Asset-Based

Valuation
Module 6: Valuation and
Concepts
Learning Content:
• Asset-Based Valuation
• Discounted Cash Flow Analysis
• Comparable Company Analysis
• Price – Earnings Ratio
• Book-to-Market Ratio
• Dividend – Yield Ratio
• EBITDA Multiple
Asset-Based
Valuation
Asset-Based Valuation
Asset has been defined by the industry as transactions that would
yield future economic benefits as a result of past transactions. Hence,
the value of investment opportunities is highly dependent on the
value that the asset will generate from now until the future. The value
should also include cash flows that will be generated until the
disposal of the asset.
Asset-Based Valuation
In practice, observe valuation as a sensitive and confidential activity in their
portfolio management. Valuation should be kept confidential to allow the
company to negotiate a better position for them to acquire an opportunity.
Since the value of the assets will depend on its ability to generate economic
benefits, it is more challenging to determine the value of a green field
investment since all shall be based on purely estimate than brown field.
Recall, the green field investments are those started from scratch while
brown field investment are those opportunities that either partially or
fully operational. Brown field investments are those already in the going
concern state, as most business are in the optimistic perspective that they
will grow in the future. Therefore, they can also be considered as going
concern business opportunities (GCBOs). Going concern business
opportunities are those businesses that have a long term to infinite
operational period.
Asset-Based Valuation
The beauty of GCBOs is that we already have a reference for their performance
either on similar nature of business or from its historical performance. With this,
the risk indicators can be identified easily and therefore can be quantified
accordingly. The Committee of Sponsoring Organization of the Treadway
Commission (COSO) suggests that risk management principles must be observed
as well in doing businesses and determining its value. It was noted in their report
that the benefits of having a sound Enterprise-wide Risk Management allows for
the company to:
1. increase the opportunities;
2. facilitate the management and identification of the risk factors that affect the business;
3. identify or create cost-efficient opportunities;
4. manage the performance variability;
5. improve management and distribution of resources across the enterprise; and
6. make the business more resilient to abrupt changes.
Asset-Based Valuation
The importance of identifying the risk is to enable the investors to
quantify the impact of the risk and/or the cost of managing these
risks. Theoretically, in valuation since it is more on the economic
benefits valuation to determine the asset value, the pertinent and
anticipated outflows must be included.
The critical part in valuing an opportunity is determining its value as
an asset for the investor or the enterprise. For GCBOs, there are
different approaches that can be used, the most popular are:
discounted cash flows or DCF analysis, comparable company analysis,
and economic value added.
Discounted
Cash Flow
Analysis
Discounted Cash Flow Analysis
The Net Cash Flows are the amounts of cash available for distribution
to both debt and equity claim from the business or asset. This is
calculated from the net cash generated from operations and for
investment over time. For GCBO, the net cash flows generated will be
based on the cash flows from operating and investing activities, since
this represents already the amount earned or will be earned from the
business and the amount that is required for you to infuse in the
operations to generate more profit. Theoretically, it can be equated
as:
Free Cash Flows = Revenue – Operating Expenditures – Taxes – Capital Expenditures
Discounted Cash Flow Analysis
Let's bear in mind that this is cash flows based. For accounting majors and professionals, you should
consider that the operating expenditures mentioned here pertains to those above the EBITDA level
or Level of Earnings Before Interest, Depreciation and Amortization. This will allow the investor to
determine the true value of the asset based on the amount it economically generated less the
amount you've spent. The advantage of EBITDA is that it already excludes interest that represents
the cost of financing the asset, taxes you pay to the government because this should be accounted
separately, and depreciation and amortization which is part of the capital expenditures which will be
deducted separately as well. EBITDA Margin or the level of earnings you earn from the sales enables
the investor to have an overview of the opportunity they are going to realized among others.
There are two levels of Net Cash Flows: (1) Net Cash Flows to the Firm; and (2) Net Cash Flows to
Equity. The Net Cash Flows to the Firm represents the cash flows which was described in the
preceding paragraph.
This is the amount made available to both debt and equity claims against the company. The Net
Cash Flows to Equity represents the amount of cash flows made available to the equity stockholders
after deducting the net debt or the outstanding liabilities to the creditors less available cash balance
of the company.
Discounted Cash Flow Analysis
Since GCBOs is assumed to operate in a long period of time to almost perpetuity, the risk
and returns are inherent to the opportunity should also be quantified. Furthermore, the
economic value that will be generated by the assets is expected to be stable after some
point in time, since the projections are reliant on certain assumptions made. The
challenge for the determination of the value of the asset is to also account for the
economic returns that it will generate in perpetuity. This is addressed by the Terminal
Value. Terminal Value represents the value of the company in perpetuity or going concern
environment. The convenient way to determine the terminal value or terminal cash flows
is through this equation:
Discounted Cash Flow Analysis
To illustrate, suppose that a company assumes net cash flows as
follows:

