Objectives

To understand the various approaches to

valuation

What is the need for business

valuation?
Product Price

Company Price

What is the need for business

valuation?
Product Price

Company Price

Rs 12,50,000

Rs 5000

Context of Valuation

Raising capital for a Venture

Initial Public Offering
Acquisitions
Divestitures
PSU Disinvestment
Employee Stock Option plan
Portfolio Management

Business Valuation

Approaches to Valuation
ValuationModels

AssetBased
Valuation

DiscountedCashflow
Models

RelativeValuation

Liquidation
Value

Equity
Stable

Current

ContingentClaim
Models

Sector

Twostage
Threestage
ornstage

EquityValuation
Models

Normalized

Earnings

Book Revenues
Value

Sector
specific

Dividends
Costofcapital
approach

APV
approach

Optionto
liquidate

Young
firms

Undeveloped
land

FirmValuation
Models
Patent

FreeCashflow
toFirm

Optionto
expand

Firm
Market

Replacement
Cost

Optionto
delay

ExcessReturn
Models

Undeveloped
Reserves

Equityin
troubled
firm

Asset Based Valuation

Asset Based Valuation

A type of business valuation that focuses on
a company's net asset value, or the fairmarket value of its total assets minus its
total liabilities.

When to use Asset based

valuation?
Scenario 1
Firms who value drivers largely depends on tangible
assets. Example, mines, minerals, oil, Cell phone
towers
Scenario 2
Firm whose assets are separable and marketable.
Example Real estate companies
Scenario 3
Determining the value of firms undergoing liquidation.

ONGC

The company grew its global footprints with

acquisition of oil and gas assets and now has
projects in 16 countries

operations in 26 countries and a commercial

presence in over 50 countries.

DLF's primary business is development of

residential, commercial and retail properties.
From developing 22 major colonies in Delhi,
DLF is now present across 15 states-24
cities in India.

Asset based Valuation Methods

Book value
Method

Market Value
Method

Replacement
Cost

Liquidation
value

Book Value of an asset

The book value of an asset refers to the amount at
which an asset is shown in the balance sheet of a
firm.
Book value = Initial acquisition cost accumulated depreciation

Book Value of a business

Book value of a business refers to total book
value of all valuable assets (excluding fictitious
assets, such as accumulated losses and deferred
revenue expenditures, like advertisement,
preliminary expenses, cost of issue of securities
not written off) less all external liabilities
(including preference share capital).

Market value
Market value refers to the price at which an asset
can be sold in the market.
The market value can be applied with respect to
tangible assets only; intangible assets (in
isolation), more often than not, do not have any
sale value.
Market value of a business refers to the aggregate
market value (as per stock market quotation) of all
equity shares outstanding.
The market value is relevant to listed companies
only.

Replacement Value

Replacement value is the potential amount that

one will have to spend at current rates to replace
the existing assets of a company.

S.no
1
2
3
4
5
6

S.no
1
2
3
4
5
6
7
8
9
10
11
12
13

Company
India cements
Madras cement
Tata Steel
Hindalco
JSW Energy
JP Associates

Company
Grasim
India Cements
Madras Cement
Shree cement
Tata Steel
Hindalco
JSW Energy
JP Power Ventures
Phoenix Mills
Jaypee Infratech
GMR Infra
JP associates
IRB Infrastructure

Replacement Cost
Adjusted
replacement cost (FY
12)
in crores
7600
6800
1,21,000
52,000
15,900
30,400

Adjusted
replacement cost (FY
15)
in crores
44,700
10,800
9,900
19,000
1,79,600
60,000
19,400
23,200
6200
16,100
17,600
44,100
9000

Market Cap

Potential upside %

2460
3613
40,669
23,445
8011
14,683

208.9
88.2
197.5
121.8
98.5
107

Market Cap

Potential upside %

22,438
2,460
3,613
9,197
40,669
23,445
8011
9,252
2560
6375
8699
14,683
3938

99.2
339
174
106.6
341.6
155.9
142.2
150.8
142.2
152.5
102.3
200.3
128.5

Valuation of Indus Towers

One of the largest Cell phone towers in India

With 1,16,454 towers in 15 circles across the country, Indus has

the widest coverage in India.

Liquidation Value
Liquidation value represents the price at which each
individual asset can be sold if business operations are
discontinued in the wake of liquidation of the firm
In operational terms, the liquidation value of a business is
equal to the sum of (i) realisable value of assets and (ii)
cash and bank balances minus the payments required to
discharge all external liabilities.
In general, among all measures of value, the liquidation
value of an asset/or business is likely to be the least.

