Valuation Handbook

A Practitioner's Guide

By Punish Oberoi, CFA

 INDEX
1. Cash Flow Valuation
- Dividend Discount Model (DDM)
- Free Cash Flow to the Equity (FCFE)
- Free Cash Flow to the Firm (FCFF)

2. Residual Income Valuation

3. Relative Valuation or Comparable Analysis

4. Other Valuation Approach

- Real Option Valuation
- Alternative approach to Bank Valuation
 DISCOUNTED CASH FLOW
USED FOR SECTORS:

ENGINEERING
INFRASTRUCTURE
MANUFACTURING

DCF  RESIDUAL INCOME RELATIVE VALUATION OTHERS

 DISCOUNTED CASH FLOW

The purpose of DCF-Valuation is to determine the value of a company in terms

of its future cash flows. The cash flows are adjusted with certain items (e.g.
those not related to company´s core businesses or those with no cash effect)
in order to make sure the flows reflect the actually generated cash as good as
possible.
THREE VARIANTS

FCFF FCFE DDM

PROS Cons

• Earnings are susceptible to different • The greater the number of inputs,

accounting decisions. FCF on the other the higher the possibility for errors in
hand is a true measure of a firm’s the valuation
cash.
• Projecting the future performance of
• Easy to see key drivers of share a company
value
• Small changes in inputs have a high
• Focused on intrinsic value magnitude effect on the valuation.

• Backwards calculation • Not for short term investments

• Negative free cash flow.

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 WHAT CASH FLOW TO USE?

Cash Flows

To Equity To Firm

The Strict View The Broader View (FCFE) EBIT (1-t)

Dividends + Net Income - ( Cap Ex - Depreciation)
Stock Buybacks - Net Cap Ex (1-Debt Ratio) - Change in Working Capital
- Chg WC (1 - Debt Ratio) = Free Cashflow to Firm (FCFF)
= Free Cashflow to Equity

WHEN TO USE FCFE WHEN TO USE FCFF WHEN TO USE DDM

• for firms which have stable  for firms which have leverage • the company is dividend-
leverage, whether high or not, which is too high or too low, paying.
and and expect to change the
leverage over time.
• if equity (stock) is being
• the board of directors has a
 for firms for which you have dividend policy that has an
valued
partial information on leverage understandable relationship to
(eg:interest expenses are profitability.
missing)

 in all other cases, where you • the investor has a non-

are more interested in valuing control perspective.
the firm than the equity.

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 STEPS IN DISCOUNTED CASH FLOW
The steps:
1. Project operating results and free cash flows
2. Estimate the terminal value of the business by 1 of 2 methods:
- perpetuity formula
- exit multiple
3. Calculate appropriate discount rate
4. Discount the annual cash flows and the terminal value to present
5. Determine range of values
6. Interpret the results and perform sensitivity analysis

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 Financing Weights EQUITY VALUATION WITH FCFE
Debt Ratio = DR

Cashflow to Equity Expected Growth

Net Income Retention Ratio *
- (Cap Ex - Depr) (1- DR) Return on Equity
- Change in WC (!-DR) Firm is in stable growth:
= FCFE Grows at constant rate
forever

Terminal Value= FCFE n+1/(ke-gn)

FCFE1 FCFE2 FCFE3 FCFE4 FCFE5 FCFEn
Value of Equity .........
Forever
Discount at Cost of Equity

Cost of Equity

Riskfree Rate :
- No default risk Risk Premium
- No reinvestment risk Beta - Premium for average
- In same currency and + - Measures market risk X risk investment
in same terms (real or
nominal as cash flows
Type of Operating Financial Base Equity Country Risk
Business Leverage Leverage Premium Premium

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 EQUITY VALUATION WITH FCFF

Cashflow to Firm Expected Growth

EBIT (1-t) Reinvestment Rate
- (Cap Ex - Depr) * Return on Capital
Firm is in stable growth:
- Change in WC
= FCFF Grows at constant rate
forever

Terminal Value= FCFF n+1 /(r-gn )

FCFF1 FCFF2 FCFF3 FCFF4 FCFF5 FCFFn
Value of Operating Assets .........
+ Cash & Non-op Assets
Forever
= Value of Firm
- Value of Debt Discount at WACC= Cost of Equity (Equity/(Debt + Equity)) + Cost of Debt (Debt/(Debt+ Equity))
= Value of Equity

