2. Valuation
FIN 449 Michael Dimond

3. Introduction What this class will cover
How do I get an A in this class?
Relevance
Schedule
Tools & resources
Student Information

4. So what’s the difference?
Definitions
Investment: Purchase of an asset which will create future cash flows.
Speculation: Taking a significant business risk to obtain a commensurate gain.
So what’s the difference?
Gambling: To bet or wager on an uncertain outcome.
Investment:
Discuss definition of “Asset”
Discuss expense vs investment
Side of beef vs buying a calf
Buying livestock vs buying stock in a company
Real assets vs financial assets
Savings account or Certificate of Deposit
How does compound interest work?
Speculation: Difference is significant risk.
Risk = Uncertainty of outcome
Downside risk
Upside risk
Gambling
Uncertainty which does not have commensurate gain.
Absolute Uncertainty: Would you bet a million dollars on a single coin flip?
"An investment operation is one which, upon thorough analysis, promises safety of
principal and an adequate return. Operations not meeting these requirements
are speculative."
-- Graham and Dodd's Security Analysis (original 1934 edition)

5. Value
A fundamental question which must be addressed in any business decision is:
“What is this worth?”

6. Valuation Concepts
There is no single value. Value opinions can change dramatically depending on the answers to these questions:
What is being valued?
Why is it being valued?
What is the appropriate standard of value?
What is the appropriate premise of value?
When is it being valued?
How will you value it?
What discounts or premiums are appropriate?

7. What is being valued? Certain assets Interest-bearing debt
Preferred stock
Common stock
Controlling interest
Non-controlling interest
Enterprise Value (or market value of invested capital)

8. Why is it being valued? Transactions Tax Litigation
Buying/Selling/Merging
Privatization
Strategic internal decisions
ESOPs
Tax
Estate, gift & inheritance taxes
Estate recapitalizations
Charitable contributions
Ad valorem taxes
Buy/Sell agreements
Litigation
Dissolution of corporation or partnership
Review/critique of another expert’s report
Damages
Lost profits
Marital dissolution

9. What is the appropriate standard of value?
FMV (Market Value)
The “cash value” of an asset to a non-specific, hypothetical buyer when there is no compulsion to sell and both parties have reasonable knowledge of relevant facts.
Investment Value
Intrinsic value. The value to a specific strategic buyer, not a hypothetical buyer. For private firms, this is often used on family law courts.
Fair Value
Created by State legislatures, “Fair Value” is defined differently in different states. It is usually used as a standard of value for dissenting stockholder lawsuits and minority oppression lawsuits.

10. What is the appropriate premise of value?
Value as a going concern
Assets in continued use as a viable business enterprise
Value as an assemblage of assets
Assets not in current use in the production of income and not as a going-concern business enterprise
Value as an orderly disposition
Assets sold individually with normal exposure to the market
Value as a forced liquidation
Assets sold individually with limited or no exposure to the market

11. When is it being valued?
Valuation date is at a particular moment in time
Could be historic date or as of the current date
Only data that is “known or knowable” as of the valuation date should be incorporated in the report
Date depends on purpose
Transaction-related (expected event, e.g. purchase)
Tax-related (date of gift, date of death, etc.)
Litigation (event date or change of value over a range of dates)

12. How will you value it? General Valuation Concepts:
The economic value of any investment asset is derived from the present value of future economic benefit that will accrue to the owner
The most theoretically correct way to value an investment is to project the future economic benefits of ownership and discount those benefits to present value at a rate which reflects the time value of money and the uncertainty (risk) associated with ownership.

13. Value
A fundamental question which must be addressed in any business decision is:
“What is this worth?”
“Value” is the present value of future cash flows.
We will be valuing companies based on their free cash flows
Damodaran has variations on FCF which we will learn: FCFF = Free Cash Flow to the Firm FCFE = Free Cash Flow to Equity

14. Considerations in Valuation
Price buyers are paying for similar assets
Cash flow generating ability
Risks associated with achieving projected cash flows
Value of the net assets owned by the business
Percent of ownership interest
Right to vote and influence business decisions
Marketability of ownership position
Special perquisites of ownership or management

15. Approaches to Valuation
Market Approaches
Example: Relative valuation estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common variable like earnings, cashflows, book value or sales.
Income Approaches
Example: Discounted cashflow valuation relates the value of an asset to the present value of expected future cashflows on that asset.
Asset-based Approaches
Example: Adjusted net asset value method adjusts all individual assets and liabilities to market value. The amount by which asset value exceeds liability value is the equity value.
Option-based Approaches
Example: Contingent claim valuation, uses option pricing models to measure the value of assets that share option characteristics.

16. Basis for all valuation approaches
The use of valuation models in investment decisions (i.e., in decisions of which assets are under valued and which are over valued) are based upon
a perception that markets are inefficient and make mistakes in assessing value
an assumption about how and when these inefficiencies will get corrected
In an efficient market, the market price is the best estimate of value. The purpose of any valuation model is then the justification of this value.
Implicit in most valuation is the assumption that markets make mistakes and that we can find those mistakes by using the right valuation models. An often unstated assumption is that markets will correct their mistakes, resulting in excess returns for investors.
If you do believe that markets are efficient, valuation still may be a useful tool in different contexts:
Valuing private businesses (where there is no market to yield a price)
Valuing the effect of a restructuring or a merger, where the market has not had a chance to react to the changes being considered.

17. What discounts/premiums are appropriate?
Value may be influenced by extenuating factors
Premiums
Control
Strategic acquisition
Discounts
Lack of control
Lack of marketability (liquidity)
Trapped-in capital gain
Key person
Known (or potential) environmental liability
Pending litigation
Concentration of customer base or supplier base

18. Where are we going with all this?
Facts & Information:
Business Model
History
Industry
Peer Firms
Free Cash Flows
Financial Statements
Adjusting & Forecasting CF
Risk &
Costs of Capital
Gateway Assessm’t
Strawman Model
Assignments
Team Project
Final Project
DCF Computations
Relative Valuations
Value Hypothesis
& Perspective

19. Valuation – The Big Picture