GOOD AFTERNOON

CLASS!!!
Asset Based Valuation
(Going Concern &
Liquidation)
By: Edelwin Fajutagana
INTENDED LEARNING OUTCOME:
After reading this modules, you should be able to:
• Discuss thoroughly the steps in making financial model
(continuation of previous discussion)
• Know the impact of the weighted average cost of capital
• Identify the different parameters used in financial
models
• Understand liquidation value and its importance to
business decision making

Asset Based Valuation (Going Concern and Liquidation)

What are the steps in doing a financial model for going concern
opportunities?

1. Gather historical information and references

2. Establish drivers for growth and assumptions
3. Determine the reasonable cost of capital 
4. Calculate for the Value using Valuation Methods 

Asset Based Valuation (Going Concern and Liquidation)

What are the steps in doing a financial model for going concern
opportunities?
Determine the reasonable cost of capital 
In determining the reasonable cost of capital, the financial modeler must be able to use
the appropriate parameters for the company. Generally, cost of debt and cost of equity
are weighted to determine the cost of capital reasonable for the valuation. For cost of
debt, the prevailing market interest rates are used. While for the cost of equity, industry
average can be conveniently used or internally assess the cost of equity using the
Capital Asset Pricing Model.

Parameter:
EBITDA stands for Earnings before interest, tax, depreciation, and amortization.

Asset Based Valuation (Going Concern and Liquidation)

What are the steps in doing a financial model for going concern
opportunities?
Determine the reasonable cost of capital 

Parameter:
EBITDA is a measure of a company’s operating performance. It eliminates the effects
of financing and accounting decisions. The higher the EBITDA growth the better is the
company’s growth potential.

Asset Based Valuation (Going Concern and Liquidation)

Concept of Weighted Average Cost of Capital, Cost of Equity
and Cost of Debt
Most important concept:
DCF Change: Cost of Cost of WACC Implied Value
Equity Debt from Unlevered
DCF:
Smaller Company Higher Higher Higher (*) Lower (*)
Bigger Company Lower Lower Lower (*) Higher (*)
Emerging Market Higher Higher Higher Lower
Higher Risk-Free Rate Higher Higher Higher Lower
Lower Risk-Free Rate Lower Lower Lower Higher
Higher taxes Lower (***) Lower (***) Lower (***) Depends, Usually Lower

Lower taxes Higher (***) Higher (***) Higher (***) Depends, Usually Higher

Asset Based Valuation (Going Concern and Liquidation)

EBIT Vs. EBITDA Vs. Net Income
Is EBIT or EBITDA better? What about NET INCOME? How are they
different?

Which one(s) should you use in valuation multiples when analyzing companies?

1. EBIT (Earnings Before Interest and Taxes): This is a proxy for core,
recurring business profitability before the impact of capital structure and taxes.
2. EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization):
This is a proxy for core, recurring business cash flow from operations, before
the impact of capital structure and taxes.
3. Net Income: Profit after taxes, the impact of capital structure, and non-core
business activities.

Asset Based Valuation (Going Concern and Liquidation)

EBIT Vs. EBITDA Vs. Net Income
Difference of each Parameters:
1. Availability of Money
EBIT and EBITDA: Equity Investors, Debt Investors, Preferred
Stock Investors, and the Government all have claims.
Net Income (to Common): Only Equity Investors have a claim
because the Debt Investors received their Interest, and the
Government got its Taxes…but no Common Dividends yet
And: Principal payments of Debt do not count as the investors
“getting paid” – they’re just payback of the initial amount.

Asset Based Valuation (Going Concern and Liquidation)

EBIT Vs. EBITDA Vs. Net Income
Difference of each Parameters:
2. OpEx vs. CapEx
EBIT: Deducts OpEx and the after-effects of CapEx (Depreciation),
but it does not deduct CapEx directly
EBITDA: Deduct OpEx, but not CapEx (Both the initial amount and
the Depreciation afterward are ignored)
NET INCOME: Similar with EBIT, it deducts OpEx and
Depreciation, but not Capital directly.
SO: EBIT and Net INCOME are more useful if you *want* to
reflect a company’s capital spending
Asset Based Valuation (Going Concern and Liquidation)
EBIT Vs. EBITDA Vs. Net Income
Difference of each Parameters:
3. Interest, Taxes, and Non-Core Activities
EBIT: Completely ignores or “adds back” Interest, Taxes, and Non-
core Business Income
EBITDA: Same with EBIT
NET INCOME: The opposite! Deducts Interest and Taxes, adds
Non-Core Income, and subtracts Non-Core Expenses
So. This is one big reason why Net Income is not useful when
comparing different companies – too many differences due to capital
structure, side business, tax treatments, etc.

Asset Based Valuation (Going Concern and Liquidation)

EBIT Vs. EBITDA Vs. Net Income
Difference of each Parameters:
4. Valuation Multiples
EBIT: Pairs with Enterprise Value to create the TEV/EBIT multiple
EBITDA: Pairs with Enterprise Value to create TEV/EBITDA multiple
NET INCOME: Pairs with Equity Value to create the P/E, or Price to Earnings,
multiple

Asset Based Valuation (Going Concern and Liquidation)

What are the steps in doing a financial model for going concern
opportunities?
Calculate for the Value using Valuation Methods 
Normally in Financial Modelling, DCF is used to calculate for the value. Since most
information are already available in Financial model, it can be easier to use other
capital budgeting techniques like Internal Rate of Return, Profitability Index etc.