Cost of Equity Cost of Debt Weights

(Riskfree Rate Based on Market Value
+ Default Spread) (1-t)

Riskfree Rate :
- No default risk Risk Premium
- No reinvestment risk Beta - Premium for average
X
- In same currency and + - Measures market risk risk investment
in same terms (real or
nominal as cash flows
Type of Operating Financial Base Equity Country Risk
Business Leverage Leverage Premium Premium

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 EQUITY VALUATION WITH DIVIDENDS

Dividends Expected Growth

Net Income Retention Ratio *
* Payout Ratio Return on Equity
= Dividends Firm is in stable growth:
Grows at constant rate
forever

Terminal Value= Dividend n+1/(ke-g n)

Dividend 1 Dividend 2 Dividend 3 Dividend 4 Dividend 5 Dividend n
Value of Equity .........
Forever
Discount at Cost of Equity

Cost of Equity

Riskfree Rate :
- No default risk Risk Premium
- No reinvestment risk Beta - Premium for average
- In same currency and + - Measures market risk X risk investment
in same terms (real or
nominal as cash flows
Type of Operating Financial Base Equity Country Risk
Business Leverage Leverage Premium Premium

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 AN EXAMPLE OF FCFE
DIS COUNTED FREE CAS H FLOW TO THE FIRM
Valuation date Aug 09
Next year-end Dec 09 Beta adjusted for
drift
COS T OF CAPITAL CONTINUING GROWTH AS S UMPTIONS
Risk free rate (%) 9.5 Long-term GDP growth (%) 5.0
Equity risk premium (%) 4.9 Long-term inflation (%) 5.0
Long term average
Beta (x) 0.7 Long term growth rate 10.0
ROE of the
Cost of equity (%) 13.0 Sustainable ROE (%) 11.5 company
Cost of debt (%) 9.6 Sustainable payout ratio 13.0
Tax rate (%) 22.7

DIS COUNTED FREE CAS H FLOW TO THE FIRM

Year to Dec (NGNm) FY09F FY10F FY11F FY12F FY13F Cont. value
Operating profit 8,526,730 10,760,797 13,361,162 15,316,903 18,116,534
add: depreciation 2,497,702 2,542,651 2,641,089 2,932,186 3,179,064
add: other non-cash items 733,995 804,540 910,451 789,174 803,044
change in working capital inv 506,561 (990,075) (948,987) (120,756) (629,323)
less: capex (6,832,013) (9,673,643) (12,952,689) (15,182,595) (17,149,151)
less: notional cash tax (1,932,201) (2,438,452) (3,027,708) (3,470,888) (4,105,299)
Free cash flow 3,500,774 1,005,818 (16,682) 264,024 214,868 7,768,130
Beta (x) 0.7 0.7 0.7 0.7 0.7 0.7
Debt/(debt + equity) (%) 10.7% 7.4% 4.6% 2.6% 1.1% 1.1%
Weighted cost of capital (%) 13.0 13.0 13.0 13.0 13.0 13.0
Discount period 0.38 1.38 2.38 3.38 4.38 4.38
Discount factor @ WACC 0.99 0.96 0.94 0.91 0.89 0.89
Present value of free cash flow 3,465,480.8 969,717.9 (15,663.7) 241,446.2 191,369.4 6,918,586.8

Value of operations 11,770,937

add: net cash (5,081,412)
add: net nonoperating assets 45,324,475
Equity value 52,014,000
No. of shares (k) 1,280,576
Fair value (NGN/share) 40.6

TOTAL RETURN S ENS ITIVITY ANALYS IS

G D P G ro w th ra te (% )

Target price (NGN/share) 45.9 Cost of equity (%)

Current price (NGN/share) 37.0 Fair value 40.6 12.0 12.5 13.0 13.5 14.0
Expected capital gain (%) 24.1 9.0 40.6 39.8 39.2 38.8 38.4
9.5 41.7 40.6 39.8 39.3 38.8
Dividends (NGN/share) 2.2 10.0 43.3 41.7 40.6 39.8 39.3
Dividend yield (%) 6.1 10.5 46.0 43.3 41.7 40.6 39.9
11.0 51.2 46.0 43.3 41.7 40.6
Expected total return 30.2

