Corporate Valuation: Principles

and Practices
Basic Concept
Business Valuation is the process of
determining the "Economic Worth" of a
Company based on its Business Model
and External environment and
supported with reasons and empirical
evidence.
Corporate valuation depends upon
1. Purpose of valuation
2. Stage of Business
3. Past financials
4. Expected financial results
5. Industry scenario
Approach to Valuation
Discounted free cash flow method
Relative Valuation (Comparable company
market multiple method)
Comparable Transactions (Mergers &
Acquisition) Multiple (CTM) method
Price of recent investment method
Net asset value method (NAV)
Discounted Free Cash Flow
Method
Two alternative approach can be used
1. Measuring the discounted cash flow to the firm
2. Measuring the discounted cash flow to equity
Discounted Free Cash flow to the firm
. The DFCF to firm method expresses the present value of
the business attributable to all claimants (like equity
shareholders, debt holders, preference shareholders,
warrants etc) as a function of its future cash earning
capacity.
. This methodology work on the premise that the value of
business is measured in terms of future cash flow streams,
discounted to the present time at appropriate discount rate
. This approach seeks to measure the intrinsic ability of the
business to generate cash attributable to all the claimants.
Discounted Free Cash Flow
Method
Discounted Free Cash flow to equity
The DFCF to firm method expresses the
present value of the business attributable
to equity shareholders as a function of its
future cash earning capacity.
The value of equity is arrived at by
estimating the free cash flow to equity and
discounting the same at the cost of equity
Steps in measuring FCFF
Steps for finding FCFF
Earning before interest Step 1: Arrive at EBIT
* and taxes Step 2: Multiply with (1-tax
(1-tax rate) rate)
= Operating profit after Step 3: Arrive at Operating
+ tax profit after tax
Non Cash Cost Step 4: Add back non cash
- cost (already subtracted
- Capital expenditures earlier)
+ Increase in NCWC Step 5: Subtract Capital
Terminal Value Expenditures
Step 6: Subtract increase in
NCWC
Step 7: Add terminal value of
the firm at the final year
= Free cash flow to firm
= Discounted Free Cash Step 8: Discount the FCFF for
Flow to Firm each year at the cost of
Steps in measuring FCFE
Steps for finding FCFFE
Profit Before Tax
- Taxes
= Profit After Tax
+ Non Cash Cost
- Capital expenditures
- Increase in NCWC
Changes in Debts
+ Terminal Value
= Free cash flow to equity
= Discounted Free Cash
Step 1: Arrive at PBT
Step 2: Less taxes
Step 3: Arrive at PAT
Step 4: Add back non cash
cost (already subtracted
earlier)
Step 5: Subtract Capital
Expenditures
Step 6: Subtract increase in
NCWC
Step7: Take into account the
effect of changes in debt
Step 8: Add terminal accruing
to equity holder at the final
year
Step 8: Discount the FCFE for
Arriving at cost of capital
Key things to remember
Cost of capital for the firm should be
comparable with firm with similar business
and financial risk
CAPM can be utilized to calculate debt,
equity asset for publicly listed firm from
the historical data. Hence beta have a
historical character
Return on risk free security can be
estimated based on 10 year Indian
Government Bond Yield
Equity risk premium can be arrived from
Comparable company market
(CCM)multiple method
CCM multiple method uses the valuation ratios of a
publicly traded company and applies that ratio to the
company being valued
The valuation ratio typically expresses the valuation as
a function of measure of financial performance or book
value (e.g. turnover, EBIDTA, EBIT, EPS or book value)
Methodology is based on current market stock price
Limitations:
1. Difficulty in selecting comparable firms with similar
business and financial risk (EBIDTA or Cash Flow)
2. Measuring the multiple (mean or median value can
be used)
Comparable Transactions (M&A)
Method (MTM)
This methodology helps in arriving the
value of the company on the basis of
similar deals matured in the market
This provides and indicative value as it
helps in reaching the value which market is
providing to similar companies
Can be arrived through sales multiple,
EBIDTA multiples or PAT multiples
NAV Method
NAV is the net value of all the assets of the company. If you
divide it by the number of outstanding shares, you get the
NAV per share.
One way to calculate NAV is to divide the net worth of the
company by the total number of outstanding shares. Say, a
companys share capital is Rs. 100 crores (10 crores shares
of Rs. 10 each) and its reserves and surplus is another Rs.
100 crores. Net worth of the company would be Rs. 200
crores (equity and reserves) and NAV would be Rs. 20 per
share (Rs. 200 crores divided by 10 crores outstanding
shares).
NAV can also be calculated by adding all the assets and
subtracting all the outside liabilities from them. This will
again boil down to net worth only. One can use any of the
two methods to find out NAV.
Tobins q
Tobin's q was developed by James Tobin
(Tobin 1969) as the ratio between the
market value and replacement value of the
same physical asset.
Tobins q= (Market Value of Equity+ Book
Value of Debt)

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(Book Value of Equity + Book
Value of Debt)