Lesson 1 – OVERVIEW OF VALUATION CONCEPTS AND METHODS

Unit 1 – Foundation and Concepts of Valuation

Overview:
The fundamental point behind success investments is understanding what is the prevailing value and the key drivers that
influence this value. In this lesson, the valuation and the processes in valuation will be discussed.

Learning Objectives:
After successful completion of this lesson, you should be able to:
1. Describe the use and importance of valuation
2. Illustrate Porter’s Five Forces
3. Enumerate the principles and processes in creating value

Course Materials:

Valuation
It is the estimation of an asset’s value based on variables perceived to be related to future investment returns, on
comparison with similar assets, or when relevant, on estimates of
immediate liquidation proceeds, says CFA Institute.

OBJECTIVE OF THE VALUATION EXERCISE

1. Intrinsic Value – refers to the value of any asset based on the assumption assuming there is a hypothetically
complete understanding of its investment characteristics. It is the value that an investor considers, on the basis of
an evaluation or available facts, to be the “true” or “real” value that will become the market value when other
investors reach the same conclusion.
2. Concern Value – the going concern assumption believes that the entity will continue to do its business activities
into the foreseeable future.
3. Liquidation Value – the net amount that would be realized if the business is terminated and the assets are sold
piecemeal. It is particularly relevant for companies who are experiencing severe financial distress.
4. Fair Market Value – the price, expressed in terms of cash equivalents, at which property would change hands
between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in
an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable
knowledge of the relevant facts.

ROLES OF VALUATION IN BUSINESS

Portfolio Management
 Fundamental Analyst – these are persons who are interested in understanding and measuring the intrinsic value
of a firm. Fundamentals refer to the characteristics of an entity related to its financial strength, profitability or risk
appetite.
 Activist Investors – activist investors tend to look for companies with good growth prospects that have poor
management. Activist investors usually do “takeovers” – they use their equity holdings to push old management
out of the company and change the way the company is being run.
 Chartists – they rely on the concept that stock prices are significantly influenced by how investors think and act
and on available trading KPIs such as price movements, trading volume, short sales – when making their
investment decisions.
 Information Traders – they react based on new information about firms that are revealed to the stock market.
The underlying belief is that information traders are more adept in guessing or getting new information about firms
and they can make predict how the market will react based on this.

Valuation Techniques in Portfolio Management

 Stock selection
 Deducing market expectations
Business Deals for Analysis
 Acquisition – an acquisition usually has two parties: the buying firm that needs to determine the fair value of the
target company prior to offering a bid price and the selling firm who gauge reasonableness of bid offers.
 Merger – transaction of two companies’ combined to form a wholly new entity.
 Divestiture – sale of a major component or segment of a business to another company.
 Spin-off – separating a segment or component business and transforming this into a separate legal entity whose
ownership will be transferred to shareholders.
 Leverage buyout – acquisition of another business by using significant debt which uses the acquired business as a
collateral.

VALUATION PROCESS

1. Understanding the business – it includes performing industry and competitive analysis and analysis of publicly
available financial information and corporate disclosures. An
investor should be able to encapsulate the industry structure. One of the most common tools used in encapsulating industry
is Porter’s Five Forces:
Generic Corporate Strategies to achieve Competitive Advantage
 Cost leadership – incurring the lowest cost among market players with quality that is comparable to competitors
allow the firm to be price products around the industry average.
 Differentiation – offering differentiated or unique product or service characteristics that customers are willing to
pay for an additional premium.
 Focus – identifying specific demographic segment or category segment to focus on by using cost leadership
strategy or differentiation strategy.

2. Forecasting financial performance – can be looked at two perspectives: on a macro

perspective viewing the economic environment and industry where the firm operates in and micro perspective focusing in
the firm’s financial and operating characteristics. Two Approaches of Forecast Financial Performance
 Top down forecasting approach – international or national macroeconomic projections with utmost consideration
to industry specific forecasts.
 Bottom-up forecasting approach – forecast starts from the lower levels of the firm and builds the forecast as it
captures what will happen to the company.

3. Selecting the right valuation model – it depends on the context of the valuation and the inherent characteristics
of the company being valued.

4. Preparing valuation model based on forecasts – there are two aspects to be considered:
 Sensitivity analysis – common methodology in valuation exercises wherein multiple other analyses are
done to understand how changes in an input or variable will affect the outcome.
 Situational adjustments – firm specific issues that affects firm value that should be adjusted by analysts
since these are events that are not quantified if analysts only look at core business operations.