Year Net Cash Flows (in million PHP)

1 5.00
2 5.50
3 6.05
4 6.66
5 7.32
Discounted Cash Flow Analysis
In the given illustration, you may note that the net cash flows are growing
annually. Assuming this is a GCBO, and it is expected that the net cash flows
will behave on a normal trend. The growth rate (g) is compounded using
compounded annual growth rate formula:
Discounted Cash Flow Analysis
Substituting the given figures, the growth is computed as:
Discounted Cash Flow Analysis
The growth rate is 0.10 or conversely 10%. In the illustration, it will be assumed
that the company will continuously grow by 10% from 5th year onwards. With this,
the terminal value is PHP 73.20 million computed as follows:
Discounted Cash Flow Analysis
The net present value of the Net Cash Flows represents the value of
the assets. It may be recalled further that the assets are financed by
debt and equity. Hence, these are the claims which are presented at
the right side of the Statement of Financial Position, under an account
form of reporting.
DCF Analysis is most applicable to use when the following are
available:
– Validated Operational and Financial Information
– Reasonable appropriated cost of capital or required rate of return
– New quantifiable information
Discounted Cash Flow Analysis
Supposed Bagets Corporation projected to generate the following for
the next five years, in million pesos:
Revenue Operating Expenses* Taxes
1 92.88 65.01 8.36
2 102.17 71.52 9.19
3 112.38 78.67 10.11
4 123.62 86.53 11.13
5 135.98 95.19 12.24
*Operating Expenses exclude depreciation and amortization
Discounted Cash Flow Analysis
The capital expenditures
that was purchased and
invested in the company
amounted to PHP 100
Million. The terminal value
was assumed to be
computed using 10%
growth rate. It was noted
further that there is an
outstanding loan of PHP 50
Million. If you are going to
purchase 50% of Bagets
Corporation, assuming a
7% required return, how
much would you be willing
to pay?

Based on the foregoing information, the value of Bagets Corporation equity

PHP 150 Million. If the amount at stake is only 50% then the amount to be
paid is Php13.33 Million (Php26.65 x 50%).
Comparable
Company
Analysis
Comparable Company Analysis
In Financial Management, financial ratios are used as tools to assess and
analyze business results. Recall that one of these purposes can be used to
determine market value. These financial ratios are P/E Ratio, Book to
Market Ratio, Dividend Yield per Share and EBITDA Multiple. Ratios or
multiples are useful tools for doing comparative company analysis. The
advantage of having ratios and multiples is that it creates better and
relevant comparison knowing that opportunities or investments have
distinct drivers of their performance. Economic Value Added can also be
used as a comparator or as tool in comparable company analysis.
Comparable company analysis is a technique that uses relevant drivers for
growth and performance that can be used as proxy to set a reasonable
estimate for the value of an asset or investment prospective.
Comparable Company Analysis
In determining the value using comparable company analysis, the
following factors must be considered:
– Comparators must be at least with similar operations or within the similar
industry
– Total and absolute values should not be compared
– Variables used in determining the ratios must be the same
– Period of observation must be comparable
– Non-quantitative factors must also be considered
Price –
Earnings
Ratio
Price – Earnings Ratio
P/E Ratio represents the relationship of the market value per share
and the earnings per share. It sends the signal on how much the
market perceives the value of the company as compared to what it
actually earned. P/E Ratio is computed using the formula:
Price – Earnings Ratio
To illustrate, Chandelier Co. is a listed company with the market value per
share of Php12.0 and reported earnings per share of PHP 4.0. Using the
equation, the P/E ratio is 3. This means that the Chandelier Company can
create 3x the value of what it earns. P/E Ratio is also known as P/E
Multiples or Price Multiples. To determine the value of a company using P/E
ratio, management accountants and analysts uses P/E of the comparable
company.
For instance, Jopet Hotels and Leisure is a hospitality company. Based on
the income statement of the company, it reported earnings of PHP 7.00 per
share. Based on the listed companies under hospitality industry the average
P/E ratio is 4.25. With the foregoing information, you can expect that the
value of Jopet Hotels and Leisure is PHP 29.75 per share [PHP 29.75 =
Php7.00 x 4.25]
Book-to-Mar
ket Ratio
Book-to-Market Ratio
Book-to-Market Ratio is used to determine the appreciation of the market to the value of the
company as oppose to the value it reported under its Statement of Financial Position. It may be
recalled that the book values of the company are based on historical costs and does not purely
incorporates the value of the market. However, the only limitation of this ratio is that certain
values incorporated does not represent the true value of the company. Hence, further due
diligence is imperative. Book-to-Market ratio is computed using this equation:

