Valuation of Business

for M & A

By : Gaurang Badheka
CRV, Sem - 4
 Basics

“Some men know the price

of everything and the
value of nothing”
- Oscar Wilde
 Value Vs. Price
value
• Not a static figure
• Nothing called precise
value
• Arrival of transaction not
necessary
• Fundamentals are the key
• Always involves economic
benefits
• Value is ‘should be price’
- the basis of negotiation
of price
price
• A static figure
• Always precise
• An outcome of a
transaction
• May not be driven by
fundamentals always
• Includes economic & non-
economic factors
• May not look on valuation
 Business valuation - define
Business Valuation
‘An act or process of determining the value of a
business, business ownership interest, security or
intangible assets’
{The International Glossary of Business Valuation Terms}
Alternative Definition
‘Business Valuation is a logical, defendable
process of arriving at the opinion as to the worth of a
business given the information available, assumption
& limiting conditions as on the valuation date’
 Purpose of valuation Examples
Valuation for transactions
Business purchase , Business sale, M&A (Mergers
& Acquisition), Reverse merger, Recapitalization,
Restructuring, LBO (Leverage Buy Out), MBO
(Management Buy Out), MBI (Management Buy In),
BSA (Buy Sell Agreement), IPO, ESOPs, Buy back
of shares, Project financing and others
Valuation for court cases
Bankruptcy, Contractual disputes, Ownership
disputes, Dissenting and Oppressive shareholder
cases, Divorces cases, Intellectual property
disputes and other
Valuation for compliances Fair value accounting, Tax Issues

Valuation for planning

Estate planning, Personal financial planning, M&A
planning, strategic planning
 Business valuation (when)
• IPO
• Privatization
• Going Private (LBO, MBO)
• Mergers and Acquisitions
• Downsizing and Restructuring
• Security Analysis
• Value Management
 Business valuation (who)
• Acquirer, Target, and Intermediary
• Managers
• Investors
• Investment Bank
• Commercial Bank
• Law Firm
• Accounting Firm
• Consulting Firm
 Business valuation (why)
• Successful Transaction or Negotiation:
Overvaluation or Undervaluation?
• Value Increasing or Decreasing?
• Buy or Sell?
 Business valuation (how)
• Various valuation approaches
 Valuation Models

Asset Based Discounted Cashflow Relative Valuation Contingent Claim

Valuation Models Models

Liquidation Equity Sector Option to Option to Option to

Value delay expand liquidate
Stable Current Firm
Market
Young Equity in
Replacement Two-stage firms troubled
Cost Normalized firm
Three-stage
or n-stage Earnings Book Revenues Sector Undeveloped
Value specific land

Equity Valuation Firm Valuation

Models Models
Patent Undeveloped
Dividends Reserves

Cost of capital APV Excess Return

Free Cashflow approach approach Models
to Firm
 Business value
• Book value
• Replacement value
• Liquidation value
• Market value
 Factors affecting valuation
• Nature of business
• Stage of the company
• Industry / sector dynamics
• Economic outlook
• Accounting and financial aspects
• Potential/ contingent liabilities
• Intellectual properties
• Qualitative aspects
• Authenticity of information
• And many other
 Basic approaches
• Asset based methods
• Earning based methods
• Market based methods
 Value of share and company
• In this concept, the value of the firm is
equal to the value of the shareholders
claim in the company.
• Value per share = shareholders equity
no. eq. shares o/s

Value of company = value per share * no. of

equity shares
 Value of share and company
• If shares are traded:
Value of the company = MV of the share *
no. of shares o/s
• Another way:
Company value = equity value + debt
value + pension claim +
other claims
 Asset based valuation
• The value of the enterprise indicates the
net asset of the enterprise as shown in the
books of account. Under this method, the
valuation of the enterprise is based on the
net asset of the company. The net asset
value is the difference between the assets
and the liabilities based on their balance
sheet value with some accounting
adjustments.
 Asset based valuation
• All tangible and non tangible assets
• Fictitious assets should be ignored
• Present worth of goodwill to be taken.
• All outside liability to be taken.
• Any arrears to be considered.
• From the net asset, the claim of the
preference shareholders should be
deducted.
 Asset based valuation
Current Assets + Investments + intangibles

less: long term debt + short term debt + contingent

liabilities + accumulated losses + mics. Exp. not
written off

= Net assets of the company

less: Preference share capital
= Net assets for equity shareholders
 Asset based valuation

Intrinsic value of equity shares =

Net asset available to shareholders

Number of equity shares
 Asset based valuation
• Example 5A – Asset Based Valuation.
Valuation relative to ind. average
• Dividend yield method
• Earnings yield method
• Return on capital employed method
• Price/ earning method
 Dividend yield method
• Value per share =
dividend per share
industry avg. div. per share

OR
Rate of dividend X nominal value of share
industry normal Div. rate
• Value of business = value per share X
Total no. of eq. shares
 Dividend yield method
• Exercise 5B – Relative Valuation
Example 1 and 2.
 Earning yield method
• To overcome the problem of dividend, the
yield based upon the earning can be used.
The total amount of dividend belongs to
the shareholders whether distributed as
dividend or not. The undistributed profit
will be used to finance the growth of the
business and thus helps in increase the
value of the business.
 Earning yield method

Value of business =

company’s expected future profit

industry’s normal earning yield
 Earning yield method
• Exercise 5B: Relative valuation
Examples 3 and 4
Return on capital employed method
• It is a simple method which considers the
rate of return on capital employed which
will be required from the company whose
shares are to be values.
• This is based on the predetermined
expectation of the rate of return investor
would expect on the investment.
Return on capital employed method
• Step 1: select the past period of
investigation.
• Step 2: estimate the future maintainable
profit.
• Step 3: establish the industry’s normal rate
of return
• Step 4: calculate the firm value by using
estimated profit and industry’s average
rate of retun.
Return on capital employed method

Value of business =

Company’s future maintainable profit

Industry’s normal rate of return on capital
employed
Return on capital employed method
• Exercise 5B: Relative valuation
Examples 5 and 6
 Price / earning method
• Many companies are regularly described
in terms of their Price/ Earning (P/E) ratio.
P/E ratio is the inverse of earning yield,
dividing price by earning rather than
earning by price.
• The value of the share or the value of the
firm as a whole can be calculated by using
a simple formula.
 Price / earning method
• Value of business = future maintainable
profit X industry avg. P/E ratio

• Value of share = expected EPS X industry

avg P/E ratio
 Price / earning method
• Exercise 5B: relative Valuation
Example 7
 Fair value of shares
• The fair value of share is the average of
the values obtained by “Net Asset Method”
and “Dividend Yield Method”.

(Value of share by Net Asset Method +Value

of share by dividend Yield Method) / 2
 DCF Valuation Methods
• Discounted Dividend model
• Discounted Cash flow model
• Discounted IRR model
• Discounted EVA model
 Theoretical Valuation model
• Dividend Growth Valuation model
• Walter’s Share valuation model
• MM dividend irrelevant model
• Capital Asset Pricing Model
 Funding options
• Issue of eq. shares of the acquirer company
• Issue of pref. share of the acquirer company
• Issue of secured debt instruments of the
acquirer company
• By payment in cash
• Any combination of the above
 Issue of equity shares
• Share swap method
• Not applied to unlisted company
• Constraint in using share swap method
– Determination of correct swap ratio
– Determination of long term value
– Leads to dilution of EPS
– Problem with capital gain as per Income Tax
Act