5. Applying valuation conclusions and providing recommendation

KEY PRINCIPLES IN VALUATION
 The value of a business is defined only at a specific point in time.
 Value varies based on the ability of business to generate future cash flows.
 Market dictates the appropriate rate of return for investors.
 Firm value can be impacted by underlying net tangible assets.
 Value is influenced by transferability of future cash flows.
  Value is impacted by liquidity.

Lesson 2 – GOING CONCERN ASSET BASED VALUATION

Unit 2 – Comparable Company AnalysisOverview:

In this lesson, different financial ratios as a tool will be discussed and illustrate to help
students assess the relationship of each drivers and show the how these tools could actually
simplify the decision making of investors.

Learning Objectives:
After successful completion of this lesson, you should be able to:
1. Define the financial ratios to compare company performance.
2. Describe the use of financial ratios in estimating entity value and investments.
3. Apply the financial ratios in decision making.

Course Materials:

Comparable company analysis is a technique that uses relevant drivers for growth and
performance that can be used as a proxy to set a reasonable estimate for the value of an asset
or investment prospective. It uses tools to enable the comparison between companies given the
difference in 3s – Strategy, Structure, and Size. Its objective is to enable the analyst or
management accountant to determine the value of the company based on the behavior of
similar businesses in the industry which captures the risks factors and other micro and macro
economic considerations.

The following factors are considered in determining the value in comparable company
analysis: ∙ Comparators must be at least with the similar operation or industry.
∙ Total and absolute value 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.

Financial Ratios:

Price-Earnings ratio – known as Price Multiples or P/E Multiples, represents the relationship of
the market value per share and the earnings per share. It shows how much the market
perceives the value of the company as compared to what it actually earns. This can be
computed as follows:

P/E = Market Value Per Share/Earnings Per share

To illustrate, Payaman Co. is a listed company with the market value per share of
Php12.00 and reported earnings per share of Php4.00. Using the equation above, the P/E ratio
is Php3.00 which means that Payaman can create 3x the value of what it earns.

Book-to-Market ratio – determines the appreciation of the market to the value of the company
as oppose to the value it reported under its Statement of Financial Position. Though it has
limitation for some values incorporated in this ratio does not represent the true value of the
company. It can be computed as:
Book to Market = Net Book Value Per Share/ Market Value Per Share

To illustrate, Payaman Co. reported a book value per share of Php35.00 and with a
market value per share of Php12.50. the book-to-market ratio is 2.80.

Dividend-Yield ratio – describes the relationship between the dividends received per share and
the appreciation of the market on the price of the company. It is also known as dividend multiple.
This theory assumes that the value of the firm is affected by the dividends the company pays.

DYR = Dividend Per Share

Market Value Per Share
To illustrate, Starlight Inc. declared and paid dividends of Php1.50 per share and their
market value per share is Php12.50. Based on the foregoing, the dividend yield ratio is 0.12
which means that for every Php1.50 dividends they pay, it will translate into 12% of the market
value of the equity and this can be computed as follows:

1.5/
DYR = 12.5

EBITDA Multiple – it is Earnings Before Interest, Taxes, Depreciation and Amortization which
represents for the net amount of revenue after deducting operating expenses and before
deducting financial fixed costs, taxes and non-cash expenses.

EBITDA Multiple = Market Value Per Share

EBITDA Per Share

EBITDA per share is derived by dividing EBITDA into outstanding share for common
equity or ordinary share. To illustrate, Starlight Inc. reported EBITDA per share of Php6.00 and
the market value per share being Php12.00. Given the equation the EBITDA Multiple is 2
(2=Php12.0/Php6.0).

Economic Value Added (EVA) – it is the most conventional way to determine the value of the
asset is through its economic value added. It is the convenient for this is assessing the ability of
the firm to support its cost of capital with its earnings. It is the excess of the earning after
deducting the cost of capital. The assumption is that the excess shall be accumulated for the
firm the higher the excess the better. Elements that must be considered in using EVA are:

∙ Reasonableness of earnings or returns

∙ Appropriate cost of capital
EVA = Earnings – Cost of Capital
Cost of Capital – Investment Value x Rate of Capital Cost

To illustrate, Starlight Inc. projected earnings to be Php350 Million per year. The board
of directors decided to sell the company for Php1,500 Million with a cost of capital appropriate
for this type of business is 10%. With the given data, the EVA is Php200 Million (Php350 Million
– (Php1,500 Million x 10%)). This result 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.

