CHAPTER 7

OTHER CONCEPTS AND VALUATION

TECHNIQUE

Genesis E. Sahagun

Joh-anna Cathlyn T. Prado

Ayzel Faye A. Ramirez

 OBJECTIVES
As mentioned in the previous chapters, there are various business valuation methods
appropriate for unique circumstances. You may have encountered some terms and
concepts related to valuation. The following special topics will be discussed in this
chapter.
 Due Diligence
 Mergers and Acquisition
 Divestures
 Other Valuation techniques discussed in other literature

 LEARNING CONTENT Section 1 – Due Diligence

Due diligence
A process of validating the representations made by a seller, normally to an
investor. This process would require a thorough examination of records relevant to
the realization of returns or the so-called advertised benefits.
Was started to be a formal exercise since the mid-1900.
Due diligence team
R.A. 8799 or the Securities Regulation Code
Serves as the equivalent regulation that protects investors in the country.
The law enumerates the information that needs to be disclosed by companies
and the frequency to enable the commission to monitor the operations of the
partnerships and corporations in the Philippines.

Types of Due Diligence

1. Corporate Due Diligence
- If the due diligence exercise is to be conducted or commissioned by a company or
corporation that will invest to the business.
2. Private Due Diligence
- If the due diligence exercise is facilitated or conducted by individual or at least few
individual
investors but is not yet incorporated
3. Government Due Diligence
- If the due diligence is commissioned or conducted by the government.
- This type of due diligence is for the protection of the public or evaluation of the
operations of the company for the public interest.

Due Diligence According to Subject

1. Hard Due Diligence
- When the due diligence focuses on the data and hard evidential information.
Examples of hard diligence activities include, but not limited to:
a. Review and audit of the financial statements
b. Validation of the projection for future performance
2. Soft Due Diligence
- Focuses on the internal affairs or the internal organization of the company and its
customers.
Examples of soft due diligence activities include, but not limited to:
a. Competency Assessment
b. Quality Assurance on Customer Services
3. Combined Due Diligence
- When the focus of the due diligence exercise is to cover both quantitative and
qualitative areas of the company.
- Also known as Comprehensive due diligence.

Factors to be considered in the Due Diligence Process

1. Market Capitalization
- Provides an indication on how volatile the value of the company is in the market.
2. Performance/Profitability Trend Analysis
- This would add more integrity to the company on the realization of the future
earnings.
- May provide sufficient data for the projection.
3. External Environment Analysis
- Assessing the position of the company in the industry is also a good input to the due
diligence exercise.
4. Management and Share Ownership
- Assessment of the personalities involved in the governance and policy making of the
company is also critical.
5. Financial Statements
- Serves as the best document to support the financial performance and financial
position of the company including their cash flows.
6. Stock Price History
- Investors should research both the short-term and long-term price movement of the
stock and whether the stock has been volatile or steady.
7. Stock Dilution Possibilities
- Investors should know how many shares outstanding the company has and how that
number relates to the competition.
8. Market Expectations
Investors should find out what the consensus of market analysis is for earnings growth,
revenue, and profit estimates for the next two or three years.
9. Long and Short-term Risks
The main objective of due diligence is essentially risk management.

LEARNING CONTENT Section 2 - Mergers and Acquisitions (M&As)

Mergers and Acquisition

A corporate strategy that allows a company to combine its assets to another
company or to acquire another company.
Merger - two companies combine to form another company.
Acquisition - taking over or taking a part of a company.

Reasons why companies entered into M&As:

o Manage the cost capital
o Expansion and growth
o Economies of scale
o Diversify for expanded market coverage
o Widen access in the industry
o Technological advancement
o Tax management strategies
o Legal strategies
o Control over supply chain

In M&As there should be:

 Company must be willing to take the risk and vigilantly make investments to
benefit fully from the merger as competitors and the industry take heed quickly.
 Multiple bets must be made to maximize the opportunities available.
 The acquiring firm must be patient in the realization of its investment.

M&As according to Form

1. Absorption - done when a company takes over another company, normally the
latter in a more disadvantageous position.
2. Consolidation - when two companies combined its assets and/or restructure their
debt profile.

M&As according to Economic Perspective

1. Horizontal - when two firms in the same industry combined.
2. Vertical - when two companies merged from different stages of production or
value chain.
3. Conglomerate - mergers and acquisitions from completely unrelated industries.