Book Value per share can be derived by dividing the net book value to the number of outstanding
shares available to common or ordinary. Net book value is the difference of the total assets and
the total liabilities. This represents the claim of the equity stockholders to the company.
Book-to-Market Ratio
To illustrate, Chandelier Co. reported a Book Value per share of PHP 35 and with a market value
per share of PHP12.50. The Book-to-Market ratio is 2.80 which is computed as follows:

This means that for every PHP35 per share that is owned by a stockholder it is 2.8x larger than its
value in the market.
If Book-to-Market approach is used for comparable company analysis, the key component of the
financial statement needed is the Statement of Financial Position. To illustrated, Jopet Hotels and
Leisure reported a book value per share of PHP16.5 and the Book-to-Market is 0.5 then the value
of Jopet Hotels and Leisure can be estimated around PHP33 per share [PHP33 = PhP16.50 / 0.5]
Dividend –
Yield Ratio
Dividend – Yield Ratio
Dividend Yield Ratio describes the relationship between the appreciation of the
market on dividends received per share and the price of the company.
Dividend-Yield Ratio is also known as dividend multiple. Next to Price Earnings
Multiple, this is a more popular tool because it provides the investors with the
value which they can actually get from the company. This is under the principle of
Bird-in-the-Hand Theory popularized by Myron Gordon and John Lintner. The
theory assumes that the value of the firm is affected by the dividends the
company pays. The Dividend YieId Ratio (DYR) is computed using this equation:
Dividend – Yield Ratio
To illustrate, Chandelier Co. declared and paid dividends of PHP 1.50 per share and their market
value per share is Php12.50. Based on the foregoing, the dividend yield ratio is 0.12 computed as
follows:

This means that for every PHP 1.50 dividends they pay, it will translate into 12% of the market
value of the equity. Using this as a tool for comparable company analysis, DYR will work as a
multiplier to the dividends per share declared by the company.
Suppose, that Jopet Hotels and Leisure declared PHP 1.50 per share and the average dividend
multiple of the similar industry, 0.047. The market value per share is then can be estimated to be
around PHP 31.91 per share [PHP 31.91 = PHP 1.50 / 0.047]
EBITDA
Multiple
EBITDA Multiple
EBITDA or Earnings Before Interest, Taxes, Depreciation and Amortization
represents for the net amount of revenue after deducting operating
expenses and before deducting financial fixed costs, taxes and non-cash
expenses. Given the components, EBITDA can serve as a proxy of cash flows
from operating activities before tax. Traditionally, cash flows from operating
activities is computed by collections less payments for operating expenses
or indirectly, net income add back depreciation and amortization and
adjusted to working capital adjustments. EBITDA is determined by this
equation:
EBITDA Multiple
EBITDA per share is derived by dividing EBITDA into outstanding share for
common equity or ordinary share. To illustrate, Chandelier Co. reported EBITDA
per share of PHP 6.0 and the market value per share being PHP 12.0. Given the
equation, the EBITDA Multiple is 2 [2 = PHP 12.0 / PHP 6.0]
This means that the value of the firm to the market is 2x for every peso of EBITDA
earned. In practice, others adjust the EBITDA to incorporate costs relative to other
quantified risks. This is done by adding more costs or recognizing contingent
expenses to generate a more conservative EBITDA results which will serve as
driver for the value of the market.
To illustrate, Jopet Hotels and Leisure reported an EBITDA multiple of PHP 8.50 per
share. The average EBITDA multiple of the hospitality industry is 3.5. Given the
foregoing, the value of the equity is about PHP 29.75 [PHP 29.75 = PHP 8.50 x 3].
EBITDA Multiple
To illustrate further, it also assumed that it will have to procure insurance
and security costs to protect the plant assets of the company. This is about
Php0.5 per share. Given this additional information on the foregoing, the
value of equity is PHP 28.0 [PHP 28.0 = (PHP 8.50 - PHP0.50) x 3.5]. You may
note that the value of the firm decreased by PHP 1.75 [PHP 1.75 = PHP
29.75 – PHP 28.0] after the risk management cost is incorporated.
In summary, comparable company analysis uses tools to enable the
comparison between companies given the differences in 3S - Strategy,
Structure and Size. The objective is to enable the analyst or management
accountant to determine the value of similar businesses in the industry that
more or less captured the risk factors and other micro and macro-economic
considerations.
EBITDA Multiple
In the given illustration, we can compare the results generated using
comparable company analysis under various tools discussed:

