What is Value?

• Depends on who is asking and why

• Generally an economic concept where what a buyer is
willing to pay and what a seller is willing to take overlap

Implies transferability

Implies agreeable to both parties
Equity Valuation
• In the real world it is normally a range, not a point

What is a Valuation? Why are Valuations Performed?

• Part art, part science • Transaction pricing • Bankruptcy,

(mergers, acquisitions) reorganization and
• A process to arrive at an estimate of value for a restructuring
company involving: • Privatization/post
privatization • Allocation of purchase

An analysis of the economic environment; price
• Financing

An analysis of the industry; • Litigation
• Tax and audit support

An understanding of the historical, current and • Planning
future operations of the company; • ESOPs
• Value based

An analysis of the financial history and • Management buyouts
management
prospects of the company; and • Joint venture
• Other

Applying acceptable valuation methods investments
3 4
Why Valuation? Why Valuation?
Basics of sound investing
Valuation plays a key role in many allied areas of finance:

• portfolio management
• sell-offs
• acquisitions
Do not buy it for more • mergers
than its worth Do not sell it for less • joint ventures
than its worth • buy-backs
• corporate finance

Price is what you pay. Value is what you get. For every complex problem there is a simple solution that is wrong.
--Warren Buffett --G B Shaw

What does accounting track .. Liability

Financial Year
• A liability is what a business owes to outsiders. Liabilities finance
various assets
Inflows & Outflows of cash
Consumption of resources & Sales • A liability could arise by borrowing money or by acquiring other
resources on credit

• Liabilities can be for a Long Term or Short Term

End of End
earlier of this
financial financial • Liabilities are raised according to the end use of those funds
year year

Assets & Assets &

Liabilities Liabilities
7 8
 Liabilities Current Liabilities & Provisons
(Sources of Funds)

• Liabilities to be discharged in the near future

Share
Capital • They include credit received from suppliers, short-term bank
finance, advances received from customers, tax dues
Others Reserves
& Surplus
• Employees also offer short-term credit to their employer. Unpaid
salary would be a part of current liabilities
• Provisions are made for any of the foreseen liabilities in current
future

9 10

Assets Fixed Assets

(Application of Funds)

• Asset simply means what a business owns. It implies any owned • Fixed Assets are assets which are acquired for a long-term
resource available at the disposal of the firm. use in business

• Assets can take physical forms like factory, land, machinery or • For instance, a machine will be used for a long period of
capital inventory time. When bought, the intention is not to sell it.

• Or they can take monetary form such as a bill yet to be paid by a

client, cash, bank balances, deposits with suppliers are all legal • Fixed Assets form the business infrastructure.
claims which have a value

• Some assets are also called as Intangible Assets, these are,

Goodwill, Patents, Software, Licenses, Trademarks

11 12
 Current Assets Examples of Current Assets

• Current Assets are assets which are acquired not with a view to • Raw Material Inventory
retain them for a long time but to convert them into a product or a
service or a job or a contract which provides value to a customer • Spares Inventory
• Receivables or Debtors or Outstanding
• Advances to suppliers
• These remain properties of the organization for a short time. Either
they are: • Cash & Bank Balance

Converted to another form • Loans & Advances

Sold to a customer

Converted into money.

13 14

Working Capital
Exercise:
Identify out of the following items which are current assets
& which are fixed assets. • This stands for ‘rolling’ money which forms a part of the money cycle.
Particulars Identify whether Current It is the most dynamic component of the investment made in
Asset or Fixed Asset business

Balance in Current Account with a bank

Advance paid to a supplier • This amount needs to be invested before customer ultimately pays
Bank balance at a manufacturing location
Bank balance at the head office
• This investment takes the form of various ‘Current Assets’,
Stock of beverages for a hotel collectively called as ‘Gross Working Capital / Current Assets (CA)
Credit card sales
Bill raised on the customer, not yet paid
Head-office building owned by the
company

