Valuation Methodologies — An Overview

Unravel the complexities of valuation methodologies. A comprehensive overview awaits, shedding light on the intricate processes that determine a company's worth. From traditional approaches to innovative techniques, delve into the world of valuation and its pivotal role in business and investment decisions.

Valuation

Valuation is a process of determining the value of a company or an asset.

• Price is what you pay, and value refers to the worth of the asset; price is the result of negotiation between willing and unwilling buyers and sellers
• Depending on the structure of the transaction, management may want to value the entire business or a component of a business, or just a part of it

Discounted Cash Flow (DCF) Method

Valuers take into consideration the past profits of the company and future profitability

• The free cash flows are discounted by a Weighted Average Cost of Capital (WACC)
• WACC is an appropriate rate of discount to calculate the present value of the cash flows as it considers equity-business risk, debt-equity ratio and the equity risk premium
• After discounting future cash flows and the perpetuity value, present value is a fair indicator of the business

Valuation Methods

Valuer normally, uses several methodologies of valuation to arrive at a fair price for the entire business.

• Net Asset
• Discounted Cash Flow
• Earnings Capitalisation
• EV/EBIDTA multiple
• Comparable Transaction
• Market Price Method

COMPARABLE TRANSACTION METHOD

A relative valuation method, wherein the details of recent transactions of similar business/ companies are considered to estimate the business/ company value.

• Adequate care is to be exercised by the valuer when carrying out valuation since, the comparable transaction value may include control premium or liquidity discount which needs to be adjusted.

NET ASSET VALUE (“NAV”) METHOD

The Net Assets Method represents the value of the business with reference to the asset base of the entity and the attached liabilities on the valuation date

• Calculated using one of the following approaches: At Book Value
• While valuing the Shares/Business of a Company, the valuer takes into consideration the last audited financial statements and works out the net asset value.
• At Intrinsic Value
• When a transaction involves the transfer of assets from one entity to another, or when the intrinsic value is easily available.

Market Price Method

Valuer evaluates the value on the basis of prices quoted on the stock exchange

• Average of quoted price is considered as indicative of the value perception of the company by investors operating under free market conditions
• The average for such Market Prices could be taken on a Weighted Average method taking into consideration the value and the volumes of the transactions taken place
• At times, the valuer may also want to ignore this value if the company’s underlying asset or profitability status is not reflected

Conclusion

In practice, the valuer may consider one or more of the above methods to arrive at a fair value of the business

• A judicial recognition to the weighted average of the Net Assets Method, the Earning Capitalisation Method and the Market Price Method is found in the decision of the Supreme Court in Hindustan Lever Employees’ Union vs. 1-1LL & Others (1995) 83 Company Cases 30.
• Merger Valuations only

Earnings Capitalization Method

This method is used while valuing a going concern business with a good profitability history

• It involves determining the future maintainable earning level of the entity from its normal operations
• The maintainable profit, considered on a post tax basis, is then capitalised at a rate, which in the opinion of the valuer, combines an adequate expectation of reward from enterprise and risk to arrive at the business value

EV/EBIDTA MULTIPLE METHOD

EV/EBITDA multiple is the ratio of the value of capital employed (enterprise value) to EBITDA

• This method is similar to Earnings Capitalisation Method, with the only difference being that enterprise value needs to be capitalized to arrive at the Enterprise Value
• Enterprise Value = (Market Value of Equity + Market Value of Debt)

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