• We can say that after using various comparative tools the price of Jopet Hotels
and Leisure is between PHP 29.75 to PHP 33.00, subject to due diligence.
Economic
Value Added
Economic Value Added
The most conventional way to determine the value of the asset is
through its economic value added. In Economics and Financial
Management, economic value added (EVA) is the most convenient for
assessing the ability of the firm to support its cost of capital with its
earnings. EVA is the excess of the earnings after deducting the cost of
capital. The assumption is that the excess shall be accumulated for
the firm. The higher the excess, the better. The elements that must be
considered in using EVA are:
– Reasonableness of earnings or returns
– Appropriate cost of capital
Economic Value Added
The earnings can easily be determined, especially for GCBOs, based on their historical
performance or the performance of the similarly situated company in terms of the 3S
and risk appetite. The appropriate cost of capital will be lengthily discussed in the
succeeding chapters, which can be determined based on the mix of financing that will be
employed for the asset. The EVA is computed using this formula:

To illustrate, Chandelier Co. projected its earnings to be Php350 Million per year. The
board of directors decided to sell the company for PHP 1,500 Million with a cost of capital
appropriate for this type of business at 10%. Given the foregoing the EVA is PHP 200 [PHP
350 – (PHP 1,500 x 10%)]. The result of PHP 200 Million means that the value offered by
the company is reasonable for the level of earnings it realized on an average and sufficient
to cover for the cost for raising the capital.
Other factors to be considered in Valuation
Once the value of the asset has been established, there are factors that can be
considered to properly value the asset. These are the earning accretion or
dilution, equity control premium and precedent transactions.
Earning accretion are additional value inputted in the calculation that would
account for the increase in value of the firm due to other quantifiable attributes
like potential growth, increase in prices, and even operating efficiencies. Earnings
dilution works differently but in both cases, these should also be considered in the
sensitivity analysis.
Equity Control premium is the amount that is added to the value of the firm in
order to gain control of it. Precedent transactions, on the other hand, are
experiences, usually similar with the opportunities available.
These transactions are considered risks that may affect further the ability to
realize the projected earnings.
Summary
Summary
• In determining the value of equity, it is necessary to value the asset first.
• Methodologies on asset based valuation are discounted cash flows or DCF analysis, comparable company
analysis and economic value added.
• Discounted cash flows analysis is meticulous but more conservative method or approach that can be used to
determine the asset value for it clearly demonstrate the movement of the transactions.
• Comparable company analysis is used to value the asset based on the performance of similar companies or
firms within the same industry. Ratios and multiples are good tools in order to compare the companies’
apples to apples e.g. P/E ratio, Book-to-Market Ratio, Dividend Yield, and EBITDA Multiple.
• Economic Value Added is a form of income approach in determining the value of the company by determining
any excess of the average earnings after deducting the cost of capital.
• Other valuation approaches are Earning Accretion that based the value on the incremental attributes of the
project or assets; and Equity control premium is the amount added to the value of the firm in order to gain
control.
End of
Discussion