15 16
Net Working Capital / Net Current Reserves
Assets
• Profits earned from business belong to shareholders
• Net Working Capital implies the net funds blocked in
Current Assets after reducing current liabilities
• However, entire profits may not be distributed due to needs
such as expansion, diversification
• Many organizations are striving to push ‘net working
capital’ to zero or sub-zero
• These profits accumulate as reserves

• Thus, they want to finance their investment in working

capital out of supplier (credit) or customer (advance) funds • Reserves are a liability to shareholders

17 18

Net Worth Capital Employed

• Liability of the company to shareholders • Amount of investment in infrastructure + net working capital

• Capital + Reserves
• Can also be derived by adding the following:

Net Worth
• Networth of a company is the same as the
Long Term Borrowings
networth of an individual

19 20
 Net Worth & Capital Employed Revenues

Based on the following data calculate the net worth &

capital employed for a company for the last two years. • Basically sales revenues

Has the financing mix for the company changed? • Sales revenue from the products and services of the company

Rs. Crores 2009 2008

Equity Capital 65 65
Reserves 422 375
Secured Loans 403 224
Unsecured Loans 23 13

21 22

Cost Profit

Profit is the difference between Revenue & Cost

Compensation (expressed in monetary terms) paid to the Costs can be defined narrowly or widely to derive different definitions of
profit
supplier of any service or commodity
Different Profit Terms:
What is the difference between cost & price?

Net Profit or Profit after Tax (PAT) : All costs reduced

Profit before Tax (PBT): All costs but tax reduced

Profit before Interest & Tax (PBIT): All costs other than interest
& tax reduced

Profit before Interest, Depreciation & Tax (PBIDT): All costs
other than interest, depreciation & tax reduced (personnel,
operating & other)

Gross Profit (GP): Only material consumed / processed

23 24
 Financial statements answers these
Cash Surplus vs. Profit questions ..

• In business, cash surplus is different from profit Financial Nature Focus Key Information
Statement
• Time lags involved in:
Balance Position Financial position on Composition of assets
Sheet Statement a particular date (resources) & liabilities

Earning of revenue & collecting it (sources)

Incurring expenses & paying for them
Income Flow Statement Profitability during a Revenues & costs
Statement financial period
• Infrastructure investments involved Cash Flow Flow Statement Cash inflows & Cash inflows arising
Statement outflows during a from revenue &
• Ability to inject funds into the system by raising funds
financial period liabilities and cash
outflows arising from
costs & assets

25 26

What do we keep account of? Profit & Loss Statement

Rs. in Crore
• Income Our charges to customers
Firm A Firm B
• Expenses Our costs, consumption of resources Revenue (Sales) 200 180
Costs
Outsourcing 55 25
• Inflow Inflow of money into the system Food Materials 45 55
Manpower Costs 12 18
• Outflow Outflow of money from the system
Maintenance & Depr. 15 14
Power & Fuel 8 13
Other Overheads 15 15
• Assets What we own
Interest Cost 10 13
• Liabilities What we owe to others Profit before taxes 40 27
Profit After Tax 28 19

27
 Balance Sheet Cash Flow Statement

Where is the money coming from & where

Rs. in Crore
is it going ?
Liabilities Firm A Firm B Assets Firm A Firm B
Operating Financing Investing
Capital 10 20 Fixed Assets 118 112 Cash Flow Cash Flow Cash Flow

Cash generated in Cash received & Cash paid out in

Reserves 50 40 Inventory 25 65 regular course of paid out in raising making fresh
business net of money for the investments in
Bank Borrowing 65 85 Receivables 35 25 taxes and net of business & Long Term Assets
increase in servicing or cash realized
Current Liabilities 55 65 Bank Balance 2 8 inventories & previously raised from sale of
receivables funds respectively previous
Total 180 210 Total 180 210 investments

30

Financial management

• Key objective:

Profit Maximization?