Asset-Based Approach to Valuation

Assets-based method focuses on determining the value of
Net assets = (Total assets (excluding fictitious assets) Total external
obligations)
(1)
Net assets per share can be obtained dividing total net assets by the
number of equity shares outstanding. It indicates the net assets
backing per equity share (also known as net worth per share).
Net assets per share = Net assets / Number of equity shares issued
and outstanding
(2)

Example 1: Following is the balance sheet of Hypothetical Company Limited as on March 31, current
year.
Share capital
40,000 11% Preference shares of
Rs 100 each, fully paid-up
1,20,000 Equity shares of Rs 100 each,
fully paid-up
Profit and loss account
10% Debentures
Trade creditors
Provision for income tax

40
120
23
20
71
8
282

Fixed assets
Less: Depreciation
Current assets:
Stocks
Debtors
Cash at bank
Preliminary expenses

Rs 150
30
100
50
10

120

160
2
____
282

Additional Information:
(i) A firm of professional valuers has provided the following market estimates of its various assets:
fixed assets Rs 130 lakh, stocks Rs 102 lakh, debtors Rs 45 lakh. All other assets are to be taken at
their balance sheet values.
(ii) The company is yet to declare and pay dividend on preference shares.
(iii) The valuers also estimate the current sale proceeds of the firms assets, in the event of its
liquidation: fixed assets Rs 105 lakh, stock Rs 90 lakh, debtors Rs 40 lakh. Besides, the firm is to
incur Rs 15 lakh as liquidation costs.
You are required to compute the net asset value per share as per book value, market value and
liquidation value bases.

Book Value Method

Solution : Determination of Net Asset Value per Share
Book value basis
Fixed assets (net)
Current assets:
Stock
Debtors
Cash and bank
Total assets
Less: External liabilities:
10% Debentures
Trade creditors
Provision for taxation
11% Preference share capital
Dividend on preference shares
(0.11 Rs 40 lakh)
Net assets available for equityholders
Divided by the number of equity shares (in lakh)
Net assets value per share (Rs)

(Rs lakh)

(i)

Rs 120
Rs 100
50
10

160
280

20
71
8
40
4.4

143.4
136.6
1.2
113.83

(ii) Market value basis

130

Fixed assets (net)

Current assets:
Stock

102

Debtors

45

Cash and bank

10

Total assets
Less: External liabilities (as per details given
above):
Net assets available for equityholders
Divided by the number of equity shares (in lakh)
Net assets value per equity share (Rs)

157
287
143.4
143.6
1.2
119.67

(iii) Liquidation value basis

105

Fixed assets (net)

Current assets:
Stock

90

Debtors

40

Cash and bank

10

Total assets
Less: External liabilities (listed above):
Less: Liquidation costs
Net assets available for equityholders
Divided by the number of equity shares (in lakh)
Net assets value per equity share (in Rs)

140
245
143.4
15.0
86.6
1.2
72.17

OPTIONS

Obligation Vs Option

Spice Jet
Low-cost carrier (LCC) SpiceJet on Tuesday said it would
spend $900 million to buy 30 small aircraft from Canada
Bombardier to enhance regional connectivity in the country.
India has about 90 airports in tier-II and we plan to enter
these areas, as there are no LCCs here
The Q400 NextGen turboprop aircraft from Bombardier can
seat 78 passengers and has low noise and vibration-free
features.
It uses up to 40 per cent less fuel than the regional jet aircraft

SpiceJet has also ordered 30 Boeing aircraft and

deliveries of the same would begin by 2013

Pfizer

Phases of development

TEACHING METHODOLOGY
Concepts
Guiding principles
Tools and Techniques
Exercise

Discount Cash Flow Technique

Basis for all valuation approaches

The use of valuation models in investment
decisions (i.e., in decisions on which assets are
under valued and which are over valued) are based
upon
a perception that markets are inefficient and
make mistakes in assessing value
an assumption about how and when these
inefficiencies will get corrected
In an efficient market, the market price is the best
estimate of value. The purpose of any valuation
model is then the justification of this value.

Discounted Cash Flow Valuation

What is it: In discounted cash flow valuation, the value of
an asset is the present value of the expected cash flows on
the asset.
Philosophical Basis: Every asset has an intrinsic value
that can be estimated, based upon its characteristics in
terms of cash flows, growth and risk.
Information Needed: To use discounted cash flow
valuation, you need
to estimate the life of the asset
to estimate the cash flows during the life of the asset
to estimate the discount rate to apply to these cash
flows to get present value

Discounted Cash Flow Valuation

Market Inefficiency: Markets are assumed to make
mistakes in pricing assets across time, and are assumed to
correct themselves over time, as new information comes
out about assets.

Discounted Cashflow Valuation: Basis for

Approach
t = n CF
t
Value =
t
(1+
r)
t =1
Proposition 1: For an asset to have value, the expected cash
flows have to be positive some time over the life of the
asset.
Proposition 2: Assets that generate cash flows early in their
life will be worth more than assets that generate cash flows
later; the latter may however have greater growth and
higher cash flows to compensate.

What is the use of DCF valuation?

Estimating Merger Gains and Costs
Suppose that you are the finance manager of firm A
and you want of analyze the possible purchase of
firm B. What is the first thing you look for ?
Is there any economic gain from merger ?
Economic gain arises only if the two firms are worth more
together than apart

How do you calculate economic gain?

