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Valuation is the device to assess the worth of
the enterprise which is the subject to merger
or takeover so that consideration amount
could be quantified and the price of the one
enterprise for the other could be fixed. Such
valuation helps in determining the value of
the shares of the acquired company as well as
acquiring company.
Need for Valuation
Valuation is needed to enable shareholders of
both the companies, to take decision in favour
of amalgamation and once they are satisfied
and have approved it with requisite majority,
the court approves the same while
sanctioning their scheme of amalgamation
because it is in the interest of shareholders
which will suffer in the event of wrong
Valuation answers
1. What is the maximum price that should be paid to the
shareholder of the merged company?
2. How is the above price justified with reference to the
value of assets, earnings, cash flows, balance sheet
implications of the amalgamation?
3. What should be the strength of the surviving
company reflected in market price or enhanced
earning, capacity with reference to the acquirers
strategies, plans, management perception and
potential market benefits to justify the consideration
of the merged company either in cash or in terms of
exchange of shares?
Basis of Valuation
1. Assets value
2. Capitalised earnings
3. Market value of listed stock
4. Investment value
5. Book value
6. Cost basis valuation
7. Reproduction cost
8. Substitution cost
Basis of Valuation
1. Assets value
2. Capitalised earnings
3. Market value of listed stock
4. Investment value
5. Book value
6. Cost basis valuation
7. Reproduction cost
8. Substitution cost
Valuation of listed companies Valuation of unlisted companies
• Shares of listed companies • A representative P/E ratio of
are quoted at stock a group of quoted
exchange and are available companies can be taken
openly. after suitable adjustment.
• Market price of the shares • Other factors to be taken
reflect their value. into consideration are
1. Company analysis
2. Industry analysis and high or
low growth industry
Modes of Valuation
1. Valuation based on earnings
2. Valuation based on assets
3. Discounted cash flow method
Valuation based on earnings
• Here the pre-determined rate of return expected by
investor on investment is used which is equal to
simple rate of return on capital employed.
• From the earnings, last declared by the company,
the items such as tax, preference dividends, are
deducted and net earnings are taken for calculation.
• This valuation is based on past performance of the
company. Whereas , reliable forecast of future
earnings is necessary.
Valuation based on earnings
A. Earnings Analysis: Short-Term View Point

Earnings per share(EPS) is the earning attributable to shareholders

which is reflected in the market price of the shares. This (P/E)
relationship is known as Price Earning Ratio.
A higher P/E ratio indicates that the company’s earnings in future
will grow where as a low P/E ratio indicates stagnancy in the
earnings in future. A reciprocal of this ratio depicts yield.

Share price(P) = EPS * P/E Ratio

(Note:- Target company’s P/E ratio is exit ratio and higher the ratio means the acquirer has
to pay more. If the exit ratio of target company is less than of the acquirer then
shareholders of both companies benefit.)
Before Takeover After Takeover

Acquirer Company(A) Acquired Combined (A+ T)

Company(T) Company

No. of shares 10000 5000 13750

Total Earnings 100000 50000 150000

EPS 10 10 10.91

Share Price(MPS) 20 15 ----

P/E Ratio (P/EPS) 2:1 1.5:1 ----

T’s market capitalisation = No. of shares of T * share price of T
= 5000 * 15
= Rs. 75000
Impact of merger on A’s shareholders:
Share price (A+T) = EPS(A+T) * P/E Ratio(A)
= 10.91 * (2:1)
= 21.82
Impact of merger on T’s shareholders:
Market Exchange Ratio for T’s shareholders = Share Price(T) / Share
Price (A)
= 15/20
New EPS = Market Exchange Ratio for T’s shareholders * EPS(A+T)
= 0.75 * 10.91
= 8.182
Valuation based on earnings
B. Limitation of short-term valuation of Earnings
• Results obtained in short term are based on
current earnings which are not much reliable.
• The growth of the company is reflected in future
earnings and without taking into consideration
the future earnings, valuation is misleading.
• Therefore, earnings forecast for the future is
prerequisite for fairer valuation.
Valuation based on earnings
C. Factors Affecting P/E Ratio
1. Risk
2. Abnormal Growth
3. Random fluctuations in earnings
Valuation based on earnings
D. Cash Flow or Future Earnings: Long Run Effect of
Takeover on EPS:-
The acquiring company, while acquiring the target
company, buys, in addition to assets, the experienced
management and organization carrying synergistic
effects on the growth of the company under new
arrangements of combination. The cash flows forecast
is based on past experience and carries synergistic
elements in it. I these circumstances , cash flow or
future earning approach may give, better and fairer
valuation of the target company.
Valuation based on earnings
E. Precautions in calculation of Earnings Per
1. EPS and bonus issue
2. EPS and issue of shares at full market price
3. EPS and issue of shares at discount or rights
Valuation on assets basis
An asset-based approach is a type of business
valuation that focuses on a company's net asset
value (NAV), or the fair-market value of its total
assets minus its total liabilities, to determine
what it would cost to recreate the business.
There is some room for interpretation in the asset
approach in terms of deciding which of the
company's assets and liabilities to include in the
valuation, and how to measure the worth of
Valuation on assets basis
Methods of valuation on Assets basis are:
1. Fair Value
2. Open Market Value
3. Other Approaches
i. Dividend Approach
ii. Super Profit Approach
iii. Capital Budgeting
iv. Historic Cost Approach
v. Net Realisable Value
vi. Current Replacement Costs
vii. Economic Values
Valuation on assets basis
1. Fair Value
Valuation based on fair value might be
appropriate when market value of a company
is independent of its profitability. Fair value
represents shareholders proportionate
ownership of the total value of the whole
Valuation on assets basis
2. Open Market Value
It refers to a price of the assets of the company which
could be fetched or realised by negotiating sale
provided there is a willing seller, property is freely
exposed to market, sale could be materialised within a
reasonable period. The assets of the company which
are not subject to regular sale could be assessed on
depreciated or replacement cost. This takes care of
under-valued assets to be properly assessed. Besides,
intangible assets like goodwill will also be assessed as
per normal practices of the business firms and
recognised conventions.
Valuation on assets basis
3. Other Approaches
i. Dividend Approach(for listed as well as unlisted