Shareholder wealth maximization

• Key activity:

Ensuring availability of ‘life blood’ of business: money Ratio Analysis
• Key decision issues

Financing

Investing

• Key focus areas:

Monitoring of critical variables impacting business

Financial controls
31
Financial Analysis Financial Analysis

• Comparison to industry • Ratio Peculiarities

Provides a measure of the company’s financial performance
Highly dependent on underlying accounting assumptions
and condition relative to its peers (depreciation method, inventory valuation) in the financials.
GIGO!

Common size (base zero) balance sheets

Generally consider book values, not market values

Common size income statements
Mostly post-facto, not forward-looking

Ratio analysis
No ideal standard figure across all industries, or all
companies in the same industry

Other productivity statistics, such as sales/person

33 34

Financial Analysis Financial Analysis

• Ratio Peculiarities • Ratio Peculiarities

– No ideal standard figure across all industries, or all
Formula for computing a ratio may differ across analysts
companies in the same industry o DSCR
– Depend upon relative competitive strength of business in the o Short-term debt
industry

Good or a bad ratio is a relative thing
– Depend on nature of industry/business

Single ratio cannot be seen in isolation
• Seasonality of business

To be seen in conjunction with other supporting ratios, trend
• Entire production cycle process time analysis, peers
• FMCG vs Cement vs Breweries
– Ideal ratios are rarely static – can differ for the same
company/industry, from time to time

35 36
Financial Analysis Ratio Analysis

• Analysis of trends and unusual items • Ratio is a meaningful relationship between two financial
parameters

Trend analysis – examining changes over time • Ratios are best interpreted in comparison with:

Unusual items that seem out of place compared to other
years or industry averages to be discussed in detail
Historical data

Accounts with unusual titles or those that seem out of
place compared to the normal business operations
Competition
should be investigated

Industry norms

37 38

Types of Ratios Liquidity Ratios

Judge firm’s ability to meet short term obligations

• Liquidity Ratios
• Turnover Ratios Current Assets
• Capital Structure Ratios • Current Ratio = ---------------------------
Current Liabilities
• Profitability Ratios
• Earning Ratios Liquid Assets*
• Return on Investments • Liquid Ratio = ---------------------------
Current Liabilities (normally, Bank OD is excluded)
• Market measures
* Current Assets other than inventories & pre-paids

39 40
 Turnover Ratios Capital Structure Ratios

Sales Total Debt

• Basic Turnover Ratio = ------------------------------ • Total Debt Equity = ------------------------------------
Total Assets Total Shareholders’ Equity
Sales
• F. Assets Turn. Ratio = --------------------------------
Long Term Debt
Fixed Assets
Cost of Goods Sold • L. Term Debt Equity = -------------------------------------
• Inventory Turn. Ratio= ----------------------------- Total Shareholders’ Equity
Inventory
Credit Sales Earnings Before Interest & Tax
• Debtors (Receivables) Turn. Ratio = ---------------------------- • Interest Coverage = --------------------------------
Debtors
Interest Cost
EBITDA less tax PAT + Interest + Depn
Note: when there is one figure coming from P&L and the other from balance sheet,
the balance sheet items may be taken as average of opening and closing balances • DSCR = ---------------------------- = ---------------------------------
Interest + Principal Interest + Principal
41 42

Profitability Ratios Earnings Ratios

Net Profit less Pref. Dividend

Gross Profit
• Earnings Per Share = ----------------------------------------
• Gross Profit Margin = --------------------------------
(EPS) No. of Equity Shares
Sales
Total Dividend
Net Profit or Profit After Tax
• Dividend Per Share = --------------------------------
• Net Profit Margin = ---------------------------------------
(DPS) No. of Equity Shares
Sales
DPS
Operating Profit (PBIT)
• Dividend Payout Ratio = -------------
• Op. Profit Margin = -----------------------------------
EPS
Sales

43 44
 Return on Investment Market Measures

EBIT
Earnings Per Share
Return on total assets = ------------------
Earnings Yield = --------------------------------------------
Total Assets Market Price Per Share

PAT + Interest Expenses Dividend Per Share

Return on total assets (post-tax) = ----------------------------------- Dividend Yield = --------------------------------------------
Market Price Per Share
Total Assets
Market Price Per Share
PAT + Interest (1 – tax) Price Earnings Ratio = ----------------------------------------
Net Return on capital employed (post-tax)= -------------------------------- (P/E Ratio) Earnings Per Share
Capital Employed

45 46

Financial Analysis Financial Analysis

• Conclusion & key factors to consider

• Conclusion & key factors to consider (cont’d)

Are any adjustments required to reflect the true earnings
potential of the company?