M&As based on Legal Perspective

1. Short Form - when a parent purchases more interest from its subsidiary.
2. Statutory - when a company combines with another where the company, the
acquirer, retains its name.
3. Subsidiary - the consolidation of the subsidiaries of a holding or parent company.

Five stages of M&A

1. Pre-acquisition Review
2. Investment Opportunity Scanning
3. Valuation of Target Investment
4. Negotiation
5. Integration

Considerations to Maximize M&A Opportunity

 Determine the objective behind the acquisition and the benefits expected by both
acquirer and target company from the deal.
 Understand industry of both acquirer and target.
 Identify key operational advantages of acquirer and target company.
 Check with the acquirer if the takeover is friendly or hostile.
 Analyze pre-merger operating and financial performance of acquirer and target
company through key ratios such as return on equity, gross profit margins,
operating expenses % to sales and working capital metrics.
 Evaluate tax position of both companies and determine if there are net operating
loss carry forwards and deferred tax assets in their books.

Reasons for failure of M&A:

 Poor strategic fit
 Poorly executed and ill managed integration phase
 Inadequate Due Diligence
 Too Aggressive Projections and Estimates

Major Valuation Methods used in Mergers and Acquisitions

Two involved parties: (1) the acquiring and (2) the target companies·
 Discounted cash flow (DCF) method
 The targets value is calculated based on its projected future cash flows with
appropriate discount rate.
 Comparable company analysis
Relative valuation metrics for public companies are used to determine the value of
the target.
 Comparable transaction analysis
Valuation metrics for past comparable transactions in the industry are used to
determine the value target.

 LEARNING CONCEPT Section 3 - Divestiture

Divestiture
Divestiture or divestment refer to the disposal of the assets of an entity or
business segment often via sale to third party.
A divestiture is the partial or full disposal of a business unit through sale,
exchange, closure, or bankruptcy. A divestiture most commonly results from a
management decision to cease operating a business unit because it is not part of a
company's core competency.

For example, an automobile manufacturer that sees a significant and prolonged drop
in competitiveness may sell off its financing division to pay for the development of a
new line of vehicles. Divested business units may be spun off into their own
companies rather than closed in bankruptcy or a similar outcome.
A divestiture is when a company or government disposes of all or some of its
assets by selling, exchanging, closing them down, or through bankruptcy.
As companies grow, they may become involved in too many business lines, so
divestiture is the way to stay focused and remain profitable.
Divestiture allows companies to cut costs, repay their debts, focus on their
core businesses, and enhance shareholder value.

Rationales behind Divestiture:

 Sell non-core or redundant business segments.
 Generate additional funds.
 Take advantage of resale value of non-performing segments instead of incurring
losses.
 Ensure business stability or survival
 Adapt to regulatory environment.
 Lack of internal talent.
 Take advantage of opportunistic offer from third party.

Types of Divestitures
1. Partial sell-offs - is the form of divestiture wherein the firm sells its business unit
or a subsidiary to another because it deemed to be unfit with the company’s core
business strategy. The divesting company only sells a portion of the business (an
operating segment, subsidiary, product line) in order to raise funds that can be
used to fund growth of more productive segments.
2. Equity carve-out - In an equity carve-out, a business sells shares in a business
unit. The ultimate goal of the company may be to fully divest its interests, but this
may not be for several years. The equity carve-out allows the company to receive
cash for the shares it sells now. Carve-Out in this scenario is divesting assets or
business units that are not strategic to a company for their operations. Carve-Out
is mainly done because this step can be an important part of the Company's growth
strategy. It is important to be aware that, if an asset or division is not generating
profits, or its margins are lower than those of the rest of the company, selling that
asset or resource can be an efficient way to raise capital
3. Spin-off - a business segment of the parent company is separated and is made into
an independent new company. Shares of the spin-off company is distributed to the
existing shareholders of the parent company. Ownership percentage of
shareholders is the same for both the spin-off company and parent company.
4. Split-off - a business segment of the parent company is also separated and made
into an independent entity. However, shareholders are offered the option to
 exchange parent company shares for the new company shares or just retain the
parent company shares.

When deciding to divest, three values are compared: going concern value, liquidation
value and divestiture value. Between the three, the right alternative to pursue is the
option which will yield the highest value to seller.

