Session 1.

Introduction to Valuation
EPGP, IIM INDORE
Evaluation
•Group Assignment – 30 %
• Groups of 5 students
• Assignment 1. Valuation of Airthread Connections
• Valuation using a DCF approach, relative valuation approach, including sensitivity analysis.
• 1st submission due before the start of Session 10, and 2 submission due with 2 days after the case discussion.
• Assignment 2. Select any M&A deal that has happened in the past 3 years
• Select a deal which has a publicly listed target
• Use relative valuation, comparable company analysis and precedent transaction analysis, comment on the deal price, and prepare
a partial football field (Relative valuation –all types and 52 week high low).

•End Term Examination – 70%

Valuation
What is Value?
◦ Market Price?
◦ Intrinsic value?
◦ Perceived Value?

The purpose: Valuing companies for portfolio investments, recommendations, acquisitions,

divestments
Anomalies driven by Investor sentiments, market frenzies, herding, SCANDALS
Valuation: Art or Science?
◦ View 1: It is a hard science, where there is little room for analysts views or human error
◦ View 2: It is more of an art, where savvy analysts can manipulate the numbers to generate whatever
result they want
Valuation Myths
Since valuation models are quantitative, valuation is objective
◦ Valuation is an estimate based on assumptions and informed judgements
A well-researched and well-done valuation is timeless
◦ Valuation of an asset holds till there is no new material information that can impact
valuation
A good valuation provides a precise estimate of value
◦ Range of values depicted in the football field
Summary of Approaches to Valuation
Specific Asset Values
◦ Company is a collection of assets that can be sold – static view of the company
Assets Equity and Liabilities
Assets in Place Debt Borrowed money
Existing investments Investments
that generate cash already made
flows

Growth Assets
Expected value that will Investments Equity Owner’s funds
be created from the yet to be made
future investments
Summary of Approaches to Valuation
Present Value Models, also called as DCF Models
◦ Value of an asset is the present value of future benefits (cash flows) on that assets
◦ FCFF, CCFF, FCFE, APV

Multiples / Relative
◦ Law of one price for similar assets
Relevance of Cash flows in Value Creation
•Value creation at the Heart of any Business Decision
•Reliance on Cash flows for understanding the value of an asset / firm
•First principles: To create value, the firm must generate more cash than it uses
• Sufficient cash flow, after taxes, to compensate investors for providing the firm with financing
• FCF –cash available for distribution to investors
• The value of a firm depends on its expected FCFs
Value: A Leitmotif
•Present Value of Future Cash Flows
•Can be formally written as:
𝐶𝐹1 𝐶𝐹 𝐶𝐹3 𝐶𝐹
• 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎 𝐹𝑖𝑟𝑚 / Asset = 𝐶𝐹0 + + (1+𝑟2 )2 + + …… + (1+𝑟𝑛 )𝑛
(1+𝑟1 )1 2 (1+𝑟3 )3 𝑛
• Cannot forecast too far in the future: Terminate the forecasts
• PV of TV

•Value of a firm determined by its Free Cash Flows

• Discounted at a relevant rate: opportunity cost of capital/ hurdle rate
• To consider the timing of the cash flows, as well as the risk of the cash flows
• Also to consider the capital structure of the enterprise
Free Cash Flows
•Free Cash flows are
• Cash flow available for (free) for distribution to all investors (Equity + Debt)
• After paying current expenses, taxes, and making the investments necessary for growth
• EBIT (1-t) + Depreciation – Capex – Change in NWC
• Formal Definition of free cash flows to firm (FCFF)
Value of the Firm
A firm is expected to generate cash flows (inflows minus outflows) of Rs. 10000 in year-one, Rs.
4000 for each of the next four years.
The firm can be sold Rs. 20000 at the end of year-five.
After considering other investments available in the market with similar risks, the owners of the
firm would be able to make 12 per cent on their investment in the firm.
What is the firm worth?
Value of the firm
Year Net Cash flow Present Value at Year-Zero

1 10000 8928.57

2 4000 3188.78

3 4000 2847.12

4 4000 2542.07

5 24000 13618.24

Value of the Firm 31124.78

References
Damodaran on Valuation by Aswath Damodaran, 2nd edition, Wiley Finance
Investment Valuation by Aswath Damodaran, 2nd edition, Wiley Finance