How does the company compare with the industry?

Is the overall trend in the business (revenues, profits,
etc.) improving, stable or declining?
Your conclusions are a key factor in:

Does the company have adequate liquidity? Is working
Assessing the risk of investing in the company
capital well-managed?

Developing forecast assumptions for the company

Is asset utilization acceptable?

Does the company have too much debt? Does the
company have the ability to borrow in the future if
needed?

Are the returns on equity acceptable?

47 48
 Valuation Methods

Assets Earnings DCF Multiples

Liquidation PCEV FCFE Revenues

Replacem‘nt Dividend FCFF Earnings

Valuation Methodologies Assets

Special

Of two equivalent theories or explanations, all other things being equal, the
simpler one is to be preferred. –-William Ockham

Income Approach Income Approach

• Key inputs to income approach • Income approach

Required/desired /expected rate of return Capitalized earnings

Estimates of future cash flow or normalized Estimate of normalized expected earnings is
earnings capitalized based on the required rate of return and
growth prospects
Commonly referred to as PECV (Profit Earnings
Capitalisation Value) method
Discounted cash flow
Forecasted cash flow available to investors is
discounted to present value using an appropriate rate
51
of return 52
Income Approach
Discounted Cash Flow
Discounted Cash Flow –

• Theoretically correct method

COMPONENTS
Based on future cash flows
Considers the timing of cash flows FORECAST PERIOD TERMINAL PERIOD
Considers the risk of the cash flows
Years go through ..n TERMINAL VALUE
• Potentially dangerous
Represents the value of
Reasonable inputs, unreasonable results all cash flows beyond
Easily manipulated the forecast period
VALUATION DATE
Not directly linked to market
• Typically gives a control value
53 54

Discounted Cash Flow Discounted Cash Flow

FREE CASH FLOW

• Free Cash Flows – calculation
=
Operating Profit (EBIT)
EBIT *(1-Tax Rate)
Less: Adjusted Taxes = (Tax paid + saved) = (EBIT * t)
(EBIT = Earnings Before • Gives: Net Operating Profit Less Adjusted Taxes
Interest & Taxes) (NOPLAT)
PLUS
Add: Book Depreciation

Add: Non-cash expenses/ amortization
Non-cash items (depreciation,
Amortization, write-offs) • Gives: Gross Cash Flow

Less: Increase in net Working Capital

Less: Capital Expenditure
MINUS
• Gives: Free Cash Flows to Firm (FCFF)
Incremental working
capital and
Capex

55 56
 Discounted Cash Flow Discounted Cash Flow

• Free Cash Flows – calculation • Free Cash Flows – calculation

A Corporation Ltd. A Corporation Ltd. Particulars Year2 year3
Profitability Statement Statement of Affairs
Particulars year1 year2 year3 Particulars year1 year2 year3 Operating Profit 570 700
Shareholders 1,700 1,900 2,100 Less: taxes 40% -228 -280
Revenues 1,500 1,800 2,100 Debt-holders 1,400 1,500 1,600 NOPLAT 342 420
CoGS -750 - 900 -1,050 Funds Sourced 3,100 3,400 3,700 Add: Depreciation 120 130
Cash S G & A -200 - 210 - 220 Add: Non-cash expenses 0 0
Depreciation -100 - 120 - 130 Net Block of Assets 2,700 2,900 3,100 Gross Cash Flow 462 550
Operat’g Profit 450 570 700 Investments 100 100 100
Less: Interest 100 90 80 Net Wkg Capital 250 350 450 Less: Increase in W/C -100 -100
PBT 350 480 620 Cash 50 50 50 Less: Capex -320 -330
Taxes@40% 140 192 248 Funds Applied 3,100 3,400 3,700
PAT 210 288 372 Free Cash Flow to the Firm 42 120
57 58

