1. Chapter 17
Business Valuation

2. Valuation approaches (This text assumes an acquisition context)
Valuation closely related to cash flows
≈ net present value of future cash flows
Regardless of methodology, valuation steps:
Strategic analysis of target for fit, etc.
Financial analysis, using ratios, etc.
Projection of future performance
Application of valuation approach
Chapter 17
© Philip O’Regan 2016

3. Valuation approaches ctd.
Cash flow
Most commonly used method
Determine/estimate future cash flows
DCF (discounted cash flow): apply discount factor to reflect risks, etc.
Discount factor uses WACC
This reflects risk threshold and capital structure
Assess value in context of net present value (NPV)
Chapter 17
© Philip O’Regan 2016

4. Worked example p.561 Year Amount Discount Factor NPV 1 £100,000 0.952
£95,200 2
£110,000
0.907
£99,770 3
£120,000
0.864
£103,680 4
£200,000
0.823
£164,600 5
£250,000
0.784
£196,000
Totals
£780,000
£659,250
Chapter 17
© Philip O’Regan 2016

5. Book value Less common approach Limited perspective
Adopts historic cost basis of financial accounts
Does not allow for up-to-date market value
Limited application
Zombie banks of recent years have used it!
Chapter 17
© Philip O’Regan 2016

6. Market value (capitalization)
Takes stock exchange valuation as proxy
MV = Share Price x Market value per share
Intuitively appealing
But fails to take account of:
fluctuations inspired by bid process
premium demand by key stakeholders
other stakeholders
Nevertheless, good approximation of value
Chapter 17
© Philip O’Regan 2016

7. Price (earnings) multiples
Reflects role of profits in determining value
P/E ratio can be used as multiplier
Already captures market expectations (p.357)
But based on EPS which is unsound
Best used to:
establish initial valuation and/or
in tandem with other DCF approaches
Chapter 17
© Philip O’Regan 2016

8. Enterprise value (EV) Combines strengths of other approaches
In particular, it is sensitive to capital structure of acquirer and acquiree
Allows for different debt/equity structures
Recognizes that acquiring equity not always sufficient
Value = “sum of all claims on the business”
= MV + Debt – Cash
Chapter 17
© Philip O’Regan 2016

9. Economic value added (EVA)
Not based on “accounting profits”
Adopts opportunity cost perspective
Highlights cash flow increments above WACC
= Operating Profit after Tax and WACC
Changes focus onto “economic profit”
Useful as non-accounting approach
Chapter 17
© Philip O’Regan 2016

10. Altman’s “Z-score” Insights on viability of acquisition target
May inform strategy and/or timing
Composite model that draws on financial information to predict bankruptcy
Not a valuation model per se:
More useful in determining viability
Only used as one element of process
Chapter 17
© Philip O’Regan 2016

11. Financial Information Analysis
Summary
Various valuation approaches possible
Valuation one step in acquisition process
Most valuation approaches use DCF
Credibility of cash as valuation basis
But difficulties posed by estimation/WACC, etc.
Alternatives includes “earnings” as basis
Enterprise value sensitive to structure
Acquisitions often more to do with ego!
Chapter 17
Financial Information Analysis