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 THE TERMINAL VALUE

-- Estimating the terminal value (the value of all future cash flows after the explicit forecast
period of 5 years)
1. Perpetuity growth method (Gordon growth formula):
Terminal value = FCF (n+1) / (r-g)  assumption

- forecast 5 explicit years of FCF

- grow Year 5 FCF and obtain estimate of FCF in Year 6
- “r”, the discount rate is either Er or WACC (depending on
whether we are discounting FCFE or FCFF)
- “g” is the perpetuity growth rate (the growth forever) and
in many models is often equal to GDP growth rate
- discount the Terminal Value to present using the
appropriate discount rate

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 THE TERMINAL VALUE (CONTD.)

2. Exit multiple method:

Terminal value = Statistic x Multiple  assumption

- forecast 5 explicit years of FCF, EBITDA, Net Income

- grow Year 5 FCF and obtain estimate of FCF in Year 6
- apply an “exit” multiple
- multiply and estimate Terminal Value
- discount the Terminal Value to the present using the
appropriate discount rate

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 THE DISCOUNT RATES
-- Discount Free Cash Flows to the Equity at the cost of equity:
Er = Rf + levered β x (Rm – Rf)

Risk-free rate Reflecting the risk of debt Market Risk premium

Levered β = Unlev. x (1+(1-Tax rate) x D/E)

-- Discount Free Cash Flows to the Firm at the cost of capital:

WACC = After tax cost of Debt x D/C + Er x E/C

The tax deductibility of interest expense provides a “tax shield”

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

RESIDUAL INCOME VALUATION

USED FOR SECTORS:

BANKSAND FINANCIAL SERVICES

MANUFACTURING

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 RESIDUAL INCOME VALUATION

Residual income is net income less a charge (deduction) for common

shareholders’ opportunity cost in generating net income.

WHEN TO USE CALCULATION METHODOLOGY

• A firm is not paying dividends of if it

 In the Residual Income Model (RIM)
of valuation, the intrinsic value of the
exhibits an unpredictable dividend firm has two components:
pattern.
The current book value of equity, plus
• A firm has negative free cash flow The present value of future residual
many years out, but is expected to income
generate positive cash flow at some 
RI t 
E  rBt 1
point in the future (for example, a young P0  B0    B0   t
t 1 (1  r ) (1  r ) t
t
t 1
or rapidly growing firm where capital
In the model,
expenditures are being made to fuel
future growth.
 B0 is the current book value of equity,
 Bt is the book value of equity at time
• There is a great deal of uncertainty in t,
forecasting terminal values.  RIt is the residual income in future
periods,
 r is the required rate of return on
equity,
 Et = net income during period t,
 RIt = Et – rBt-1.

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 AN EXAMPLE OF RESIDUAL INCOME
DISCOUNTED EXCESS EQUITY RETURN

Valuation date Sep 09

Next year-end Jun 10 Yield on 10 year
Govt. Bond
COST OF CAPITAL CONTINUING GROWTH ASSUMPTIONS
Risk free rate (%) 10.8 Long-term GDP growth (%) 5.0
Equity risk premium (%) 7.7 Long-term inflation (%) 5.0
Beta (x) 1.0 Long term growth rate 10.0 Average Real GDP
Cost of equity (%) 18.5 Growth for 10
Years
Beta adjusted for
drift
RESIDUAL INCOME
FY10F FY11F FY12F FY13F FY14F Cont. value
Beginning book value of equity 18,574.0 21,508.1 25,006.8 29,217.4 34,144.9
Cost of equity (%) 18.5 18.5 18.5 18.5 18.5
Equity cost 3,442.0 3,985.8 4,634.1 5,414.4 6,327.6
Adjusted
Net income 4,279.0 5,102.1 6,140.4 7,185.8 8,529.6
PAT
Excess equity return 837.0 1,116.3 1,506.2 1,771.3 2,202.1
Perpetuity value of excess equity return 28,392.1
Discount period 0.80 1.80 2.80 3.80 4.80 4.80
Discount factor @ cost of equity 0.87 0.74 0.62 0.52 0.44 0.44
Present value of excess equity return 730.2 821.6 935.3 928.0 973.3 12,548.5

