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Firm Valuation: Atty. Ivan Yannick S. Bagayao Cpa, Mba
Firm Valuation: Atty. Ivan Yannick S. Bagayao Cpa, Mba
Firm Valuation: Atty. Ivan Yannick S. Bagayao Cpa, Mba
The value of a firm is basically the sum of claims of its creditors and shareholders. Therefore, one of
the simplest ways to measure the value of a firm is by adding the market value of its debt, equity,
and minority interest. Cash and cash equivalents would be then deducted to arrive at the net value.
EV = market value of common equity + market value of preferred equity + market value of debt +
minority interest – cash and investments.
One of the reasons why the concept of EV has gained more importance than market capitalization is
because the former is more inclusive. Besides equity, it includes the value of debt as well as cash
reserves which have an important role to play in a corporation’s valuation. A buyer would have to
pay off a firm’s debt when taking over the firm. And the same could be net off from the cash and
cash equivalents available with the firm.
Another sound approach towards computing the value of a firm is to
determine the present value of its future operating free cash flows.
The idea is to draw a comparison between two similar firms. By
similar firms, we mean similar in size, same industry, etc. The firm
whose present value of future operating cash flows is better than the
other is more likely to attract higher valuation from the investors.
Operating Free Cash Flow (OFCF) is calculated by adjusting the tax
rate, adding back depreciation and deducting the amount of capital
expenditure, working capital and changes in other assets from
earnings before interest and taxes.
The formula for computing OFCF is as below :
OFCF = EBIT (1-T) + Depreciation – CAPEX – working capital – any other assets
Where,
T = tax rate
Calculating OFCF in such a way gives a more accurate picture of cash generating capabilities of a
firm. Once OFCF is computed, one can use a suitable discount rate to find the present value of OFCF.
On the basis of the sum of all the present value of future operating cash flows, one can decide on
whether to take over a firm or not.
Book Value of a Firm:
As the name implies, the book value of the firm is its value as reflected in its
‘books’ or financial statements. It is the difference between the assets and
liabilities of a firm as per its balance sheet. It is the shareholder’s equity in the
balance sheet. This is the true worth of a business when its liabilities are net
off from its assets.
For example, if company ABC has total assets worth P800 million. And its total
liabilities amounting to P500 million, the book value of the firm would be P300
million (by deducting the value of liabilities from that of assets). This means
that if a company XYZ is to purchase company ABC, then it will have to shell
P300 million out of its pocket, the actual book value of buying company ABC.
Market Value of a Firm
For example, if company ABC has 10 million shares outstanding and the
market price of each share is P50; then the market value of the
company would be P500 million, assuming there are only common
shares issued in the market.
Market value and the book value of the firm are two different concepts.
There is quite a possibility of a huge difference between the book and
market value of a company at a given point of time.
FIRM VALUATION:
= 1− + −[
+∆ ]
The market value firm is computed as follows:
− +
=
v Illustrative Problem:
8479 Corporation has projected Earnings Before Interest and Tax (EBIT) for the next year of
P600 million, with tax rate of 40%, projected depreciation expense, capital expenditures and
increase in working capital for the next year of P100 million, P200 million and P120 million,
respectively. The capital structure of the company is 40% for debt and 60% for equity. Its
WACC is 10%. The company’s free cash flow is expected to grow at a constant rate of 6
percent a year. The firm has P500 million in debt and preferred shares with 20 million
preferred shares outstanding and 300 million ordinary shares outstanding.
To compute for 8479’s stock price:
It is first important to compute for the correct free cash flow of the company.
Considering that this is a constant growth stock, it is also important to note that
the free cash flow needed for the computation is the free cash flow at the end of
the year (FCF1).
FCF1=P140 million
After computing the correct FCF, the market value of the firm should be
computed next:
FCF1
=
WACC − g
P140 million
=
10% − 6%
= P3.5 billion
Once the market value of the firm is computed, the market values of debt and
preferred must first be deducted from the market value of the firm. The resulting
market value of common or ordinary shares shall be divided by the number
outstanding ordinary shares:
Enterprise value (EV) is a measure of a company's total value, often used as a more comprehensive
alternative to equity market capitalization. EV includes in its calculation the market capitalization of a
company but also short-term and long-term debt as well as any cash on the company's balance sheet.
Enterprise value is a popular metric used to value a company for a potential takeover.
Formula and Calculation for EV
EV=MC+Total Debt−Cwhere:
C=Cash and cash equivalents; the liquid assets ofa company, but may not include marketable
securities
Example of Enterprise Value
As stated earlier, the formula for EV is essentially the sum of the market value of equity (market
capitalization) and the market value of debt of a company, less any cash. The market capitalization
of a company is calculated by multiplying the share price by the number of shares outstanding.
The net debt is the market value of debt minus cash. A company acquiring another company keeps
the cash of the target firm, which is why cash needs to be deducted from the firm's price as
represented by market cap.
Let's calculate the enterprise value for Macy's (M). For the fiscal year ended January 28, 2020,
Macy's recorded the following:
Macy's Data Pulled from 2020 10-K Statement:
Macy's enterprise value is calculated as P6.238 billion (market cap) + P6.87 billion (debt) - P1.3 billion (cash).