n 1 (1  i )
P = Share Price
n = No. of years in future
dn = Dividend paid in n years
i = The discount rate or required rate of returns
do(1  g )
(i  g )
Valuation on assets basis
3. Other Approaches
ii. Super Profit Approach

P  rT
Where, V T 
V= Valuation c
T= Net tangible assets
P= Maintainable future profits
r= Normal return expected on assets
c= Rate at which super normal profits are realised
X 1( I  T )  I X 2( I  T 2)  I 2 Xn(1  Tn)  In
Vo    ... 
(1  K 1) (1  K 1)(1  K 2) (1  K 1)(1  K 2)...(1  Kn)
Valuation on assets basis
3. Other Approaches
iii. Capital Budgeting Basis for Valuation
X 1( I  T )  I X 2( I  T 2)  I 2 Xn(1  Tn)  In
Vo    ... 
(1  K 1) (1  K 1)(1  K 2) (1  K 1)(1  K 2)...(1  Kn)

X = Cash Inflows
I = Investment
K = Cost of Capital
T= Rate of Tax
Valuation on assets basis
3. Other Approaches
iii. Capital Budgeting Basis for Valuation:- It is known for planning
expenditures of capital assets which provide return over a
period of time. Even outlays on advertising and promotions,
R&D providing benefits over a period of time are included in
capital budgeting.

X 1( I  T )  I X 2( I  T 2)  I 2 Xn(1  Tn)  In
Vo    ... 
(1  K 1) (1  K 1)(1  K 2) (1  K 1)(1  K 2)...(1  Kn)
X = Cash Inflows
I = Investment Note:-Frequently in
K = Cost of Capital vogue in USA and other
T= Rate of Tax developed nations.
Case in million

Year 2013 2014 2015 2016

Cash Flows 210 220 250 300

Investment 100 100 110 130

Cost of Capital 10% 12% 11% 10%

Tax Rates 50% 50% 40% 40%


210(0.5)  100 220(0.5)  100 250(0.6)  110

Vo   
(1  0.10) (1  0.10)(1  .12) (1  0.10)(1  0.12)(1  0.11)
300(0.6)  130

(1  0.10)(1  0.12)(1  0.11)(1  0.10)
5 10 30 50
Vo    
1.1 1.232 1.3675 1.50425
Vo  4.54  8.12  22.6  33.2
Vo  68.4(million )
Valuation on assets basis
3. Other Approaches
iv. Historic Cost Approach (for listed or unlisted
This is the most conservative method of
valuation and is not in use. It involves
valuation based on the cost of acquisition of
the assets standing at depreciated value in the
books of accounts of the target company.
Valuation on assets basis
3. Other Approaches
v. Net Realisable Value (for listed or unlisted
Assets based valuation is done for acquisition
of target as going concern. This method is not
suitable for valuation.
Valuation on assets basis
3. Other Approaches
vi. Current Replacement Costs (for listed or
unlisted companies):-
This method of valuation is not reliable as it is
difficult to find out replacement costs of the
assets which have been depreciated, rendered
technologically obsolete and inoperative.
Valuation on assets basis
3. Other Approaches
vii. Economic Values (for listed or unlisted
Economic value of the assets should be so
calculated to give its present value of expected
future cash flows. This valuation will resemble
the valuation done on the basis of dividend or
earnings as discussed with short comings of not
taking into consideration the intangible assets like
goodwill, etc.
Discounted Cash Flow Method
• The DCF analysis is the most thorough way to value a company.
There are two ways to value a company using the DCF approach:
the Adjusted Present Value (APV) method and the Weighted
Average Cost of Capital (WACC) Method. Both methods require
calculation of the free cash flows (FCF) of a company and the net
present value (NPV) of these FCFs.

• Future earnings can be determined by the DCF method. Here the

company first identifies those revenues that are attributable only to
the brand and not to other intangibles, and then the company
forecasts the future cash flows to be generated.

• The future estimated cash flows are then discounted at weighted

average cost of capital(k) depending on the strength of the brand.
• If the brand is weak then the discounted rate is
high, and similarly if the brand is strong then the
discount rate is low.
CFt CFt  1
• Value of brand = CF 
t 1 (1 k )
t 
(k  g )

• Where, = anticipated revenue in year ‘t’
k is discounting rate
g is growth rate of revenue
• Different modes of valuation.
• Different method of valuation on the assets
• What is open market valuation technique?
• What is capital budgeting?