DCF – Free Cash Flows FCFF and FCFE

• Free Cash Flows to Firm (FCFF)

Not the same as operating CF

Residual CF after meeting all cash operating
expenditure, but prior to any payments to financing
stakeholder

Net of working capital and capex needed to support
future forecast FCF

Always post-tax

Cash available to all finance providers = Debt cash
flow + Equity cash flow

We’d rather be vaguely right than precisely wrong.

–-J M Keynes
DCF – WACC DCF – WACC
• Discounting Factor • Cost of Debt

Generally, WACC
Kd = Rd (1 – Tc)

Where

WACC = [(Kd*D)+(Ke*E)] /(D+E)

where oKd = post-tax cost of debt
oRd = coupon rate of interest
oKd = post-tax cost of debt oTc = effective rate of tax paid by firm
oKe = cost of equity
oD = market value of debt
E.g. if a firm borrows debt at interest rate of
oE = market value of equity 12% and lies in 30% effective tax bracket, its
Kd is

8.4%. since 12% (1-30%) = 8.4%

DCF – WACC DCF – WACC

• Cost of Equity – CAPM • Beta (β)

Ke = Rf + β(Rm – Rf)
Measures volatility of firm’s stock price

where: relative
oKe = cost of equity to that of given market index
oRf = risk-free rate of return
Statistically, beta is relationship b/w
oβ = risk factor of the cash-flows ocovariance of selected stock with well-
oRm = rate of return on a diversified diversified market portfolio and
portfolio (SE benchmark index) othe variance of that portfolio

E.g., if the Rf is 6% and the Rm is 10%, the
β = Covariance of asset with Market/Variance
Ke of a firm with β of 2 is of the market

14%. since 6% + 2 (10% - 6%) = 14% Uncertainty is not a result of ignorance or the partiality of human knowledge,
but is a characteristic of the world itself. --M Taylor
DCF – WACC DCF – WACC
• Beta (β) • Beta (β)

Symbolic representation of riskiness of the • In case of calculations based on stock market

underlying cash flows, vis-à-vis those of a data
well diversified portfolio

Directly proportionate to firm’s sensitivity to
Un-levered industry/segment average beta is
market conditions considered

E.g. if benchmark index moves up by 5% and
Βu = βlv / [1+ (D:E)*(1-t)]
simultaneously scrip moves:

Re-levered to target company’s target D:E
o by 7%, its beta is 1.4 ratio
o by 9%, its beta is -1.8
Βrlv = βu * [1+ (Dt:Et)*(1-t)]

DCF – WACC DCF – Prevent Value of FCF

• Beta is a highly sensitive value driver • Present Value of FCFs
• To be chosen/calculated carefully. Varies with
FCFs are discounted to their present value, using the
choice of: WACC

market index (for e.g., Sensex, Nifty, BSE
200, NSE 100, etc.) Particulars Year2 Year3

time period covered by underlying
observational data points (one year, two Free Cash Flows to the Firm 42 140
years, five years, etc.) Present Value Factor @14% 0.77 0.67

return interval (daily, weekly, monthly, bi- PV of the FCFs 32.32 94.50
monthly, quarterly, semi-annually, annually, Sum of the PV FCFs (yr1) 126.81
etc.)