Impact of divestiture to firm value is enumerated below:

o If divestiture value is same as going concern, divestiture will not have impact to
the selling company’s value.
o If divestiture value is higher than going concern value, divestiture will increase
value of selling company.
o If divestiture value is lower than going concern value, divestiture will reduce value
of selling company

LEARNING CONCEPT Section 4 - Other Valuation Techniques

ROI-based Valuation Method

Return on investment or ROI measures the earnings generated by the business in
relation to the investment made to the business. ROI-based valuation method is a
quick computation of company value based on the investment that the investor is
willing to pay for the business.
- For example, if the business is asking for Php250,000 in exchange of 25%
ownership in the business, total company value can be derived using ROI-based
valuation method. 250,000/25% = Php1,000,000 – business value
- For the example above let us assume that cost of investment is only
Php600,000. Therefore, the ROI expected by the seller (you) is Php400,000 or
40% assuming 100%of the company is being sold. Now, the same ROI of 40% is
being maintained here by the seller (you) when you pitched the price of
Php250,000 for 25% of the business. This therefore make this approach
subjective.
Additional information necessary to convince investor or buyer of the result:
 Length of time to recover the investment
 The rate of returns based on the expected net income as compared with the initial
amount invested
 Aggressiveness of the assumptions used and results.
 Attractiveness of the investment

Dividend Paying Capacity Method

 Also known as dividend payout is conceptually an income-based method but can
also be classified as market approach as it also considers market information. This
method is somewhat similar to capitalization method. Instead of using earnings,
dividend paying capacity method uses estimated future dividends that can be paid
out by the business. This method links the relationship between the following
variables:
a. Estimated amount of future dividends that can be paid out (based on historical
earnings and dividend payout of the business)
b. Weighted average dividend yields of comparable companies
c. Estimated value of the business

ILLUSTRATIONS:
SV company has a five-year history of weighted average annual profits of Php500,000.
The weighted average dividend payout percentage of SV company over the last five
years is 30% while weighted average dividend yield rate of comparable companies is
at 7.5%.
a. Compute for the future annual dividends that can be paid (capacity to payout) by
multiplying average annual profits by the dividend payout ratio.

Wtd. Ave. Profits × Wtd. Ave. Dividend Payout = Future Dividends

Php500,000 × 30% = Php150,000.00
b. Compute for the value of the company by dividing future dividends by the
weighted average dividend yield rate of comparable companies at 7.5%
Future dividends / Wtd. Ave. Dividend Yield = Value of company
Php150,000 / 7.5% = Php2,000,000.00

 SUMMARY

 Due diligence is an investigation, audit, or review performed to confirm the facts

of a matter under consideration.
 There are 2 types of Due Diligence. First is based on who initiated performed the
activity and based about the activity. Former includes, company initiated and
individually initiated while the latter includes hard and soft due diligence.
 Hard due diligence is concerned with the number. Soft due diligence is concerned
with the people, within the company and in its customer base.
 Mergers and acquisitions (M&A) are defined as consolidation of companies.
Differentiating the two terms, Mergers is the combination of two companies to
form one, while Acquisition is one company taken over by the other.
 A divestiture (or divestment) is the disposal of company’s assets or a business unit
through a sale, exchange, closure, or bankruptcy.
 Valuation is important part of both M&A and divestiture.
 Other valuation technique includes ROI-based valuation method and dividend
paying capacity method.

 EXERCISES

True or False
1. Due diligence is an investigation, audit, or review performed to confirm the
fallacies of a matter under consideration.
2. In the financial world, due diligence requires an examination of legal records
before entering into a proposed transaction with another party.
3. Due diligence became common practice (and a common term) in the U.S. with the
passage of the Securities Act of 2000.
4. Company Initiated/ performed Due Diligence is due diligence is performed by
companies considering acquiring other companies as well as by equity research
analysts, fund managers, broker-dealers, and individual investors.
5. Individual Investor Initiated/performed Due Diligence this is due diligence by
individual investors is voluntary. However, broker-dealer are legally obligated to
conduct due diligence on a security before selling it.
6. Soft Due Diligence is concerned with the legal and financials of the company under
evaluation.
7. Soft Due Diligence – Soft due diligence is concerned with the people, within the
company and in its customer base. So essentially, this s qualitative, which
measurement cannot be normally done by use of mathematical calculation.
8. In traditional M&A activity, the acquiring firm deploys risk analysts who perform
due diligence by studying costs, benefits, structures, assets, and liabilities. That’s
known colloquially as soft due diligence.
9. M&A deals are also subject to the study of a company's culture, management, and
other human elements. That's known as soft due diligence.
10.Hard due diligence, which is driven by mathematics and legalities, is susceptible
to rosy interpretations by eager salespeople.
11.Hard due diligence acts as a counterbalance when the numbers are being
manipulated or overemphasized.
12.The due diligence process varies from institutions, companies or individuals doing
the activity.
13.Mergers and acquisitions (M&A) are defined as consolidation of companies.
14.Mergers is the combination of two companies to form one, while Acquisitions is
one company taken over by the other.
15.The reasoning behind M&A generally given is that two separate companies
together create more value compared to being on an individual stand.
16.Merger or amalgamation may take two forms: merger through absorption or
merger through consolidation.
17.Mergers can also be classified into three types from an economic perspective
depending on the business combinations, whether in the same industry or not, into
horizontal (two firms are in the same industry), vertical (at different production
stages or value chain) and conglomerate (unrelated industries).
18.From a legal perspective, there are different types of mergers like short form
merger, statutory merger, subsidiary merger and merger of equals.
19.There is always synergy value created by the joining or merger of two companies.
The synergy value can be seen either through the Revenues (higher revenues),
Expenses (lowering of expenses) or the cost of capital (lowering of overall cost of
capital)
20.In an M&A transaction, the valuation process is conducted by the acquirer, as well
as the target. The acquirer will want to purchase the target at the lowest price,
while the target will want the highest price

