VALUATION CONCEPTS and METHODS

“Introduction to Valuation (Toby Unravels)”

Overview of Valuation (Toby Cabug)

• Price is what you pay for, while Value is what you get.
• The value of an asset is the present value of the future cash flows it is expected to
generate.
➢ Sample Case: If you believe that dividends will be P4.00 forever and you want
to earn 8% per annum. What would you be willing to pay for the stock?
- Annual dividend= P4.00
- Required rate of return= 8%
Value of the stock= P4.00/8%= P50 — This process/method is called
discounted cash flow or intrinsic value method
• Relative Valuation is a technique that gives reference to similar assets in the
market, we use their prices as the basis for the valuation.
- Price to Earnings Ratio
Valuation of Derivatives

• A derivative is a contract between two or more parties whose value is based on an

agreed-upon underlying asset.
• Derivatives are helpful in hedging (managing exposure to risk)
• A popular example of which is options, we placed options on center stage and use
techniques like Binomial Model and Black-Scholes-Merton Model.

“Fundamental Principles of Valuation (Mark Gibson Manaois)”

Valuation

• Valuation is the estimation of an asset’s value based on variables perceived to be

related to future investment returns, on comparison with similar assets, or when
relevant, on estimates of immediate liquidation proceeds.
• Valuation places great emphasis on the professional judgement.
- Professional judgement is the ability to diagnose at the same time solve
problems.
• Mostly deals with projections about future events.

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The Value of Business Can Be Basically Linked to Three Major Factors:

1. Current Operations- how is the operating performance of the firm in recent year
2. Future Prospects- what is the long-term strategic direction of the company
Two types of strategy:
- Tactical plan includes short-term plans of the business
- Strategic plan includes long-term plans of the business
3. Embedded risks- what are the business’ risks involved in running the business.

Different Concepts of Value

Intrinsic Value

• Intrinsic Value, in general, is defined as the fair or inherent value of any asset
(whether real or financial), company, its stock, derivatives like options, etc. This term
is the most prominent in defining the value of a company’s stock.
- Intrinsic value could be higher than market value
• The intrinsic value is the perceptional value of the stock which has considered all
the factors (qualitative or quantitative) while valuing the stock. Technically, intrinsic
value of stock is defined as the present value of all free cash flows (FCF) discounted
at the rate of weighted average cost of capital (WACC).
- Quantitative factors such as sales, earnings, capital, all other information
available in the financial statements
- Qualitative factors such as past track records, goodwill, branding,
management quality and company’s reputation

Intrinsic value vs. Market value

Intrinsic value > Market value — Investor will look at it as an opportunity and
buy the stock.
Intrinsic value < Market value — Stock is considered to be overpriced and investor
will try to exit from it.

Going Concern Value

• The going concern assumption assumes that the enterprise will continue to
operate in the foreseeable future.
➢ Implications: capital assets are recorded at cost instead of liquidation value,
amortization is used, items are labeled as current or non-current.

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Liquidation Value

• Refers to the net amount that would be realized if the business is terminated and the
net assets are sold piecemeal.
- In liquidation value, it is simply assumed that the enterprise is already in the
dissolution stage.

Fair Market Value

• Refers to a price where there is a willing seller to sell and a willing buyer to buy.

Roles of Valuation in Business

1. Portfolio Management
01. Fundamental Analysts- interested in the intrinsic value
02. Activists Investors- usually do takeovers
03. Chartists- relies on the concept that stock prices are significantly influence by
how investors think and act
04. Sell-Side/Buy-Side Analysts- issue valuation judgement; look at specific
investment options

2. Analysis of Business Transactions

01. Acquisition- two parties: buying firm and the selling firm
02. Merger- is a general term which describes a transaction where two companies
had their assets combined to formed a wholly new entity
03. Divestiture- sale of a major component or segment of a business to another
company
04. Spin Off- separating a segment or component business and transforming them
into a separate legal entity
05. Leverage Buy-out- acquisition of another business by using significant debt
which uses the acquired business as collateral

3. Corporate Finance
- Involves managing firm’s capital structure including funding sources and
strategies within the business which the business should pursue maximize firm
value. Simply, corporate finance is managing the resources of the business.
- Small businesses used valuation in order for them to get capital from private
entities.
- Larger businesses used valuation in order to estimate the price they’re going
to fetch in the stock market.

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4. Legal and Tax Purposes

Valuation Process

1. Understanding of the Business- to understand the business we should know the

ins and outs of the business.
2. Forecasting Financial Performance- refers to income statement. When we
forecast income statements we used trends.
- Top-Down Forecasting Approach- the forecast starts from international or
national macro-economic projections with outmost consideration to industry
specific forecast.
- Bottom-Up Forecasting Approach- it starts from the lower level of the firm
going up.
3. Selecting the Right Valuation Model
4. Preparing the Valuation Model Based on Forecasts
5. Applying evaluation conclusions and providing recommendations

“Asset-Based Valuation (Mark Gibson Manaois)”

• Per the latest Conceptual Framework and Accounting Standards, asset is an economic
resource controlled by an entity as a result of past event.
• An economic resource is a right that has the potential to produce economic benefits.

