Financial Management Written Assignment - Unit 5 Methods of Computing

Company Valuations

THE QUESTIONS:
I. Provide a narrative explaining the market capitalization method.

II. Provide a narrative explaining the book value method.

III. Provide a narrative explaining expected future earnings method.

IV. Provide a narrative on other methods.

V. Provide a narrative that compares market capitalization, book value, and future earnings methods (and other methods mentioned) with each other.

1. Market capitalization method

The market capitalization valuation method represents the share current market price, it is
calculated by multiplying the number of shares and the current price of a single share: Market cap =
(Current market price/share) x Total number of outstanding shares.

It depends on the market perception/expectations (investors bid more for the stock price when the
earnings rise), therefore this method is not directly connected to the business but a demand for the
shares. The quoted company can have a big fluctuations in their stock prices without self-control.
Many internet/telecom companies' cap values in 1999 are worth more than their income or asset
value and this was a the causes of a crash because markets are sometimes explode in rumors,
speculations and crowd behavior.

It does’t inform about the company debt. It is only for quoted companies, not for startup ventures or
small companies.

It is fast to evaluate, would be a perfect way to value companies if they all had the same price to
earnings ratio. (Amadeo, 2019).

2. Book value method

The book value is a conservative approach: represents the value that the company based upon the
internal financial statements asking: What the different from business’s assets and liabilities? It is
more appropriate for financial holding companies because constitutes the liquid of the company
(Gordon, 2019). Can be calculate: Book Value =Total Assets − Total Liabilities (Seth, 2019).

This method does’t care intangible assets (intellectual property, human capital, and company
goodwill) because demonstrate these values poorly due to their lack of liquidity (Gordon, 2019).
This book value method fails for startup ventures types (without relevant physical assets), it is
related to the debt and potential future growth (Cameron, 2016). It also fails to measure the
intangible assets from the startup.

Creditors use the book value in order to check the ability to pay their loans and for the investors
can check the ability to pay dividends. It is also a good reference if we want to know if a company
is overvalued or undervalued: comparing market and book values price-to-book (P/B ratio).

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Financial Management Written Assignment - Unit 5 Methods of Computing

Company Valuations

It is appropriate when individual asset is more important than the value of the firm (Gordon, 2019),
even so is combined with other methods.

3. Expected future earnings method

The expected future value is based on the last Income Statement of the company is possible to
identify Revenues, Costs, amortization, investment. With this information is possible the expected
future earning. The future cash flows method uses a hurdle rate in order to calculate Net Present
Value. Therefore this method introduces the opportunity cost for the future cash flows (EDP, 2009).
The others don’t!

Although it needs a good finance projections and assumptions for the hurdle rate.

It measures the cash without influence by the shape of the company or accountability norms.

4. Other methods and comparison: market capitalization, book value, and future earnings
methods (and other methods mentioned) with each other

There are several methods and different names, but the resume is listed in four valuation methods
groups.

Base Method Comparison

Asset based (cost-based) The value of the investment can be identified by the sum of several assets
methods: Book Value less the liability.

It is a fast estimated value using the balance sheet.

Based on historical data only, so don’t consider future expectations.

Market based methods: Require financial/operational information from similar industry/business in

(Types of comparable; Based order to compare. Dividing the transaction value by EBITA, for example.
ratios & multiples) The average is multiplied by the investment amount.

This method is fast, but there are peculiar aspects from each business.

Based on historical data only (EBITDA, Net Margin, etc), so don’t consider
future expectations.

Investor valuation Require quoted companies information from similar industry/business in

(Pre and post money order to compare: trading multiple method or transaction multiple
calculations; Angel investors; method. The average is multiplied by the investment.

Venture capital; First Chicago; The estimated value is based in market information and is fast.
Strategic considerations in
valuation)

Future earnings methods/ Based on future cash flows with a rate using NPV.

Income based methods Introduce the opportunity cost.

Earning capitalization;
Build-up; DCF; Excess Value;
Value of dividends

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Company Valuations

5. CONCLUSION

The valuation has to be with more than one of the methodologies, keeping in mind the strengths and
weaknesses inherent in each approach. It is necessary to compare results among the different
methods in order to achieve a best valuation.

These methods are only informative if not combined using a crosscheck. Therefore if it one method
reveals a higher valuation than another, it may reveal something about the business

The Future earnings methods (DCF analysis) values the company according to the one item that
cannot be fudget, because it is cash. Also measures the time of the money, translating cash flows
into present value.

References:

Amadeo, k (2019). Market Cap and Why Is It Important. Three Types of Market Cap. Retrieved
from https://www.thebalance.com/market-capitalization-3305826

Cameron A. (2016). Small Business Valuation: 3 Methods to Determine Your Value. Accounting
Blog - Accounting Training, Tips, and News. Retrieve from https://www.patriotsoftware.com/
accounting/training/blog/small-business-valuation-methods-determine-value/

Gordon, J. (2019). Book value and adjusted book value methods. Retrieved from https://
thebusinessprofessor.com/knowledge-base/book-value-adjusted-book-value-methods/

Gordon, J. (2019). Business Valuation Methods. Retrieved from https://thebusinessprofessor.com/

home/entrepreneurship/business-valuation-methods/

Seth, S. (2019). Book Value Vs. Market Value: What's the Difference. Retrieved from https://
www.investopedia.com/articles/investing/110613/market-value-versus-book-value.asp

EDP. (2009). Análise de Investimentos e avaliação de projetos. [PDF document]. Retrieved from a
internal Lecture.

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