Multiple Choice Theories

Write the letter of the best answer before the number of questions or statements
being answered.

1. An investigation, audit or review performed to confirm the facts of a matter under

consideration.
a. Due Care
b. Due Diligence
c. KYC Activity
d. Forensic Review

2. With that law, securities dealers and brokers became responsible for fully
disclosing material information about the instruments they were selling.
a. Securities Act of 1933
b. Securities Act of 2000
c. Securities Act of 1983
d. Sarbanes-Oxley Act
3. This is due diligence is performed by companies considering acquiring other
companies as well as by equity research analysts, fund managers, broker-dealers
and individual investors.
a. Company Initiated /Performed Due Diligence
b. Individual Investor Initiated /Performed Due Diligence
c. Partnership Due Diligence
d. Company Initiated /Performed Due Care

4. Which of the following can do Due Diligence?

a. Individual Investor
b. Acquiring Companies
c. Companies being acquired
d. All of the Above

5. This is concerned with the legal and financial of the company under evaluation. So
essentially, this is quantitative, which measurement can be normally done by use
of mathematical calculation.
a. Hard Due Diligence
b. Soft Due Diligence
c. Legal Due Diligence
d. Forensic Due Diligence

6. This is concerned with the people, within the company and in its customer base.
So essentially, this is qualitative, which measurement cannot be normally done by
use of mathematical calculation.
a. Hard Due Diligence
b. Soft Due Diligence
c. Legal Due Diligence
d. Forensic Due Diligence
7. In 2007,the Harvard Business Review (HBR) dedicated part of its April Issue to what
it called “human capital due diligence “. Which of the following term HBR is
referring to?
a. Hard Due Diligence
b. Soft Due Diligence
c. Legal Due Diligence
d. Forensic Due Diligence

8. The following are Hard Due Diligence activities, except ______.

a. Reviewing and auditing financial statements
b. Scrutinizing projections for future performance
c. Evaluation of targeted workforce how well it will mesh with the acquiring
corporation’s culture
d. Reviewing potential or ongoing litigation

9. The following are part of Due Diligence process, except ______.

a. Market Capitalization Evaluation
b. Trend Analysis of Revenue, Profit and Margin
c. Competitors and Industry Analysis
d. All of the Above

10. Mergers and acquisitions (M&A) are defined as ______ of companies.

a. Divestiture
b. Synergy
c. Consolidation
d. Competition
11.Serves as the best document to support the financial performance and financial
position of the company including their cash flows.
a. Stock price History
b. Financial Statement
c. Market Expectation
d. Market Capitalization

12.Provides an indication on how volatile the value of the company is in the market.

a. Stock price History
b. Financial Statement
c. Market Expectation
d. Market Capitalization

13.Investors should research both the short-term and long-term price movement of

the stock and whether the stock has been volatile or steady.
a. Stock price History
b. Financial Statement
c. Market Expectation
d. Market Capitalization

14.It is when two firms in the same industry combined.

a. Conglomerate
b. Vertical
c. Horizontal
d. Collide

15.It is when two companies merged from different stages of production or value
chain
a. Conglomerate
 b. Vertical
c. Horizontal
d. Collide

16.It measures the earnings generated by the business in relation to the investment
made to the business.
a. Dividend paying capacity method
b. Split Off
c. ROI based Valuation Method
d. Spin Off

