VALUATION METHODS

May 15, 2021

 WHAT IS VALUATION ?
Valuation is the analytical process of
determining the current (or projected) worth
of an asset of a company. ... An analyst
placing a value on a company looks at the
business's management, the composition of
its capital structure, the prospect of future
earnings, and the market value of its assets,
among other metrics.
 WHAT IS VALUATION ?
Valuation is a process by which analysts determine
the present or expected worth of a stock,
company, or asset.

In finance, valuation is the process of determining

the present value (PV) of an asset.
WHAT IS PURPOSE OF VALUATION?
The purpose of a valuation is to
track the effectiveness of your
strategic decision-
making process and provide the
ability to track performance in
terms of estimated change in
value, not just in revenue.
 WHAT ARE THE BENEFITS OF BUSINESS
VALUATION?
Knowing your company's resale value
can give you a little bit more leverage
in business dealings, and also provide a
growth trajectory to help you plan for the
future. A business valuation will provide
you with an accurate estimate of
your company's value in the current
market.
 Who does a business valuation?
The appraiser will next select one or
more business valuation methods under the
standard valuation approaches. The
appraiser typically starts with
the company's historic financial statements
as a starting point. He or she then makes the
adjustments and earnings projections to
reveal the business earning potential.
 What does a valuation specialist do?
The work of a business valuation
specialist is to determine the
economic value of a business or
company. They produce a detailed
report that is used in a business sale,
litigation matters, divorce
proceedings, or in establishing
partner ownership.
 What is a Business Valuation Specialist?
Business valuation refers to the process of
determining the actual value of a business.
Business owners work with a business valuation
specialist to help them obtain an objective
estimate of their company’s value. They require
the services of business valuation specialists to
determine a business’s fair value, particularly for
the sale of a business, partnership ownership,
estate and succession planning.
 The Two Main Categories of Valuation Methods
Absolute valuation models attempt to find the
intrinsic or "true" value of an investment based
only on fundamentals. Focus on such things as
dividends, cash flow, and the growth rate for a
single company. Valuation models that fall into this
category include the dividend discount model,
discounted cash flow model, residual
income model, and asset-based model.
 The Two Main Categories of Valuation Methods
Relative valuation models, in contrast,
operate by comparing the company in
question to other similar companies.
These methods involve calculating
multiples and ratios, such as the price-to-
earnings multiple, and comparing them to
the multiples of similar companies.
 Reasons for Performing a Business Valuation
• #1 Litigation
•During a court case such as an injury case,
divorce, or where there is an issue with the
value of the business, you may need to
provide proof of your company’s worth so
that in case of any damages, they are based
on the actual worth of your businesses and
not inflated figures estimated by a lawyer.
 Reasons for Performing a Business Valuation
• #2 Exit strategy planning
• In instances where there is a plan to sell a business, it is
wise to come up with a base value for the company and
then come up with a strategy to enhance the
company’s profitability so as to increase its value as an exit
strategy. Your business exit strategy needs to start early
enough before the exit, addressing both involuntary and
voluntary transfers.
• A valuation with annual updates will keep the business
ready for unexpected and expected sale. It will also ensure
that you have correct information on the company fair
market value and prevent capital loss due to lack of clarity
or inaccuracies.
 Reasons for Performing a Business Valuation
• #3 Buying a business
• Even though sellers and buyers usually have
diverse opinions on the worth of the business, the
real business value is what the buyers are willing
to pay. A good business valuation will look at
market conditions, potential income, and other
similar concerns to ensure that the investment
you are making is viable. It may be prudent to
hire a business broker who can help you with the
process.
 Reasons for Performing a Business Valuation
• #4 Selling a business
•When you want to sell your business or
company to a third party, you need to
make certain that you get what it is
worth. The asking price should be
attractive to prospective purchasers, but
you should not leave money on the
table.
 Reasons for Performing a Business Valuation
• #5 Strategic planning
•The true value of assets may not be shown
with a depreciation schedule, and if there
has been no adjustment of the balance
sheet for various possible changes, it may
be risky. Having a current valuation of the
business will give you good information that
will help you make better business
decisions.
 Reasons for Performing a Business Valuation
• #6 Funding
•An objective valuation is usually needed
when you need to negotiate with banks or
any other potential investors for funding.
Professional documentation of your
company’s worth is usually required since it
enhances your credibility to the lenders.
 Reasons for Performing a Business Valuation
• #7 Selling a share in a business
•For business owners, proper business
valuation enables you to know the worth of
your shares and be ready when you want to
sell them. Just like during the sale of the
business, you ought to ensure no money is
left on the table and that you get good value
from your share.
 Discounted Cash Flow
• The discounted cash flow (DCF) model focuses on
calculating intrinsic value of assets to determine future
cash flows of an organization. This is the most
comprehensive of the three main valuation methods and
requires a significant amount of research, analysis and
data. DCF accounting practices are characterized by
the reduction of future value to establish a present
value. Accountants using this method discount the
worth of an asset based on present and future factors,
including elements of risk that may lower its overall
worth.
 Discounted Cash Flow
Discounted cash flow (DCF) is a valuation method
used to estimate the value of an investment based
on its expected future cash flows. DCF analysis
attempts to figure out the value of an
investment TODAY, based on projections of how
much money it will generate in the FUTURE. This
applies to both financial investments for investors
and for business owners looking to make changes
to their businesses, such as purchasing new
equipment.
 How Discounted Cash Flow Works?
The purpose of DCF analysis is to estimate the
money an investor would receive from an
investment, adjusted for the time value of money.
The time value of money assumes that a money
today is worth more than a money tomorrow
because it can be invested. A DCF analysis is
appropriate in any situation where a person is
paying money in the present with expectations of
receiving more money in the future.
 Why is discounted cash flow important?
The DCF is an important method for
evaluating and comparing investment
projects. If the price of a property or
investment is less than the sum
of discounted cash flows, then it is highly
rewarding or profitable from the point of view
of investors. Such an investment is termed as
undervalued.
 ILLUSTRATION
If you had P1,000 today, and compounded it at
14.5% per year, it would equal about P1,500 in
three years.

