WHY EMPHASIZE VALUATION IN FINANCE?

The Major Subject Area in Finance

Where a Teacher Can Be the Most Help (Quantitative Aspects)

Practical: Useful at All Levels of Companies and Other Organizations

Profit and non-profit companies

Limited liability corporations and partnerships
Company divisions
Business units
Products and product lines
Fixed asset purchases
Joint ventures
Spin-outs
Licensing agreements

Many Applications

Company strategy
Financing: IPO, ongoing business, restructuring/recapitalizi
Mergers and acquisitions
Purchase price allocation
S to C, C to S corporation conversions
 Buybacks
Shareholder (buy­sell) transactions
Exit strategy planning and evaluation
Employee stock ownership plan (ESOP) planning, impleme
Incentive compensation planning and evaluation 
Tax planning
Economic damages estimates
Eminent domain issues
Dispute resolution and litigation support
Estate planning and evaluation
Gift planning 

WHY INCLUDE PRIVATE (NON-PUBLICLY TRADED) COMPANIES IN THE C

Number of Private Companies v. Public Companies

As of 2008 from the U.S. Census

All firms with payroll
Firms with 20 employees or more
Firms with 100 employees or more
Firms with 500 employees or more

Approximate number of fims publicly traded

On exchanges (Wilshire 5000 in 2008)
Over-the-counter (Estimate)
ntitative Aspects)

nd Other Organizations

rtnerships

estructuring/recapitalizing, bankruptcy
OP) planning, implementation and administration
d evaluation 

COMPANIES IN THE CURRICULUM?

6,049,655
655,587
129,280
38,894

y traded
4,593
10,000
TWO CATEGORIES OF VALUE

Asset Value: Value of all of the assets as measured by debt + equity

Equity Value: Value of the owners' equity (net worth)

Book Value: Common Stock + Retained Earnings
Market Value: Share Value * Number of Shares Outstandin

TWO COMPONENTS OF VALUE

Operating Value: Value of the operating assets as measured by

interest bearing debt + equity

Non-operating Value: Value of other assets not directly involved

in the production of goods and services

DEFINITIONS OF VALUE

Fair Market Value: "The price at which the property would change
hands between a willing buyer and a willing seller
when the former is not under any compulsion to
buy and the latter is not under any compulsion to
sell, both parties having reasonable knowledge of
relevant facts." (IRS Revenue Ruling 59-60)

Investment Value: The value of the asset to an individual investor

Use or User Value: The value-in-use to an owner of the asset.
Sometimes used instead of investment value.

Intrinsic Value: Fundamental value. The present value of future

income.

Acquisition Value: Value, including synergy, to an acquiring firm.

ured by debt + equity

d Earnings
of Shares Outstanding

as measured by

t directly involved

perty would change

willing seller
mpulsion to
mpulsion to
nowledge of

individual investor
 er of the asset.
nt value.

nt value of future

an acquiring firm.
IRS FUNDAMENTAL VALUATION FACTORS: IRS REVENUE RULING 59-6

1. Economic environment.

2. Nature and history of the business and industry

3 Earning capacity

4. Potential for dividends

5. Past stock sales and percent to be valued

6. Public prices of the stock

7. Financial condition

8. Presence or absence of intangibles

VENUE RULING 59-60
METHODS OF VALUATION

I. INCOME METHOD: THE VALUE TODAY OF A SERIES OF FUTURE FREE CASH

A. Present Value = FCF1 + FCF2 + FCF3 +….+ FCFn + TVn

(1 + i) (1 + i)2 (1 + i)3 (1 + i)n (1 + i)n
FCF = free cash flow to capital.
i = cost of capital or hurdle rate.
t = time, usually in years.
n = the last period of the planning horizo
TV = terminal value. Value at the end o
planning horizon.

B. Primary Strength: Provides quantitative analysis of future risk an

C. Primary Weakness: Numbers must be forecast.

II. MARKET METHOD: VALUATION USING COMPARABLE UNITS (LIKE

COMPANIES OR DIVISIONS OR REAL ESTATE) ADJUSTED FOR DIFFERE
AMONG THE RELEVANT UNITS AND THE SUBJECT OF THE VALUATION

A. Calculate market value of the common equity or the enterprise

(all interest bearing debt + equity)

B. Primary Strength: in a free market economy, this is the definitio

 C. Primary Weakness: Determining comparable units.

III. ASSET METHOD: ASSETS – LIABILITIES = EQUITY

A. Net Worth calculated as

1. Assets at balance sheet value (book value) minus Liabili

2. Assets at market value (or replacement value) minus Lia

3. Assets at liquidation value minus Liabilities

B. Primary strength: tangible assets are real, with a resale value in

C. Primary weakness: an organization is more than the sum of its a

F FUTURE FREE CASH FLOWS

+….+ FCFn + TVn

(1 + i)n (1 + i)n
o capital.
r hurdle rate.

of the planning horizon.

e. Value at the end of the

alysis of future risk and reward.

E UNITS (LIKE
DJUSTED FOR DIFFERENCES
CT OF THE VALUATION.

uity or the enterprise value

my, this is the definition of value.

ble units.

ok value) minus Liabilities

ment value) minus Liabilities

Liabilities

with a resale value in the marketplace now.

than the sum of its assets

ADJUSTMENT FACTORS

A.  Cost of an audit if the books of a company, joint venture, division, or

B. Management salaries and competence, insurance costs such as key p

C. Costs of due diligence, planning, and integration

D. Total Cost of Equity Including Unsystematic Risk. Unsystematic risks

financial gains or losses from business transactions, access to capita

E. Country risk

F. Control premium

G. Discount for lack of liquidity (DLOL). DLOL has to do with the time it
and the effect on the market price. It is usually harder to sell a large

H. Discount for lack of marketability (DLOM) (ease of sale)

I. Demand / supply for the asset or company and speculation

J. Excesses or insufficiencies of assets not already priced in the market

K. Terms of purchase. Cash now is generally preferred to shares of stoc

L. Synergy. Synergy represents the buyer’s gain over and above the stan
M. If equity is the only factor valued, the current market value of interes
must be added to obtain enterprise value

N. Tax implications. For example, net operating losses (NOLs) from pre

O. If there are in-the-money options or warrants outstanding, their valu

adjustment method

P. Impact on acquiring company’s earnings per share. A negative impac

acquisition

Q. Dual classes of shares

R. The value of assets and liabilities not associated with the operations

S. Size. If comparable companies are of different sizes than the subjec

because size affects risk

T. Growth. If comparable companies grow faster or slower than the su

because growth affects value.

U. Regression to the mean. The subject company’s beta must be adjust

move toward the mean of the proxy variable (such as the S&P 500)
nture, division, or product line are unaudited

costs such as key person insurance, etc.

Unsystematic risks include potential lawsuits, unanticipated

ns, access to capital, patents and copyrights, political risks, etc.

do with the time it takes to sell an asset, the transaction cost,

arder to sell a large block of stock (especially under 50+%), than a small one

culation

ced in the market

d to shares of stock or cash over time, other things equal

and above the stand-alone value of the acquired asset

 ket value of interest bearing debt and preferred stock (if any)

s (NOLs) from previous years (if any)

tanding, their value must be calculated by the Treasury stock

A negative impact will reduce the attractiveness of an

with the operations of the business

es than the subject company adjustments must be made

slower than the subject company, adjustments must be made

eta must be adjusted since, over time, company risk tends to

ch as the S&P 500)
a small one