 
DCF – Terminal Value DCF – Terminal Value
• Terminal Value • Terminal Value

Business, as a going concern, is assumed to • FCFF(n+1)/ (WACC – g)

be carrying on operations in perpetuity, i.e., • where:
infinity • FCFF(n+1) = FCFF in year after explicit
forecast period

TV is firm’s value at end of explicit forecast • FCFF(n+1) = FCFFn * (1+g)
period • g = steady state growth rate of FCF till
infinity

TV captures firm’s value for operations • E.g., if FCFF for last forecast year is 1000,
beyond explicit forecast period WACC is 18% and terminal growth rate is
3%, the TV is
Do not count your chicken before they stopped breeding. --Aesopeus
• 6867, being 1000*1.03 / (0.18-0.03)

DCF – Terminal Value DCF – Enterprise/Equity Value

• Terminal Value • Enterprise Value

PV of FCFs during forecast period

Perpetuity formula does not work where g ≥
Add: PV of terminal value
WACC

BUT this is impossible - g exceeding r in • Equity Value

perpetuity implies the business eventually
Enterprise value
would be larger than the whole economy!!
Less: Net debt, being
oMarket value of debt
oLess: Cash & equivalents

 
DCF – Enterprise Value DCF criticism and defense
• Enterprise Value – broad steps in DCF-based • “DCF is difficult and subjective”
calculation

So, aren’t others?
Forecast FCFs Cost of Debt Cost of Equity

• “Many value drivers need to be combined to produce a

Growth rate WACC
DCF valuation”

Terminal Value
Multiples also consider same factors

DCF focuses on all value drivers rather than combining
these into one multiple
PV of FCFs PV of TV

Markets can remain irrational longer than you can remain solvent.
Enterprise Value Net Debt Equity value –-J M Keynes

DCF criticism and defense DCF conclusion

• “DCF requires WACC and nobody seems to have a clue • DCF and related techniques are powerful valuation tools
of what it is”

Differences in required return is a key factor in
• DCF is a very robust methodology, but can only work right
valuation if

the assumptions are reasonable

the application is realistic
• “DCF is very sensitive to long term growth assumptions”

So are multiples. The problem is mitigated by using
zero value adding long term growth assumptions

Investing should be dull. It shouldn't be exciting. Investing should be more like

watching paint dry or watching grass grow. If you want excitement, take $800
Take every gain without remorse for missed profits. --Joseph de la Vega and go to Las Vegas. –-Paul Samuelson
 Comparable Multiples Comparable Multiples
• Value relative to a key statistic assumed to relate to that
Advantages Disadvantages value. Key statistics commonly used:
• Easy to understand and • One key for all locks
Sales
compute • Ignores the peculiarities
Book Profits (EBIT, EBT, PAT, etc.)
• Can be used for all or specialties of target
Cash Profits (EBITDA, Cash PBT/PAT)
businesses firm
Assets (user, capacity unit, customer, etc.)
• Gives the firm’s value
vis-à-vis its peers • Valuation based on statistic multiples
• Frequently used as a
P/E, P/BV, P/eyeball, P/customer, P/sales, P/click,
sanity check of value P/bed, P/seat, etc..
derived from other
methods

One of the first questions to ask about a possible investment is 'Why is it

mispriced?' If you don't have a reason, there's a good chance it isn't really
mispriced. -- Jeffrey Tannenbaum

Comparable Multiples Comparable Multiples

EBITDA Margins PAT Margins PE EV/EBITDA
Market
Rs mn MCap FY07 FY08 FY09 FY07 FY08 FY09 FY07 FY08 FY09 FY07 FY08 FY09
Price
A 545 9,367 9.6 9.0 9.5 5.5 6.0 6.1 18.9 17.6 13.6 15.0 13.0 9.6
B 133 9,628 23.6 21.3 18.6 9.1 7.5 6.8 30.3 16.3 15.2 17.2 8.4 8.4
C 129 27,018 24.1 29.8 25.6 8.2 12.4 11.1 18.2 12.4 12.2 9.6 7.5 7.6
D 405 24,859 15.9 14.5 15.9 6.4 8.9 9.8 27.3 15.5 12.7 13.7 12.3 9.9
E 6.8 8.2 11.8 2.6 3.5 6.1
Average 23.7 15.5 13.4 13.9 10.3 8.9

Market Cap P/E EV/EBITDA (X)