Equity invested 18,574.0

Add: net adjustment to book value -
Add: excess equity return 16,936.8

Equity value 35,510.7

No. of shares (m) 250.3
Fair value (MUR/share) 141.86

TOTAL RETURN SENSITIVITY ANALYSIS

Target price (MUR/share) 162.48 Cost of equity (%)
Current price (MUR/share) 139.0 Fair value 141.9 16.5 17.5 18.5 19.5 20.5
g ro w th ra te

Expected capital gain (%) 16.9 9.0 179.2 155.1 136.2 120.9 108.3
Lo n g -te rm

9.5 185.2 159.1 138.9 122.7 109.5

(% )

Dividends (MUR/share) 5.67 10.0 192.3 163.7 141.9 124.7 110.8

Dividend yield (%) 4.1 10.5 200.4 168.9 145.2 126.9 112.2
Expected total return 21.0 11.0 210.1 174.8 149.0 129.3 113.8

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 CONSIDERATIONS IN RESIDUAL INCOME VALUATION

BALANCE SHEET ADJUSTMENTS FOR FAIR VALUE

NON-RECURRING ITEMS
Often companies report non-recurring charges as part of earnings or classify non-operating income (e.g., sale
of assets) as part of operating income. These misclassifications can lead over-estimates and under-estimates of
future residual earnings if no adjustments are made. Note that adjustments to book value are not necessary
for these items since non-recurring gains and losses do impact the value of assets in place. Non-recurring
items sometimes result from accounting rules and at other times result from “strategic” management
decisions.

An analyst should examine the financial statement notes and other sources for potential items that may
warrant adjustment in determining recurring earnings such as:
• Unusual items
• Extraordinary items
• Restructuring charges
• Discontinued operations
• Accounting changes

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

PROS CONS
• Terminal value does not make up a • The model relies on accounting data
large portion of the total value that can be subject to manipulation

• The model can be used for • When book value and ROE are
companies that do not pay dividends unpredictable, the resulting estimate is
and/or firms that have near-term less valid.
negative free cash flows

• The model can be used when cash

flows are unpredictable or difficult to
forecast. This can be particularly true
for financial institutions.

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

RELATIVE VALUATION
USED FOR BENCHMARKING THE COMPANY VALUATION TO
ITS PEERS AND CLOSELY RELATED COMPANIES

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 STEPS IN RELATIVE VALUATION

1. Determine the peer group (comps universe)

2. Gather the appropriate financial information
3. Enter the financial information into your spreadsheet
- normalize for non-recurring items
4. Calculate relevant historical or forward multiples
(P/E; EV/EBITDA)
5. Forecast your company’s future financial performance
(EBITDA, EPS, Cash Flow, etc.)
6. Apply appropriate multiples to your company’s financial stats and derive
implied valuation range

“Comparable” or “similar” in terms of:

-- Operations
- products / services; distribution; costs structure; geography; interest
exposure; customers, etc.

-- Financial Aspects
- size (sales, mkt cap); capital structure; margins / profitability; management
experience, etc.

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 WHY NORMALIZE? WHERE IS THE INFORMATION?

-- Why?
- items not expected to be part of the normal course of business in the future
should be adjusted for restructuring charges, gains/losses on sale of assets, legal
settlements, asset impairments.
- the goal is to evaluate the ongoing business, earnings and cash flows
-- Where is it?
- separate line on IS (other income/expense, COGS, SG&A)
- add back in the CF
- MD&A section

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 WHAT ARE THE RELEVANT MULTIPLES?

-- Multiples will vary by industry:

- Retail: Price/EPS, Price Earnings ratio/Growth (PEG)
- Industrials: EV/EBITDA, Price/EPS
- Internet: EV/Revenues, EV/Subscribers, EV/Page views
- Banks/Financial institutions: Price/EPS, Price/Book Value
- REITS: Funds from operations, Net asset value
- Telecommunication: EV/EBITDA, Average revenue per user (ARPU)

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 ADVANTAGES AND DRAWBACKS OF P/E
PE VALUATION
 Advantages: Valuation date Aug 09
Next year-end Dec 09
◦ Earnings power is the chief driver of
investment value COST OF CAPITAL
Risk free rate (%) 9.8

