuations are:
(1) They allow firms that are going concerns to value their ability to generate free cash flows
in the near and far term;
(2) They make an estimate of the WACC and the ability of these future free cash flows to
create wealth;
(3) They estimate the terminal value of the company and therefore capture the effect of the
companys intangible assets like branding, intellectual capital etc;
(4) They permit the owners an intelligent and economically way of transiting from the
business; and/or
(5) Provide for effective succession planning.