(US$ mn) FY08/CY07 FY09/CY08 FY08/CY07 FY08/CY07
F 1,144.8 8.8 7.4 4.0 3.4
G 386.2 16.0 10.4 8.8 6.6
H 999.5 12.7 10.7 7.7 6.6
I 435.1 13.7 12.3 4.7 4.2
J 121.4 5.9 5.9 4.1 3.2
K 157.1 4.7 3.7 4.1 3.2
Average 10.3 8.4 5.6 4.6
 Comparable Multiples
Date Target Company Bidder Company Seller Company Deal Value Enterprise Revenue Revenue EBITDA EBIT PE
USD(m) Value USD(m) Multiple Multiple Multiple Multiple
USD(m)
2008 Ranbaxy Daiichi Sankyo 4,625.00 7,622.66 1,213.69 6.28 30.42 34.58 59.78
Laboratories Company, Limited
Limited (60.62%)
2008 IL&FS Investsmart HSBC Securities
Limited (93.21% and Capital
stake) Markets (India) Pvt
ETrade Mauritius
Limited; IL&FS;
Softbank Asia
306.00 328.23 - Not Not Not
Available Available Available
23.85
Some Finer Points
Ltd. Infrastructure
Fund (SAIF)
2008 UTV Software The Walt Disney 302.00 844.02 46.74 18.06 103.52 113.57 42.71
Communications Company
Ltd (35.8%)
2007 New Delhi Prannoy Roy; 140.00 698.29 64.33 10.86 96.57 241.89 201.16
Television Limited Radhika Roy;
(NDTV) (20% RRPR Holdings Pvt
stake) Ltd
2007 India Infoline Ltd Orient Global 140.00 2,166.90 - Not 71.60 80.75 110.37
(6.48% stake) Available
2007 Infomedia India Television Eighteen ICICI Venture 45.00 113.03 32.96 3.43 26.98 44.68 131.81
Limited (formerly India Ltd Funds
Tata infomedia Management
Limited) (40%) Company Ltd

Valuation Finer Points Valuation Finer Points

• Nominal v/s. real cash-flows • Book vs market value of debt
– Inflation impact – Can impact the value in case the difference in book
– Value to be the same under either case and market values is high
• Appropriate capitalization rate • Short-term interest costs
– Depends on expected return/ beta/ D:E ratio – Two schools of thought (so, whats new??)
• Tax rate for WACC • Adjusted taxes
– Marginal rate of tax – Impact of MAT/ Deferred taxes
– All differences are timing differences • Terminal growth rate
• Target, D:E ratio – A very sensitive value driver
– Target, long-term, future, sustainable ratio • Mid-year v/s year-end discounting
– Best approximated by mid-year discounting for annual
– Ignore minor variations CFs
– Year-end often used as an approximation
 Valuation Finer Points Valuation Finer Points
• Sensitivity analysis • Economic Value Added (EVA)
– Scenarios building – Based on principle that firm’s profit should reflect all
financing costs
• Synergy/ control value – Surplus value created on firm’s investment over it’s
• Non-core assets cost of capital
– More of a management appraisal tool
• Mid-period valuations
– Adjustment required to valuation at last balance sheet • Market Value Added (MVA)
date to current date – Difference b/w market valuation and book value
– PV of future expected EVAs
• Adjusted Present Value (APV)
– Value of un-levered firm
– Add: PV of leverage benefits

Case Study 1
• As an investor you are interested in the emerging markets
of Asia. You are trying to value some stocks in Malaysia,
which does not have a long history of financial markets.
During the last three years, the stock market has gone up
Case Studies 60% a year, while the government borrowing rate has
been 15%, yielding an historical risk premium of 45%.
Would you use this as your risk premium, looking into the
future?
 Case Study 2
• Hitec Inc. has three divisions with the following
characteristics
Division Beta Market Value
PCs 1.60 $100 million
Software 2.00 $150 million
Mainframes 1.20 $250 million

• What is the beta of the firm?

• What would happen to the beta of the firm if it divested
itself of its software business?
• To value the software business for divestiture, which
beta would you use in your valuation?