◦ Main focus of security analysts Equity risk premium (%)

Beta (x)
5.3
1.2

◦ The P/E is widely recognized and used Cost of equity (%) 16.1

by investors NGN Current 1 yr fwd

 Drawbacks Forecast EPS
Est. exit P/E multiple
2.2
9.25
◦ If earnings are negative, P/E does not - Est. terminal ROE (%)
Est. exit price
16.1
20.0
make economic sense Cost of equity 16.1
Discount period 0.4
◦ Reported P/Es may include earnings Discount factor @ cost of equity 1.0 1.0

that are transitory

Present value 19.8
Fair value 19.8

◦ Earnings can be distorted by

Share price 14.7
Upside/(downside) (%) 34.9

management
 Assumption:
TOTAL RETURN
◦ Required rate of return, retention Target price (NGN/share)
Current price (NGN/share)
21.4
14.7
ratio (with DDM) and growth rates Expected capital gain (%) 45.4

are similar among comparable firms Dividends (NGN/share) 1.6

Dividend yield (%) 11.1

Expected total return 56.5

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 ADVANTAGES AND DRAWBACKS OF P/BV
PRICE BOOK VALUATION
 Advantages Valuation date Sep 09
◦ Since book value is a cumulative Next year-end Jun 10

balance sheet amount, it is

COST OF CAPITAL CONTINUING GROWTH ASSUMPTIONS
generally positive Risk free rate (%) 10.8 Long-term GDP growth (%) 5.0
◦ BV is more stable than EPS, Equity risk premium (%) 7.7 Long-term inflation (%) 5.0

therefore P/BV may be more Beta (x)

Cost of equity (%)
1.0
18.5
Long term growth rate
Sustainable ROE (%)
10.0
22.3
meaningful when EPS is
abnormally low or high
◦ P/BV is particularly MUR
Forecast DPS
1 yr fwd
5.7
appropriate for companies Forecast NAV 85.9
with primarily liquid assets Est. exit P/BV multiple 1.4

(financial institutions) - Est. terminal ROE (%)

Est. exit price
22.33
124.1
Cost of equity 18.5
Discount period 0.80
 Disadvantages Discount factor @ cost of equity 0.90

◦ Differences in asset age among Present value

Fair value 116.38
116.38

companies may make comparing Share price 139.00

companies difficult Upside/(downside) (%) (16.3)

 Assumption:
TOTAL RETURN
◦ Required rate of return, return Target price (MUR/share) 132.3
on equity, retention ratio (with Current price (MUR/share) 139.0
DDM) and growth rates are Expected capital gain (%) (4.8)

similar among comparable firms Dividends (MUR/share) 5.7

Dividend yield (%) 4.1

Expected total return (0.8)

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 ADVANTAGES AND DRAWBACKS OF EV/EBITDA
Enterprise Value Market Value of Equity + Market Value of Debt - Cash

 Advantages EBITDA Earnings before Interest, Taxes and Depreciation
◦ This represents a valuation
indicator for the overall company EV/EBITDA MULTIPLE
and not just equity. Methodology Target price
Valuation Metrics - FY2009 estimates
◦ It is more appropriate for EV/EBITDA multiple 6.70x
comparing companies that have FY09 EBITDA (NGNm) 34,916.1
different capital structures since FY09 EV (NGNm) 233,938.0
EBITDA is a pre-interest measure of FY09 Debt (NGNm) 12.3
earnings. FY09 Cash (NGNm) 14,621.8
FY09 Market Capitalization (NGNm) 248,547.5
◦ Appropriate for valuing companies No. of shares outstanding (millions) 12,000.0
with large debt burden: while Target price 20.7
earnings might be negative, EBITDA
is likely to be positive. P/E multiple Target Price 21.4

 Disadvantages
◦ Differences in capital investment is
not considered.

