Business Valuation
Meaning of Valuation
the process of determining the economic value of a business or company
Why do we do valuation?
Raising funds
Going for an IPO
Sell business
Acquire a company
Investment recommendation
Decision making
ESOPs
Valuation is a mix of Art & Science
Science Past & Present
historical analysis, ratios, trend, statistics
Art Future
forecasting, macro economics, swot
Methods of Valuation
Income Approach Discounted Cash Flow Method present value of a company's future cash flows
Capitalization of Earnings dividing the expected annual earnings by the capitalization
Market Approach Public Company Comparables compares the subject company to similar publicly traded c
Precedent Transactions comparing the subject company to recently acquired comp
Asset-Based Approach Asset-Based Valuation values a business based on the net value of its assets
Tangible Asset Valuation valuing only the tangible assets of a business
Cost Approach Replacement Cost Method determines the value of a business by estimating the cost
Historical Cost method book value of assets minus liabilities
Discounted Cash Flow Method
Usage: Most preferred and the 'REAL' way to value a company
When not preferred: Unstable cashflows (e.g. tech startup), hard to distinguish between operating & non-operati
Underlying Logic: A business is worth the present value of its future cashflows
Two-stage DCF model: Value of the firm = Cash flows from forecastable period + Terminal value
Steps: Project Cash Flows
Determine the Discount Rate
Determine Terminal Value
Calculate Present Value of Future Cash Flows & Terminal Value
Adjust for Net Debt to Enterpise Value
Divide Equity value by total shares outstanding
Perform sensitivity analysis
Key Metrics: Metrics Drivers
Revenue market size, sales mix, volume, price
Operating Margin materials cost, wage rates, tax structure
Working Capital holding periods, terms of credit
Capital Expenditure plant life, maintenance, scale
Capital Structure target debt ratios
Comparable Company Analysis
Usage: Often used with other methods
Pros: Observable value for a company
Easily available
Current
Large number of potential companies to
compare to
Cons: No perfect
Hard comparable
to adjust for growth, management
team,
Easy to fall intofactors
or other “value trap” or
“overvalued fallacy”
Steps: Select Comparable Companies - similar industry, geography, size
Determine the Metrics & Multiples Multiple to Use EV/Sales
Calculate Valuation Multiples Phase of Life cycle Early growth
Calculate Average Multiples Characterisitcs No cash or profit
Apply Multiples to the Target Company
Precedent Transactions
Usage: comparable analysis
Pros: Show the value investors paid for the entire company
Include takeover premium / control premium
Include synergy value
Cons: Hard to find
Need access to a database like Bloomberg and Capital IQ
Become stale dated quickly (valuations from years ago are not relevant today)
Difference from CCA: what acquirers have paid to acquire other companies, not what those companies’ shares are curren
Steps: Identify Comparable Transactions - similar industry, geography, size
Gather Transaction Details from press release
Calculate Valuation Multiples
Compute Average or Median Multiples
Apply Multiples to the Target Company
Adjust for Differences
capitalization rate
licly traded companies
cquired company
s assets
ting the cost to recreate it
non-operating cash (e.g. Banking companies)
EV/EBITDA EV/EBIT P/E
Rapid-slowing growth Slowing growth-maturity Early-late maturity
Cash flow positive Operating profit Stable operations
res are currently trading at
Equity Value & Enterprise Value
BALANCE SHEET EQUITY to ENTERPR
Year 1 Current Equity Value
(-) Cash & Cash-Equivalents
Equity 2,000 (-) Financial Investments
Reserves & Surplus 200 (-) Equity Investments
Preferred Stock 100 (-) Other Non-Core Assets
Noncontrolling Interests 100 (-) Net Operating Losses
(+) Total Debt
Long-Term Liabilities: (+) Preferred Stock
Long Term Debt 400 (+) Operating Leases
Deferred Tax Liability 100 (+) Capital Leases