Lesson 2 – GOING CONCERN ASSET BASED VALUATION

Unit 1 – Discounted Cash Flow Analysis

Overview:
This lesson will discuss how investors will determine how much they are willing to acquire it.
Since asset has been identified by the industry as transactions that would yield future economic
benefits as a result of past transactions. Therefore, the value of investment opportunities is
highly dependent on the value that the asset will generate from now until the future.

Learning Objectives:
After successful completion of this lesson, you should be able to:
1. Differentiate the valuation methods.
2. Describe the going concern and liquidation concern asset based approach.
3. Illustrate the capitalizing and discounted future earnings.

Course Materials:

Green field investments - those investments that started from scratch.

Brown field investments – those opportunities that are either partially or fully operational.
These are investments that are already in the going concern state, as most businesses are in
the optimistic perspective that they will grow in the future.

Going Concern Business Opportunities (GCBOs)

These are the businesses that has a long term into infinite operational period. The risk
indicators of GCBOs are identified easily as it provides reference for the performance of similar
nature of business or from historical performances.

Sound Enterprise-wide Risk Management allows the company to:

1. Increase the opportunities;
2. Facilitates the management and identification of the risk factors that affect the business;
3. Identify or create cost-efficient opportunities;
4. Manages the performance variability;
5. Improve management and distribution of resources across the enterprise;
6. Make the business more resilient to abrupt changes.

Discounted Cash Flows Analysis

This can be done by determining the Net Present Value of the Net Cash Flows of the
investment opportunity. 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. Therefore, free cash flows can be
computed as:
Free Cash Flows = Revenue – Operating Expenditures – Taxes – Capital Expenditures

Two Levels of Net Cash Flows

1. Net Cash Flows to the Firm – represents the amount of cash made available to both
debt and equity claims against the company.

5
2. 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.

Terminal Value – represents the value of the company in perpetuity or in a going concern
environment. This can be computed as:
TV = CFn
G

TV = Terminal Value
CFn = Farthest net cash flows

g = Growth rate
NCF0 = net cash flows at the beginning
NCFn = latest net cash flows
n = latest time
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

Assuming this is a GCBO, and it is expected that the net cash flows will behave on a normal
trend. The growth rate is computed as:

g=
 g = 1.10 – 1

g = 0.10

TV = 7.32/0.10
TV = 73.20

DCF Analysis is most applicable to use when the following are available:
1. Validated operational and financial information
2. Reasonable appropriated cost of capital or required rate of return
3. New quantifiable information

Supposed Bagets Corporation projected to generate the following for the next five years, in
million pesos:
Year Revenue Operating Expense* 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

The capital expenditures that were purchased and invested in the company amounted to
Php100Million. The terminal value was assumed to be computed using 10% growth rate. It was
noted further that there is an outstanding loan of Php50 Million. If you are going to purchase
50% of Bagets Corporation, assuming a 7% required return, how much would you be willing to
pay?
In million pesos Year
0 1 2 3 4 5

Revenue 92.8 102.1 112.3 123.62 135.98

8 7 8

Less: Operating Expenses (excluding 65.0 71.52 78.67 86.5 95.1

Depreciation) 1 3 9
 Less: Income Taxes Paid 8.13 9.19 10.11 11.1 12.2
3 4

Less: Capital Expenditures Purchased 100.0

0

Net Cash Flow -100.00 19.5 21.46 23.60 25.9 28.5

1 6 5

Add: Terminal Value 285.50

Free Cash Flows -100.00 19.5 21.46 23.60 25.9 314.05

0 6

Multiply: Discount Factor (7%) 1.00 0.93 0.87 0.82 0.76 0.71

Discounted Free Cash Flows -100.00 18.1 18.67 19.35 19.7 222.98
4 3

Free Cash Flows – Firm 100.0

0

Less: Outstanding Loans 50.00

Free Cash Flows - Equity 50.00

Based on the foregoing information, the value of Bagets Corporation equity is Php50 Million. If
the amount at stake is only 50% then the amount to be paid is Php25 Million

Lesson 3 – GOING CONCERN ASSET BASED VALUATION

TOOLS Unit 1 – Financial Models

Overview:
Valuation process requires incorporation of a lot of factors that can be
used to facilitate the calculation. These help investors to enable to execute the
formula and fundamentals that are necessary to determine the value and at the
same time to determine the share from the company. And one of the tools that
can also be used by investors is financial model. This lesson will show how
financial model is being prepared.

