Corporate Valuation - Chapter 2.docx

Strategic Financial Management Corporate Valuation

Chapter 2 – Corporate Valuation

4th Sem M.Com

Meaning and approach to valuation – adjusted book value approach, stock and debt approach, direct comparison approach, concept of free flow to the firm, discounted cash flow approach – two and three stage valuation models. Valuation of physical asset, value of intangible asset – brand equity and human resources , guidelines for corporate valuation What is Value ? Value is the worth of a thing. It can also be defined as a bundle of benefits expected from it. It can be tangible or intangible. Value is defined as 1. 2. 3. 4. 5.

The worth, desirability, or utility of a thing, or the qualities on which these depend Worth as estimated The amount for which a thing can be exchanged in the market Purchasing power Estimate the value of appraise ( professionally)

Valuation is defined as – the process which is undertaken to know the worth is commonly know as valuation. 1. Estimation of a thing’s worth 2. Worth so estimated 3. Price set on a thing Value/Cost/Price   

Cost is defined as resources sacrificed to produce or obtain a thing(a product or service) Price is what is charged by a seller or provider of product or service. Price si what you pay Value is what you get. Value refers to the worth of an asset.

Valuation is called for in various situations, so? The concept of Value is like beauty. Just as it is said that ‘beauty lies in the eyes of the beholder’, value is determined by a person who seeks or perceives value in a thing. Value can also be estimated, assessed, or determined by a professional called ‘Valuer’. The process of determining value is called ‘Valuation’. Business Valuation is the process of determining the economic value of a business. Valuation is an estimation, by a professional valuer, of a thing’s worth. Basis for valuations: The different bases that can be used in valuations are: 1. Cash flows: the cash flow to equity shareholders (dividends) or to both equity shareholders and debtors (free cash flow) 2. Returns: The difference between the company’s capital and the cost of capital. 3. Operational Variables: Production capacity, subscriber base (as in telecom), etc.

Devaki Prasad H, Ananya Institute Of Commerce and Management, Tumkur.

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Strategic Financial Management Chapter 2 – Corporate Valuation Valuation is called for in various situations, some of them are listed below:

4th Sem M.Com

1. Purchase/ Sale of business / Shares: Valuation plays an important role in case of takeover/acquisition of business/shares of a company. A valuer needs to apply appropriate valuation methodologies depending upon the nature of business being transferred and the industry to which it belongs. 2. Merger: In case of merger, one needs to determine the share exchange/ swap ratio i.e. number of shares of Transferee Company to be allotted to the shareholders of Transferor Company. The attempt is to arrive at the relative value of the shares of the transferor and transferee company. 3. Demerger: It involves transfer of undertaking fromone entity to other. The resulting company issues shares to the shareholders of the demerged company, which is based on the share entitlement ratio to be recommended by the valuer. 4. Regulatory requirements: Recently there has been many regulatory changes governing valuations under FEMA as well as Income-tax Act like transfer of shares of an Indian company between residents and non- resident, valuation needs to be done using DCF method. 5. Impairment testing: As per AS-13 “Accounting for Investments”, long-term investments are usually carried at cost. However, when there is a permanent diminution in the value of such investment, the carrying amount needs to be reduced to recognise the diminution. To ascertain this diminution, valuation of such investment needs to be carried out. Thus, the purpose of valuation and the structure of transaction needs to be understood before commencement of the valuation exercise. What to Value?  Value all assets and liabilities to know the value of ‘what we own’ and ‘what we owe’.  Assets will include both the tangibles and intangibles.  Liabilities will include both the apparent and contingent. Business Valuation:  The objective of any management today is to maximize corporate value and shareholder wealth. This is considered their most important task. A company is considered valuable not for its past performance, but for what it is and its ability to create value to its various stakeholders in future.  Therefore, in analyzing a company, it is not suffi cient just to study its past performance. We must understand the environment – economic, industrial, social and so on – and its internal resources and intellectual capital in order to gauge its future earning capabilities.  It is therefore essential to understand that business valuation is important in determining the present status as well as the future prospects of a company, which in turn is important to understand how to maximize the value of a company. The creation and development of corporate value is the single most important long – term measure of the performance of a company’s management. Further, this is the only common goal all shareholders agree on.  Business Valuation is a fascinating topic, as it requires an understanding of fi nancial analysis techniques in order to estimate value, and for acquisitions, it also requires good negotiating and tactical skills needed to fix the price to be paid

Devaki Prasad H, Ananya Institute Of Commerce and Management, Tumkur.

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Strategic Financial Management Factors determining Value:

Chapter 2 – Corporate Valuation

4th Sem M.Com

There a host of factors that go into determining value. Some of them are listed below: 1. Level of technology 2. Design and engineering 3. Material of construction. 4. Aesthetics 5. Features in a product, asset or business 6. Performance of an asset or business 7. Reliability 8. Maintenance and upkeep 9. Service features 10. Level of obsolescence of asset, or stage of product in its life cycle The various factors relevant in a business valuation are: • The nature of the business and its history from its inception. • The economic outlook in general and the condition and outlook of the specific industry in particular. • The book value and the financial condition of the business. • The earning capacity of the company. • The company’s earnings and dividend paying capacity. • Whether the enterprise has goodwill or other intangible value. • Sales of the stock and the size of the blocks of stock to be valued. • The market price of the stock of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market. • The marketability, or lack thereof, of the securities. Written Valuation Reports: A written valuation report must summarize the appraisal procedures and the valuation conclusions. It should consist of the following: * Company description. * Relevant valuation theory, methodology, procedures. * A valuation synthesis and conclusion. * A summary of the quantitative and qualitative appraisal. * A listing of the data and documents the valuer relied on. * A statement of the contingent and limiting conditions of the appraisal. * An appraisal certification. * The professional qualifications of the principle analysts. The valuer’s role of review constitutes the following pieces: Evaluation of data provided through discussion and analysis. Broad review of management estimates in terms of public domain information. Discussions on the data provided with management. Hence, review / analysis is very necessary and a pre-requisite for any valuation analysis.

Devaki Prasad H, Ananya Institute Of Commerce and Management, Tumkur.

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Strategic Financial Management Chapter 2 – Corporate Valuation 4th Sem M.Com Role of professionals: Management of companies always sought help of professionals like Chartered Accountants or Investment Bankers to value intrinsic worth of business / shares using various techniques of valuation. Some of the important aspects that needs to be taken care of are listed below: Understanding the nature of transaction. Proper understanding of the business and the industry scenario. Back up of data used for valuation Representation letter on various information received from the management. Filing of working papers. Format of valuation report giving details on data considered, information received, methods used, factors considered for valuation, the final recommendation and also the scope limitations. Conclusion The Indian courts have acknowledged that valuation is a technical and challenging discipline. The judiciary is conscious of the fact that the word value means different things to different people and the result will not be the same. Valuation involves high degree of professional judgement, knowledge of business, analysis of facts, interpretation, developing financial models, methods and procedures, which may result into different conclusions in each given situation. Therefore, the objective of every valuer should be “to build confidence and trust in valuation process by creating a framework for delivery of credible valuation opinions by suitably trained valuation professionals acting in an ethical manner”. The Institute of Chartered Accountants has made it mandatory for all valuers in India to abide by the Business Valuation Practise Standard thatwas brought into effect on 1st April, 2010. Further, the valuer should maintain an impartial attitude and should never develop or report biased analyses, opinions and conclusions.

Devaki Prasad H, Ananya Institute Of Commerce and Management, Tumkur.

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