17.________ is a business segment of the parent company is also separated and

made into an independent entity. 
a. Dividend paying capacity method
b. Split Off
c. ROI based Valuation Method
d. Spin Off

18.What does DCF stands for

a. Discounted Cash Flow
b. Designated Cash Flow
c. Divert Cash Flow
d. Dissatisfaction Cash Flow

19.It refers to the disposal of the assets of an entity or business segment often via

sale to third party.
a. Divestiture
b. Bankruptcy
c. Spin Off
d. Split Off
20. A business segment of the parent company is also separated and made into an
independent entity. 
a. Divestiture
b. Bankruptcy
c. Spin Off
d. Split Off

Multiple Choice Problem

Write the letter of the best answer before the number of the question or statement
being answered.

1. Coco Melon, Inc. is planning to sell 20% of its business to ABC, Inc. Coco Melon
would like to maintain an ROI of 25% over its Cost the Investment. Based on the
recent Balance Sheet, Book Value of the Invested Capital is at Php200,000.00.
What will be the minimum price that will be accepted by Coco Melon?
a. Php 50,000
b. Php 40,000
c. Php 25,000
d. Php 20,000

2. Bounce Patrol, Inc has revenue increasing exponentially in 5 years. Based on the
industry, this increase in revenue has an applicable earning valuation multiplier of
3. EBIT for the last 12 months is P900,000. How much is the business value of the
company?
a. Php 1,800,000
b. Php 2,700,000
c. Php 2,800,000
d. Php 2,500,000
3. As of the end of 2019, Baby Shark, Inc. has a Total Assets of Php 5,000,000 and
with a Debt to Equity Ratio of 4:1. Using Book Value Method, what is the minimum
value it can sell the 30% of the business?
a. Php 1,500,000
b. Php 1,200,000
c. Php 300,000
d. Php 700,000

4. Baby Heinz, Inc. has a five-year history of weighted average profits of Php
250,000. Its weighted average dividend payout percentage over the last five years
has been 30 percent and dividend yield rate are 7.5%.
a. Php 75,000
b. Php 1,000,000
c. Php 1,075,000
d. Php 1,200,000

5. Baby Heinz, Inc. has a ten-year history of weighted average profits of Php
1,000,000. Its weighted average dividend payout percentage over the last ten
years has been 30 percent. The company has valued its business using dividend
paying capacity method and would like to sell 20% of its business at an amount of
Php 750,000. What is the average dividend yield rate of the company for the past
10 years?
a. 8%
b. 7%
c. 2%
d. 5%

6. Mommy Hai-dee, Inc. as of yearend of 2019 has a Total Working Capital of Php
3,000,000 and a Current ratio of 2:1. Non-current asset balance is Php 2,000,000
comprised of Fixed Asset. There is no longer-term debt with debt ratio of only
 0.25:1. Using Book Value Method, what is the minimum value it can sell the 15% of
the business?
a. Php 750,000
b. Php 550,000
c. Php 450,000
d. Php 400,000

7. Mother Josie, Inc. has revenue increasing exponentially in 5 years. Based on the
industry, applicable earning valuation multiplier is 2. EBIT of the last 12 months is
Php 1,500,000. How much is the minimum price it can sell 30% of the business?
a. Php 1,050,000
b. Php 3,000,000
c. Php 1,500,000
d. Php 2,500,000

Nos. 8 to 10. Baron Family, Inc. for the last 12 months has the following financial
information:

Balance Sheet

Total Liabilities – Php 9,000,000

Income Statement

Sales – Php 20,000,000

Gross Profit – Php 5,000,000

OPEX – Php 2,000,000

Financial Ratios

Debt to Equity Ratio – 3:1

Dividend Yield Ratio – 10%

Dividend Pay-out Ratio – 0.20:1

Baron Family, Inc. is planning to sell 20% of its business and would like to calculate
the value of its business using various valuation methods.

8. How much id the value of 20% of the business using Book Value Method?
a. Php 800,000
b. Php 9,000,000
c. Php 600,000
d. Php 3,000,000
9. How much is the value of 20% of the business using Dividend Paying Capacity?
a. Php 6,000,000
b. Php 1,200,000
c. Php 600,000
d. Php 3,000,000

10.How much is the value of 20% of the business using Multiples of Earning Valuation
Method assuming appropriate multiplier of 1.5?
a. Php 4,500,000
b. Php 1,200,000
c. Php 600,000
d. Php 900,000