(+) Unfunded Pensions
Current Liabilities (+) Noncontrolling Interests
Short Term Debt 100 Current Enterprise Value
Accounts Payable 150
Accrued Expenses 200
TOTAL EQUITY & LIABILITY 3,350
Long Term Assets
Net PP&E 1,240
Long Term Investments 500
Current Assets
Inventory 200
Accounts Receivable 300
Short Term Investments 400
Cash & Bank Balance 710
TOTAL ASSETS 3,350
EQUITY to ENTERPRISE VALUE
3,000
Equivalents (710)
(900)
500
100
ng Interests 100
prise Value 2,090
Share Price ₹ 15
Share Outstanding 200
Current Equity Value 3,000
Equity Value - in case of Diluted Shares
Reasons for Dilution:
- stock options
- convertible bonds
- restricted stock units
Equity Value Calculation
Current Share Price ₹ 25.00
Basic Shares Outstanding (Millions) 500
Diluted Shares Outstanding (Millions) 500.48
Basic Equity Value 12,500.00
Diluted Equity Value 12,512.00
Diluted Shares Calculation
Treasury Stock Method:
Stock Options (Millions) 1.2
Exercise Price ₹ 15.00
Dilution 0.48 0.48
=I14-I14*I15/_xlfn.single(Share_Price)
Amount No. of shares
Total 30 1.2
Paid 18 0.72
Discount 12 0.48
Valuation Metrics
Enterprise Value Equity Value
EV/Revenue Equity Value/Net Income
EV/EBIT Price per share/EPS
EV/EBITDA P/FCFE
EV/Capital Employed P/Book Value
EV/Free Cash Flow
(denominator is before interest expense) (denominator is after interest expense)
Important Terms Formula Amount
Revenue Net Sales / Turnover - the Topline 1,000
EBIT Earnings Before Interest and Taxes 250
Operating Income on the Income Statement
adjusted for non-recurring charges
EBITDA EBIT + Depreciation & Amortization 670
(link D&A from CFS)
Earnings Net Income - the Bottom Line 105
NOPAT Net Operating Profit after taxes 175
Net Debt Total Debt less Cash and cash equivalents 210
Free Cash Flow Cash Flow from Operations – CapEx 125
Unlevered Free Cash Flow NOPAT+D&A +/- Change in Working Capital – CapEx. 195
Net Income + D&A +/- Change in Working Capital –
Levered Free Cash Flow CapEx – Debt Repayments + Debt Issuances 65
Equity Value Market Cap = Share Price x Shares outstanding 2000
Enterprise Value Equity Value + Net Debt 2,210
Calculation of Multiples
EV/Revenue 2.2x
EV/EBIT 8.8x
EV/EBITDA 3.3x
EV/Capital Employed CE = BV of Debt + Equity 2.3x
EV/FCFF 11.3x
PE Ratio 19.0x
P/B Multiple Market Cap/ Book value of Equity 3.1x
P/FCFE 30.8x
INCOME STATEMENT BALANCE SHEET CASH FLOW STATEM
Revenue 1,000 Shareholder Funds
Operating expenses (350) Common Stock 250
EBITDA 650 Retained Earnings 400
Depreciation (400) Long Term Liabilities
EBIT 250 Long Term Debt 250
Interest expenses (100) Current Liabilities
Earning before Taxes 150 Short Term Debt 50
Taxes (45) Other Liabilities 100
Net Income 105 TOTAL 1,050
No. of shares 100 Long Term Assets
Share Price 20 Tangible Assets 800
Current Assets
Tax rate 30% Cash 90
Other Assets 160
TOTAL 1,050
INCOME STATEMENT METRICS Free Cash Flow to Firm (FCFF/UFCF)
EBIT from P&L 250 EBIT 250
(+) Non-Recurring Charges - (-) Operating Lease Interest -
EBIT 250 NOPAT 175
(+) D&A from CFS 420 (+) D&A from CFS 420
EBITDA 670 (+/-) Deferred Income Taxes -
Lease Rentals - (+/-) Change in WC (300)
EBITDAR 670 (-) Capital Expenditures (100)
Unlevered Free Cash Flow (UFCF) 195
FREE CASH FLOW
Cash Flow from Operations 225
(-) Capital Expenditures (100)
Free Cash Flow (FCF) 125
CASH FLOW STATEMENT
Net Income 105
(+) D&A 420
(+/-) Deferred Tax -
(+/-) Changes in WC (300)
Cash Flow from Operations: 225
Capital expenditure (100)
Cash Flow from Investing: (100)
Debt repayment (60)
Cash Flow from Financing: (60)
Net Change in Cash: 65
Opening Cash 25
Closing Cash 90
Free Cash Flow to Equity (FCFE/LFCF)
Net Income 105
(+) D&A from CFS 420
(+/-) Deferred Income Taxes -
(+/-) Change in WC (300)
(-) Capital Expenditures (100)
(-) Debt Repayment (60)
(+) New Debt Issuances -
Levered Free Cash Flow (LFCF) 65
Which one is expensive?
Compare Cost of Property (in lacs) Sq ft Rate/ sq ft
House A 200 5000 4000
House B 50 1000 5000
Compare Current Enterprise Value ($MM) EBITDA EV/EBITDA
Co. A 800 100 8
Co. B 300 10 30