 Assumption:
◦ Required rate of return, growth
rates, working capital needs, capital
expenditures and depreciation are
similar among comparable firms

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 AN EXAMPLE OF RELATIVE VALUATION

Public Comps Valuation Analysis

Market Data Valuation Multiples

Closing 52 Market Enterp. Price / Earnings Price / Cash EV / Revenues EV / EBITDA EV / EBIT P/B
Value Value Flow
Price Week (Diluted) (Diluted) (Diluted) (Diluted) (Diluted) (Diluted)

29-Oct-09 High Low (Diluted-TS) (Diluted) 2002 2002 2002 2002 2002 2002 2002 2002 2002 2002 LTM

CRM Companies
Convergys Corp (CVG) $10.00 $12.00 $8.00 $1,552,349 $1,281,449 9.4x 8.7x 5.0x 4.7x 0.6x 0.6x 3.0x 2.7x 4.6x 4.1x 1.5x
Minacs Worldwide Inc. (MXW) $10.00 $12.00 $8.00 $1,257,783 $1,273,145 nmf nmf 286.2x 303.4x 15.4x 14.4x 258.3x232.0x nmf nmf 74.7x
Sitel (SWW) $10.00 $12.00 $8.00 $830,086 $935,220 46.8x 38.5x 11.9x 12.1x 1.2x 1.2x 10.5x 10.6x 22.0x 20.5x 4.4x
Teletech Holdings (TTEC) $10.00 $12.00 $8.00 $645,820 $582,069 20.0x 17.2x 9.9x 8.4x 0.9x 0.8x 6.4x 5.3x 10.4x 8.4x 2.1x
West Teleservices Corp (WT) $10.00 $12.00 $8.00 $645,034 $621,920 11.8x 10.8x 7.0x 6.4x 1.0x 0.9x 4.7x 4.4x 6.7x 6.4x 1.6x
APAC Customer Services (AP)$10.00 $12.00 $8.00 $498,916 $583,097 40.8x 32.3x 10.9x 11.5x 1.3x 1.2x 8.7x 8.8x 17.4x 15.8x 7.2x
Sykes Enterprises (SYKE) $10.00 $12.00 $8.00 $414,406 $328,072 16.5x 16.0x 6.6x 6.5x 0.5x 0.5x 3.9x 3.7x 7.1x 6.7x 1.7x
Telespectrum (TLSP) $10.00 $12.00 $8.00 $357,935 $494,854 nmf nmf 17.3x 11.9x 1.5x 1.6x 18.5x 16.1x 73.6x nmf 2.3x
ICT Group (ICTG) $10.00 $12.00 $8.00 $129,134 $142,298 24.5x 18.1x 9.3x 8.1x 0.9x 0.7x 7.9x 6.8x 15.1x 11.4x 2.4x
RMH Teleservices (RMHT) $10.00 $12.00 $8.00 $89,391 $86,397 33.3x 25.2x 19.5x 16.7x 0.7x 0.6x 12.9x 9.8x 17.9x 12.3x 3.0x
Mean 25.4x 20.8x 38.3x 39.0x 2.4x 2.3x 33.5x 30.0x 19.4x 10.7x 10.1x
Mean - adjusted 21.2x 17.4x 10.8x 9.6x 1.0x 0.9x 8.5x 7.6x 12.6x 10.2x 2.9x
Median 22.2x 17.6x 10.4x 10.0x 1.0x 0.9x 8.3x 7.8x 15.1x 9.9x 2.3x
Median - adjusted 20.0x 17.2x 9.9x 8.4x 0.9x 0.8x 7.9x 6.8x 12.7x 9.9x 2.3x

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

OTHER VALUATION
APPROACH

Real Option Valuation

Alternative approach to Bank Valuation

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 REAL OPTION VALUATION
Valuation under real option method is based on decision tree analysis. We
can value the company using the call option model.

We can use an example to explain the valuation technique.

STEP: 1
Forecast Discounted Cash Flow of a company

DCF Value: 10,597

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

STEP: 2

Calculate the value of d1 and d2

Inputs Used Outcome

STEP: 3
Compare the Call value with the DCF DCF VALUE > CALL VALUE
value. If DCF value> Call value, go 10,597>9824
ahead with the project.

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS

 ALTERNATIVE APPROACH TO BANK VALUATION
The implied price / book value multiple for a bank is calculated comparing the
bank’s profitability to its cost of equity capital adjusted for the growth rate.

Implied or Target P / BV = ( ROE – g ) / ( CoE – g )

The implied price of a banking stock is derived through the following

equation:

Fair Price of a Banking Stock = Target P / BV times Current BV

DCF RESIDUAL INCOME RELATIVE VALUATION OTHERS