Learning Objectives:
After successful completion of this lesson, you should be able to:
1. Define the financial models.
2. Describe the steps in developing a financial model.
3. Enumerate the components of financial model.

Course Materials:

Financial models are mathematical models designed to aid in coming up with a

recommended decision and at the same time can be used to validate the
assumptions made. It is similar to financial plan or quantification of strategies and
operating plans of the enterprise that is used to facilitate the following:
- Determination of asset value or enterprise value and equity value.
- Identification of risk.
- Development of scenarios and sensitivities.

Steps in developing a financial model:

1. Gather historical and material information - historical information may
come from audited financial statements where past performance of the
company is reported, from corporate disclosures which provide more
context for the future plans and strategies of the company, from contracts
which shows the covenants and existing agreements of the firm with
other parties and peer information that provides other researches and
support
to identified risks from industry experts and other consultants.

2. Establish driver for growth and assumptions – drivers are data that have
been validated by government or experts. Growth drivers are based on
population as most of the products are consumer goods so the growth
indicators may be inflation, population growth, GNP or GDP growth. The
bases may come from different sources such as Philippine Statistics
Authority (PSA), Bangko Sentral ng Pilipinas (BSP), National Economic
and Development Authority (NEDA) and other government agencies.
- 1 x 100%
CPIn CPIo

Inflation
To illustrate, in year 2019, the CPI is 151 so the cost of the basket is
PHP151. In
year 2020, the CPI published is Php155. Since there is an increase of
4 from 2019 to 2020 CPI, there is an inflation of 2.64% using the equation
above.

Financial ratios may be used as tools to determine the growth

drivers and assumptions. Trend analysis will also help you establish the
trajectory of growth pattern. The financial modeler must assess whether
the company can sustain the pattern otherwise, it is conservative to
assume a less aggressive growth. Normally, the weighted growth pattern
will be considered in the long-term financial perspective. It must be
assessed whether the average year on year growth will be sustained or
may be surpassed.
To illustrate, PIP Company’s historical production grows
10% per year. It is expected that in the next five years, the
 probability are as follows:
Scenario Rat e Probability
A 5% 10%
B 10% 40%
C 15% 50%

Given the data above, the weighted average growth rate to be

used is 11.55% computed as follows:
Scenario Rat e Probability Weighted
A 5% 10% 0.5%
B 10% 40% 4.0%
C 15% 50% 7.5%
Total 11.55%

3. Determine the reasonable cost of capital – financial modeler must be

able to determine the appropriate cost of capital by weighing the
portion of the asset that is funded of equity and of debt. To do this, the
weighted average cost of capital (WACC). WACC = (Ke x We) + (Kd x
W d)
Ke – cost of equity
We – weight of the
equity financing
Kd – cost of debt
after tax
Wd – weight of the debt financing

Ke = Rf + B (Rm – Rf)
Rf –risk free rate
B – beta
Rm – market return

Kd = Rf + DM
Rf – risk free rate
DM – debt margin

To illustrate, the risk- f r e e rate is 5% and the prevailing

interest rate is 6%. The cost of debt is then 11%. Based on
the current share of financing, equity is 30% and debt is 70%
while tax rate is 30%. Using the formula above, the WACC is 10%.

4. Execute the formula to compute for the value – financial modeler usually
use DCF or Discounted Cash Flow in applying the capital budget
techniques such as Internal Rate of Return (IRR) or Net Present Value
(NPV) for an instance. Below example shows the computation and
 formula of NPV and IRR in excel/spreadsheet.
In million pesos
1 2 3 4 5
Revenue 92.88 102.17 112.38 123.62 135.98
Less: Operating Expenses 65.01 71.52 78.67 86.53 95.19
(excluding Depreciation)
Less: Income Taxes Paid 8.13 9.19 10.11 11.13 12.24
Less: Capital Expenditures 100
Purchased
Net Cash Flow -80.26 21.46 23.6 25.96 28.55
Add: Terminal Value 285.5
Free Cash Flows -80.26 21.46 23.6 25.96 314.05

ultiply: Discount Factor (7%) 0.93 0.87 0.82 0.76 0.71

Discounted Free Cash Flows -74.6418 18.6702 19.352 19.7296 222.976

Free Cash Flows – Firm 206.09

Less: Outstanding Loans 50.00
Free Cash Flows - Equity 156.09
Net Present Value ₱206.72 =NPV (7
Internal Rate of Return 58% =IRR (B9

