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An overview

What is business valuation...?


Business valuation is a study or a process which determines the value of a business or an entity.

The purpose behind valuing a business


Expansion of business. Acquisition of a business or an entity. Selling a business or an entity. Identify the current worth of the business. Etc....

Methods of valuation

Market based

Asset based

Earnings based

Dividend based

Cash flow based

Market Based Valuation


Most common and accurate method of valuing a business which considers the market value of the business using the prevailing market indicators.(especially quoted investments or assets) Example : Market price per share, Market value of assets etc.....

Asset based valuation


Assumes the value of the business to be equal to the net assets attributable to its equity shares.

Value of business = Net assets of company ( Equity + reserves) Most simple and accurate method of valuing a business in the absence of market information of the company.

Asset based valuation


( Sub classes)

Book value

Replacement value

et present value

Considers the book value of assets to be the value of the business

Value of the business is considered to be the net asset replacement cost

Future earnings of the assets are considered as the present value of the business

Earnings Based Valuation


Assumes the value of a business to be its present value of the future earnings generated by its activities.

Uses the Price earnings ratio and post tax profits of a Company in arriving at the market value. Relies on similar and comparable businesses.

Example
Company A Profit after tax = 10 million Company BMarket price per share = QR.50 EPS = 10 P/E Ratio of B =5 (50/10). Value of Company A = 5* 10mn (P/E ratio * PAT) = 50 million

Dividend based Valuation

Value of an entity is equal to the present value of future dividends payable by the business. This method assumes the dividend to be the major indicator of growth based on the Signalling effect Shown by growth in dividends.

DVM -Relies heavily on cost of equity. And -Dividend growth rate.

Dividend based Valuation


(Sub classes)

Dividend yield

Dividend growth

Assumes the dividend growth of a company is to be 0.

Assumes the dividend of a company to grow at a constant annual rate.

Dividend based Valuation contd..


Dividend growth model
M r et ri e er sh re Dividend* ( Growth)/ Cost of e uity

Do(1+g)/(Ke-g)

Example : Ke= 10% Gr t = 2% i idend= 5(Per s

re)

MP = 5*(1.02)/ 0.08 = 63.75

Cash flow based Valuation


Assumes that the value of a business to be the Net present Value of future cash flows it generates.

CBV - Relies heavily on future expected cash flows of the company. - Cost of capital used.

Strength & Weaknesses of Valuation Methods


Market Based Valuation
Strength Provides an accurate value for the business. Relatively easy to compute.

Weakness Market price is heavily Influenced by speculation.

Asset Based Valuation


Strengths Valuation is fairly readily available. Provides a minimum value of the business. Weaknesses Future profitability expectations are ignored. B/S Valuation depends on accounting convention, this leads to a different value from market valuation. Difficult to allow for intangible assets.

Earnings based valuation


Strengths Commonly used and is well understood. Relevant for valuing a controlling interest in an entity.

Weaknesses Based on accounting profits rather than cash flows. Difficult to identify a suitable P/E ratio (Ex. Valuing an Unquoted Company) Difficult to establish the relevant level of sustainable earnings.

Dividend based valuation


Strengths Value is based on the present value of the future dividend income stream. Useful for valuing minority share holdings. Weaknesses
Difficulties associate with calculating MPS. Different expectations of share holders - Higher Dividend growth, capital gains. Different attitudes between institutional and individual investors .

d0

is based on EPS, so factors affecting EPS should be considered.

Suitable for valuing small share holding rather than for valuing a controlling interest

Cash Flow based valuation


Strengths It can be used to place a maximum value on the entity. It considers the time value of money.

Weaknesses It is difficult to forecast cash flows accurately. Determination of discount rate tends to be subjective and complexed.