ASSIGNMENT NO.

2 Value of the Firm

Submitted To Dr. Nouman Afghan

Submitted By Danish Jawaid Rasool

Date of Submission 7th December, 2012

NUST BUSINESS SCHOOL

Determining the value of a company is a process which includes a lot of subjectivity into it making it highly controversial; however it is very important at the same time. The value can be used at the time of mergers, sales and also identifying new ways to add value to a company. Benefits of calculating the value of the firm for both the firm and external parties: It shows the maximum price that the buyer would be willing to pay, and the minimum that the seller would be willing to accept. Share price is influenced by the company value. For listed companies the shareholders can compare the value of the firm with the price and make decisions accordingly. Aids in identify sources of value creation. The decision of the firm to be a going concern is based on the value of its firm, i.e. whether to stay in business, sell it out or merge with other businesses. As we discussed in class one of the methods in order to calculate the value of the firm was Discounted cash flow model in which we discount back the future cash flows of the company at a required rate of return. Several other methods of finding (V) are available but I would be explaining an income approach called the Adjusted Present Value(APV). The approach focuses on finding the value of the firm by separating the effects of value of debt financing from the business assets. The APV approach estimates the expected value of debt benefits and cost separately from the value of the operating assets, something that is different to the usual method where the discount rate is used to see the effects of debt financing. Three steps to calculate the value of the firm: 1. Estimate the value of the firm with no leverage 2. Calculate the present value of the interest tax saving which is created because of the money that has been borrowed. 3. Calculate the expected cost of bankruptcy and the effect of borrowed money on the chances of the company going bankrupt. The value of the firm can also be written as: Firm Value = Unlevered Firm Value + PV of tax benefits of debt - Expected Bankruptcy Cost

Generally the bankruptcy cost is not included in finding the value of the firm so a more simplified form of the formula is: V = EBIT (1 t) / (Ke g) + DT

Where, EBIT (1 - t) = earnings before Interest but after tax Ke = Cost of Equity DT = tax savings on debts g = growth rate

Reference Business valuation, needs and techniques by CA Hofeza Natawala . Methods designed to determine the value of the firm and their Deficiencies by Cndea Diana Marieta.