On the other hand, NPV and IRR may be computed manually

using the below formula: NPV = PV * (1/(1+i) n
PV – present value
I – interest
n – number of years or period

5. Make scenarios and sensitivity analysis based on the result – a financial

model could easily be adjusted based on the perceived or desired result
or information on a given situation. Hence, the “what if analysis” can be
done using the financial model. For an instance, the 7% cost of capital
may be 10% or 12% and with the use of financial model, the results like
the equity value can easily be computed even when the sudden changes
happen.

The scenarios may be presented in financial model based on the possible

occurrences like level of operating expense, mode of operations, capital
expenditure development. This is where Risk Based Valuation could
actually be used as it incorporates climate change, war, economic
sabotage and pandemic. While sensitivity analysis is almost similar to
 scenario modelling. The only difference is that sensitivity analysis will
have to select a driver or few drivers, ceteris paribus, and check the
degree of change it will cause to the results. It is very useful in
developing ballpark estimates. Ballpark figures are quantitative drivers or
multipliers that allow the investors to quickly make an estimate or offer.

COMPONENTS OF FINANCIAL MODEL

1. Title Page
2. Data Key Results
3. Assumption Sheet
4. Pro-forma Financial Statements
5. Supporting Schedules

Lesson 4 – LIQUIDATION BASED VALUATION

Unit 1 – Liquidation Value

Overview:
An alternative approach to Going Concern Based Valuation when
going-concern ability of a business is being question or doubtful is the
Liquidation Based Valuation or use of liquidation value. This chapter will discuss
the concept of this valuation and describe the situations or scenarios to consider
in this valuation.

Learning Objectives:
After successful completion of this lesson, you should be able to:
1. Identify situations that would require liquidation value.
2. Enumerate the principles to apply in liquidation valuation.

Course Materials:

Liquidation value
It is a value of a company if it were dissolved and its assets were sold
individually. It represents the net amount that can be gathered if the business is
shut down and its assets are sold in piecemeal. This is known as Net Asset
Value.

Situations to Consider Liquidation Value

a. Business Failures – low or negative returns are signs of business failures
that is why it is the most common or usual reason why a certain
business closes or liquidates.

Types of Business Failures

i. Insolvency, when a company cannot pay liabilities as they become due.
ii. Bankruptcy, when liabilities become greater than an asset balance.

Factors causing Business Failures

 iii. Internal Factors – can come from mismanagement, poor
financial evaluation and decisions, failure to execute
strategic plans, inadequate cash flow planning or failure to
manage working capital.
iv. External Factors – are severe economic downturn,
occurrence of natural calamities or pandemic, changing
customer preferences, and adverse governmental
regulations.

b. Corporate/Project End of Life – normally, corporations have stated their

finite life in their Articles of Incorporation. If there will be no extension on
the corporate life, the terminal value may be computed using liquidation
value.

c. Depletion of Scarce Resources – this is most applicable to mining and oil

where availability of scarce resources influences the value of the firm.
Liquidation happens in this business when the permits or contracts with
the government expire and the operation will no longer be allowed to
execute.

General Principles on Liquidation Value

1. If the liquidation value is above income approach valuation (based
on going concern principle) and liquidation comes into
consideration, liquidation value should be used.
2. If the nature of the business implies limited lifetime (e.g. quarry,
gravel, fixed term company etc.), the terminal value must be
based on liquidation. All costs necessary to close the operations
(e.g. plant closure costs, disposal costs,
rehabilitation costs) should also be factored in and
deducted to arrive at the liquidation value.
3. Non-operating assets should be valued by liquidation method as
the market value reduced by costs of sales and taxes. Since they
are not part of the firm’s operating activities, it might be
inappropriate to use the same going concern valuation technique
used for business operations. If such result is higher than net
present value of cash flows from operating the asset, the
liquidation value should be used.
4. Liquidation value must be used if the business continuity is
dependent on current management that will not stay.