Gain = PVAB - ( PVA + PVB ) =

PVAB

Cost of acquiring B
Cost = Cash paid - PVB
Net Present value = Gain - Cost
=

PVAB - ( Cash paid - PVB )

NPV = wealth with merger - wealth without merger

How do you calculate economic gain?

Firm A has a value of Rs 200 million and B has
a value of Rs 50 million. Merging the two
would allow cost savings with a present value of
Rs 25 million. Calculate the (NPV)Economic
gain from the merger.Assume firm B is bought
for cash Rs 65 million.

Discounted Cash Flow Valuation

Equity Valuation

Cash flows to equity

Discount rate
(cost of equity)

Firm valuation

Cash flows to firm

Discount rate
(WACC)

Value of a firm

Equity investors

Cash Flows to Equity

All investors
(Equity & Debt)

Cash flows to Firm

I.Equity Valuation
The value of equity is obtained by discounting expected
cashflows to equity, i.e., the residual cashflows after
meeting all expenses, tax obligations and interest and
principal payments and reinvestment needs, at the cost of
equity, i.e., the rate of return required by equity investors
in the firm.
0

FCFE1 FCFE2

FCFE3

FCFE4

t=n CFtoEquity

ValueofEquity =
t=1

(1+ k )

FCFE5

n
FCFEn

e
where,
CF to Equityt = Expected Cashflow to Equity in period t

ke = Cost of Equity

II. Firm Valuation

Cost of capital approach: The value of the firm is
obtained by discounting expected cashflows to the firm,
i.e., the residual cashflows after meeting all operating
expenses and taxes, but prior to debt payments, at the
weighted average cost of capital, which is the cost of the
different components of financing used by the firm,
weighted by their market value proportions.
0

FCFF1 FCFF2

FCFF3

FCFF4

CFtoFirm t
t
t =1 (1+ WACC)
t= n

ValueofFirm =

FCFF5

FCFFn

Generic DCF Valuation Model

DISCOUNTED CASHFLOW VALUATION

Expected Growth
Firm: Growth in
Operating Earnings
Equity: Growth in
Net Income/EPS

Cash flows
Firm: Pre-debt cash
flow
Equity: After debt
cash flows

Firm is in stable growth:

Grows at constant rate
forever
Terminal Value

Value
Firm: Value of Firm
Equity: Value of Equity

CF1

CF2

CF3

CF4

CF5

CFn
.........
Forever

Length of Period of High Growth

Discount Rate
Firm:Cost of Capital
Equity: Cost of Equity

 Assume that you are analyzing a company with the following cash
flows for the next five years. Assume also that the cost of equity is
13.625 % and that the firm can borrow long term at 10 % ( The tax
rate for the firm is 50 % ) The current market value of equity is Rs
1073 and the value of debt outstanding is Rs 800
year
CF to equity interest (1-t)
CF to firm
1
50
40
90
2
60
40
100
3
68
40
108
4
76.20
40
116.20
5
83.49
40
123.49
Ter Val
1603
2363
Calculate the value of the firm using Equity valuation and Firm
valuation approaches.

Example 4
Suppose a firm has employed a total capital of Rs 1,000 lakh (provided equally by 10
per cent debt and 5 lakh equity shares of Rs 100 each), its cost of equity is 14 per cent
and it is subject to corporate tax rate of 40 per cent. The projected free cash flows to
all investors of the firm for 5 years are give in the table:

Year-end 1
2
3
4
5

Rs 300 lakh
200
500
150
600

Compute
(i) valuation of firm and (ii) valuation from the perspective of equityholders. Assume
10 per cent debt is repayable at the year-end 5 and interest is paid at each year-end.

Solution : (i) Computation of Overall Cost of Capital

Source of capital

After tax cost (%)

Equity
Debt
Weighted average cost of capital
(k0)

14
6*

Weights
0.5
0.5

Total cost (%)

7
3
__
10

* 10% (1 0.4 tax rate) = 6 per cent

(ii) Valuation of Firm, Based on K0
Year-end
1
2
3
4
5
Total present value/valuation of firm
Less value of debt
Value of equity

FCFF
Rs 300
200
500
150
600

PV factor
(0.10)
0.909
0.826
0.751
0.683
0.621

Total present
value
Rs 272.70
165.20
375.50
102.45
372.60
1,288.45
500.00
788.45

(iii) Valuation of Equity, Based on Ke

Year-end

FCFF to
all
investors

After tax
payment to
debtholders

FCFE to
equityholder
s

PV
factor
(0.14)

Total
present
value

Rs 300

Rs 30*

Rs 270

0.877

Rs 236.79

200

30

170

0.769

130.73

500

30

470

0.675

317.25

150

30

120

0.592

71.04

600

530**

70

0.519

36.33

Total present value

* Interest on Rs 500 lakh @ 10% = Rs 50 lakh; Rs 50 lakh (1 0.4) = Rs 30 lakh

** Inclusive of debt repayment of Rs 500 lakh at year-end 5.

792.14