Php1, 000.00 x (1  .145)  Php1,500.00

3

Php1,500.00
Php1, 000.00 
(1  .145) 3
 Ilustration
Alternatively, if you had P1,200 today, and
compounded it at just 7.7% per year, it would equal
about P1,500 in three years

Php1,500.00
Php1, 200.00 
(1  .077) 3
 Discounted Cash Flow Formula
CF1 CF2 CF3 CFn
DCF     ... 
(1  r ) (1  r ) (1  r )
1 2 3
(1  r ) n

where :
DCF  Discount Cash Flow
CFi  Cash Flow period i
r  int erest rate
n  time in years
 Example of Discounted Cash Flow
Problem #1:
When a company looks to analyze whether it should invest in a
certain project or purchase new equipment, it usually uses
its weighted average cost of capital (WACC) as the rate when
evaluating the DCF. The WACC incorporates the average rate of
return that shareholders in the firm are expecting for the given
year.

You are looking to invest in a project, and your company's WACC

is 5%, so you will use 5% as your rate. The initial investment is
$11 million and the project will last for five years, with the
following estimated cash flows per year:
Example of Discounted Cash Flow
Cash Flow
Year Cash Flow
1 $1 million
2 $1 million
3 $4 million
4 $4 million
5 $6 million
 Example of Discounted Cash Flow
Discounted Cash Flow
Discounted Cash
Year Cash Flow
Flow
1 $1 million $952,381
2 $1 million $907,029
3 $4 million $3,455,430
4 $4 million $3,290,810
5 $6 million $4,701,157
 Example of Discounted Cash Flow
• If we sum up all of the discounted cash flows, we get a
value of $13,306,728. Subtracting the initial investment
of $11 million, we get a net present value (NPV) of
$2,306,728. Because this is a positive number, the cost
of the investment today is worth it as the project will
generate positive discounted cash flows above the
initial cost. If the project had cost $14 million, the NPV
would have been -$693,272, indicating that the cost of
the investment would not be worth it.
 Example of Discounted Cash Flow

Problem #2.
If a person owns an initial amount of
P100,000 on the first year and it grows at
3% for the next four years. If the cash
flow is compounded 15% annually.
Construct the table and determine the
DCF.
Example of Discounted Cash Flow
YEAR ACTUAL CASH FLOW DISCOUNTED CASH FLOW

1 100,000.00 86,956.52

2 103,000.00 77,882.80

3 106,090.00 69,755.90

4 109,272.70 62,477.02

5 112,550.88 55,957.68

353,029.92
 Example of Discounted Cash Flow
Problem #3.
Suppose you’re a financial analyst at a company, and you are
recommending whether the company should invest in Project A or
Project B.
Each of the two projects has been proposed by a lead engineer, but the
company can only invest in creating one of them this year, and so your
manager wants you to give her advice on which one to invest in. Your
company’s WACC is 9%, so you’ll use 9% as your discount rate.
Here are the two projects:
Example of Discounted Cash Flow
 Example of Discounted Cash Flow

• Project A starts with an initial investment to make a tech

product, followed by a growing income stream, until the
product becomes obsolete and is terminated.
• Project B starts with an initial investment to make a different
product, and makes no sales, but the whole product is
expected to be sold in five years to some other company for
a large payoff of $14 million.
• Which project, assuming both carry the same risk, should the
financial analyst recommend to her manager?
Example of Discounted Cash Flow
 Example of Discounted Cash Flow

•Therefore, the Net Present Value (NPV) of

this project is $6,707,166 after we subtract
the $3 million initial investment.
Example of Discounted Cash Flow
 Example of Discounted Cash Flow

•Therefore, the Net Present Value (NPV) of this

project is $6,099,039 after we subtract the $3
million initial investment.
 Example of Discounted Cash Flow

• We can conclude that from a financial standpoint, Project A

is better, since it has a higher net present value.
• Even though Project B will bring in $14 million in cash over
its lifetime and Project A will only bring in $12 million,
Project A is more valuable because of the earlier timing of
those expected cash flows.
• Then, you should advise your manager to pick Project A to
invest in for this year, if she can only invest in one.