Green Field vs. Brown Field

Green Field Investments
• Started from scratch
• More challenging to determine the value as these are based on estimates

Brown Field Investments

• Partially or fully operational
• Are already in the going concern business opportunities

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Enterprise-Wide Risk Management
• Increase the opportunities
• Facilitate management and identification of the risk factors that affect the business
• Identify or create cost-efficient opportunities
• Manage performance viability
• Improve management and distribution of resources across the enterprises
• Make the business more resilient to abrupt changes

4 Popular Methods To Determine The Value Of Assets

1. Book Value Method- BV can defined as the value recorded in the accounting records
of a canopy
- Assets and Liabilities- Categorized into current or non-current assets
- Advantages of Using Book Value Method:
a. More transparency
b. More verifiable
- Disadvantage of Using Book Value Method:
c. Reflects Historical Value

Net Book Value of Assets- The value of the enterprise is based on the book value of
the assets less all non-equity claims against it
NBV of Assets= Total Assets – Total Liabilities
Number of Outstanding Shares

2. Replacement Value Method- is the cost of similar assets that have the nearest
equivalent value as of the valuation date.
- Factors that affect the replacement Value:
a. Age of the asset
b. Size of the asset
c. Competitive advantage of the asset

Replacement Value per share= Net Book Value + – Replacement adjustment

Outstanding Shares

3. Reproduction Value Method- is an estimate of cost of reproducing, creating,

developing or manufacturing a similar asset.
- Steps in determining the equity value using the reproduction value method:
• Conduct reproduction cost analysis on all assets
• Adjust the book value to reproduction costs values

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 • Apply the replacement value using the figures calculated in the
preceding step.

4. Liquidation Value Method

• Considers the salvage value as the value of the asset
• Value of the company if it were dissolved and its assets are sold individually.
• Represents the net amount that can be gathered if the business is shutdown,
and its asset are sold piecemeal.
• Also known as the net asset value.
• Considers the present value of the sums that can be obtained through disposal
of the assets, net of the sums set aside for the closure costs, repayment of
debts and other liabilities and net of taxes and costs of liquidation.

Liquidation Value per share= Total liquidation value

Outstanding Shares

Situations to Consider Liquidation Value Method

1. Business Failures
- Low or negative returns
- Consistent operating losses
- May lead to insolvency or bankruptcy
2. Corporate or Project end of life
3. Depletion of Scarce Resources

“Time Value of Money (Tim Coching)”

• The concept of time value of money is important especially when it comes to

accounting for financial instruments.
• Time value of money (TVM) is the concept that money you have now is worth
more than the identical sum in the future due to its potential earning capacity. This
core principle of finance holds that provided money can earn interest, any amount of
money is worth more sooner it is received. TVM is also sometimes referred to as
present discounted value.
• Applies the concept of compounding of interest

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Interest

• Interest is the monetary charge for borrowing money—generally expressed as a

percentage, such as annual percentage rate (APR).
Types of Interest

Simple Interest

• Interest calculated on the outstanding principal, or original amount of a loan.

- Outstanding principal- portion ng principal na hindi pa bayad
- Stated/ nominal interest rate- yan yung interest rate na nakalagay dun sa
certificate of deposit
Interest= Principal x rate x time

Compound Interest

• Interest calculated on the outstanding principal amount and on the accumulated

interest of previous periods and can thus be regarded as “interest on interest”.
- Accumulated interest of previous periods- mga interest na nacompute
mo since nagstart ka magcompute ng interest.
• The term is divided into compounding periods. At the end of each compounding
period, previous interests are accumulated prior to the computation of interest for the
next period.
• Normally, the longest compounding period is one year. One year can also be divided
into several compounding periods e.g., monthly, quarterly or semi-annually.

Time Value of Money

• Present value (PV) is the current value of a future sum of money or stream of cash
flows given a specified rate of return.
• Future value (FV) is the value of a current asset at a future date based on an
assumed rate of growth.

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Ordinary Annuity

• An ordinary annuity is a series of equal payments made at the end of consecutive

periods over a fixed length of time.

Annuity Due

• Annuity Due is a series of equal payments due immediately at the beginning of each
period over a fixed length of time.

Present Value Formulas

Present value of 1= (1 + i)–n
Present value of Ordinary Annuity= 1 – (1 + i)–n

i
Present value of Annuity Due= 1 – (1 + i)–n x (1 + i)
i

Legend:
i= interest for compounding period
n= number of compounding period

Future Value Formulas

Future value of 1= (1 + i)n
Future value of Ordinary Annuity= (1 + i)n – 1

i
Future value of Annuity Due= (1 + i)n – 1 x (1 + i)
i

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“ What is Valuation- Meaning, Scope and Scope (The WallStreet School)”

• Valuation is an estimation of the worth of something.

Something?
- Priced and Valued/Priced
- Priced (gold, bitcoin, silver) These assets can only be priced because it does
not generate any future cash flows. They can be priced but not valued.
- Valued/Priced (company, loan given and project) These assets generate cash
flows in the future.

Valuation vs. Pricing

• Pricing is what you pay and Value is what you get.
• Valuation is driven by:
- Cash flow from existing assets in place.
- Cash flow from future assets
- How fast assets will grow?
- Cost of funds to get assets in place (present and future)
• Price is driven by:
- Demand and supply (expectations, momentum and moods)

Approaches to Valuation

Valuation Techniques
1. Income based approach
- Discounted cash flow
- Dividend discount model
2. Asset based approach
- Liquidation Value
3. Market based approach
- Trading Comps
- Transaction Comps

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Income based approach (Discounted cash flow)

Logic- The intrinsic value of firm is present value of all the cash flow that business is
expected to generate in future.
Steps to calculate present value of all future expected cash flows you need:

1. Forecast future free cash flows (FCFF/FCFE).

2. Calculate expected cost of capital (WACC/Ke).
3. Calculate terminal value (Constant growth model or Multiple based approach)
4. Calculate present value of forecasted cash flows and terminal value (Value of
operations)
5. Add non-operating items like cash and investments to Step 4 (Value of firm)
6. Subtract debt and other non-equity claims (Intrinsic value of equity)
7. Divide Step 6 by number of diluted shares outstanding (Intrinsic value per equity share
capital)

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