company valution

7/30/2019 Company Valution

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www.bradford.ac.uk/management

Lecture 4

Company Valuation
http://www.bradford.ac.uk/managementhttp://www.bradford.ac.uk/management


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Learning Objectives

Value a company and its shares using:

Net Assets Value method

Price:Earnings Ratio method

Discounted Cash Flow method

Discuss the limitations of these three methods

Reading: Pike and Neale: Ch 12


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Company Valuation

WHYdo we want to value companies?Armed with knowledge of valuation principles:

we can value acquisition candidates (and also assess

own firms value when defending!)valuation for privatisation

valuation for flotation (IPO - Initial Public Offerings)


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How Do We Value Companies?

Quoted Companies do we trust the market value?

is the stock market efficient?

Unquoted Companies use various techniques of valuation


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The Three Basic ValuationMethods

Net asset value (from the Balance Sheet)

Price-earning multiples (focus on the P&L)

Discounted cash flow /Shareholder value

analysis


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Remember Your Accounting!

What did the accounting equation say?

Assets dont grow on trees!

i.e. every asset has to be financed somehow

Total Assets = Total Financing

= [Equity + Debt]

Valuation methods tend to focus on equity value i.e. value ofnet assets:

Net Asset Value / Equity Value = [Total assets - total debts]


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Total Company Value vs.Equity Value

Total Company Value is also called Enterprise Value(= equity + debts)

How to acquire a firm:

a) to buy a whole company, ie, buy equity and pay off the

debt. It is usually more expensive.

b) to buy out the owners equity stake and to take

responsibility for the debt.

usually, carry the debt on (assume it)


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Net Asset Value (NAV)

NAV

Remember, NAV = Net Assets

= Value of Shareholders Stake

From the accounts:

NAV = Total AssetsTotal

Liabilities

Fixed Assets

+

Current Assets

Current

Liabilities

+

Long-term

Debt

=


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Illustrative Example

Shark vs. Minnow

Shark proposes to take over MinnowAssume:

Minnows depreciation charge = 0.3m p.a.


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Shark vs. Minnow extracts from accounts

Shark Minnow

m m

Fixed assets (net) 12.2 3.5

Current assets 7.3 3.7

Current liabilities (2.2) (1.1)

10% long-term loan stock(bonds) (3.5) (0.5)

Net assets 13.8 5.6Ordinary share capital (par value 1) 10.0 5.00

Share premium - 0.2

Profit and Loss Account 3.8 0.4

Shareholders funds 13.8 5.6

Profit after tax attributable to

ordinary shareholders 2.4 1.5

Current market price/share 2.40 n/a

EPS 24p 30p

P:E ratio 10:1 n/a


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NAV of Minnow

What is NAV of Minnow?

NAV = [FA + CA - CL - LTD]

= [3.5m + 3.7m - 1.1m - 0.5m]

= 5.6m

Or, in terms of value per share

NAV = 5.6m/5m = 1.12 per share

But what is the value of the whole company?

Total assets: 3.5 + 3.7 = 7.2m


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Problems with the NAV

Fixed Assets usually valued at Historic Cost

Some debtors may not be collected

Are there any off-balance sheet liabilities?

Are the accounts reliable?

Window dressing/creative accounting

Fundamental Problem:

Ignores Earning Power of the Assets


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Price:Earnings Multiples

Remember, P:E ratio = Price per share

Earnings per Share

EPS (Earnings per Share)= Profit after Tax / No of

(ord.) Shares

For example,Suppose EPS = 20p and a share price = 2

P:E ratio = 2 / 0.2 = 10:1


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Indicates how the market values each 1 of firms

profits

Suggests how quickly firm will recover its currentshare price via earnings

High PER indicates good growth potential


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Alternatively, P:E ratio = Value of equityProfit after tax

( value of equity = share price xno of shares)

Value of equity = [Profit after tax] x [P:E ratio]


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P:E Valuation of an UnquotedCompany

Take the P:E Ratio for a comparable quoted company- Shark? ie, P : E = 10

Apply to maintainableprofits of target firm

Minnow:

Value of equity = [Profit after tax] x P:E ratio

= 1.5m x 10

= 15m

Value per share = 15m / 5m = 3

Lower the P:E ratio, lower the valuation

-- e.g. if P:E = 6,

value of equity = 1.5 * 6 = 9m


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Problems with the P:E Approach

Uses accounting profits as a basis, with all itsdistortions

e.g. inter-company comparisons suspect

How close a fit is the surrogate?

different mgt. ability, markets, products, etc

i.e. different growth capacities

Comparability of quoted and unquoted companies

stock market awards a premium for size, stabilityand marketability


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EBITDA

Earnings (profit) Before Interest, Tax Depreciationand Amortisation

A more cash-oriented yardstick

Rough guide to operational cash flow

Often combined with capital employed to yield CashFlow Return on Investment

CFROI = EBITDA/Capital Employed

Used on a comparative basis i.eas a cross- check onvalue


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Discounted Cash Flow (DCF)

The DCF model states that the value of the owners

stake in a company is the sum of future discounted free

cash flows:

WhereFCF = Free Cash Flow

r = the rate of return required by shareholders.

n

n

r

FCF

r

FCFr

FCFV)1(

...)1()1(2

210


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What is Free Cash Flow?

Free cash flow cash left in the company after meeting

all operating expenditures, all mandatory expenditures

such as tax payments and investment expenditure.

Free cash flow (FCF) =

Operating profit + Depreciation Interests Taxes

Investment expenditure


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Discounted Cash Flow (DCF)

Predict future cash flows from operations

Roughly, profit after tax, plus depreciation

Adjust for known investment needs

e.g. to replace worn-out equipment, expansion Result is FREE CASH FLOW

Discount at shareholders required return

Value of equity = Sum of discounted FCFs


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Minnows Cash Flows

How much is the cash flow?CF = Profit after tax + Depreciation (roughly)

= [1.5m + 0.3m] = 1.8m

How much investment is required to replace worn-outassets (replacement expenditure)?

assume this expenditure = depreciation charge

FCF = [1.8m - 0.3m] = 1.5m


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Minnows Value Lifetime of company?

-- Assume perpetuity

Recall the formula for calculating PV of a perpetuity

Value = Free Cash Flow / Discount rate

-- Assume investors require 15% return

Value of equity = 1.5m / 15%

= 10m

Value per share = 10m / 5m = 2

r

CperpetuityPV


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Problems with the DCF Approach

Still based on accounting figures i.e. PAT

Can the future investment be accurately predicted?

Assessing the required return

Assessing the relevant time horizon

if less than perpetual, what to assume for later years?No further cash flows??


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So what have we learned??

How to value a company by applying

- NAV

- P:E ratio and- DCF

The limitation of each method.


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Thank you !

company valution

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