Asset Based Valuation (Going Concern and Liquidation)

 What are the steps in doing a financial model for going concern
opportunities?
Illustration:
Jamie Company’s last EBITDA reported is Php50 Million. Historically, their sales grew by 12% every year. The scenarios were
built based on the plan of the company to purchase an asset within the year with the cost of Php150 Million. The weighted
average cost of capital would be 10%. Terminal cash flows were estimated to be Php250 Million. The company reported total
liabilities of Php100 Million. Using the financial model and with the given facts the value of the equity is Php78.55 Million.  

in million pesos 112%

Year 1 Year 2 Year 3 Year 4 Year 5
EBITDA, base 50.00 56.00 62.72 70.25 78.68
Multiply: (1 + Growth Rate) 112% 112% 112% 112% 112%
EBITDA, adjusted 56.00 62.72 70.25 78.68 88.12
Less: Interest Payments 5.00 5.00 5.00 5.00 5.00
Less: Corporate Income Taxes 18.30 20.32 22.57 25.10 27.94
Free Cash Flows from the Firm 32.70 37.40 42.68 48.58 55.18
Less: Additional Asset 150.00
Terminal cash flows 250.00
Free Cash Flows - Firm - 117.30 37.40 42.68 48.58 305.18
Discount Factor @ 10% 0.91 0.83 0.75 0.68 0.62
Discount Cash Flows - 106.74 31.04 32.01 33.03 189.21
Value to the Firm 178.55
Less: Outstanding Loans 100.00
Value to the Equity Stockholders 78.55 Asset Based Valuation (Going Concern and Liquidation)
Liquidation
Liquidation value refers to the value of a company if it were dissolved and its
assets sold individually.
Liquidation value represents the net amount that can be gathered if the business
is shut down and its assets are sold piecemeal.
The liquidation value indicates the present value of the sums that can be obtained
through the disposal of the assets of the firm in the most appropriate way, net of
the sums set aside for the repayment of the debts and for the termination of legal
obligations, and net of the tax charges related to the transaction and the costs of
the process of liquidation itself.

Asset Based Valuation (Going Concern and Liquidation)

General concepts considered in liquidation value are as follows:

• If the liquidation value is above income approach valuation (based on going-

concern principle) and liquidation comes into consideration, liquidation value
should be used.
• If the nature of the business implies limited lifetime (e.g. a quarry, gravel,
fixed-term company etc.), the terminal value must be based on liquidation.
• Non-operating assets should be valued by liquidation method as the market
value reduced by costs of sale and taxes. If such result is higher than net
present value of cash-flows from operating the asset, the liquidation value
should be used.
• Liquidation valuation must be used if the business continuity is dependent on
contemporary management that will not stay.

Asset Based Valuation (Going Concern and Liquidation)

General concepts considered in liquidation value are as follows:

Identifying the type of liquidation that will happen is important because it affects
the costs connected with liquidation of the property, including commissions for
those facilitating the liquidation (lawyers, accountants, auditors) and taxes at the
end of the transaction. That entire outflow affects the final value of the business.
Here are the gradations of liquidation value:
• Orderly liquidation: Assets are sold strategically over an orderly period of
time to attract the most money for the assets.
• Forced liquidation: Usually, creditors have sued or a bankruptcy. Filed that
calls for immediate liquidation, so everything gets sold on the market in a
hurry fetching lower prices.

Asset Based Valuation (Going Concern and Liquidation)

As to the Liquidation of a Partnership:
The basic procedure in liquidation whether lump sum or installment liquidation
are the following:
1. The operating income or loss to date of liquidation should be distributed to the partners
in accordance with their profit and loss
2. The non-cash assets are converted to cash. Realization is the conversion of non-cash
assets to cash. The gain or loss on realization is distributed to the partners in accordance
with their profit or loss
3. Outside creditors are paid. If liabilities are not fully paid yet, an amount equal to the
unpaid amount be set aside before making any cash distribution to the partners.
4. Liquidation expenses and any unrecorded liabilities are paid. These items are distributed
to the partners as losses in accordance with their P/L ratio
5. In installment liquidation, cash is normally reserved for future liquidation expenses
6. Any remaining cash after procedures is distributed to partners in accordance with the
schedule of safe payment prepared periodically or with the use of cash priority program

Asset Based Valuation (Going Concern and Liquidation)

Illustrative Example:
Gourmet Company showed below balances from its accounting records. Gourmet
Company has 500,000 outstanding shares.

Asset Based Valuation (Going Concern and Liquidation)

Illustrative Example:
Gourmet Company is undergoing financial distress and management would want determine the
liquidation value to decide on the next steps to take for the business. If assets will be
sold/realized, they will only realize based on below table. To compute for the adjusted value of
the assets, the current book values should be multiplied by the assumed realizable value if they
are liquidated.

Asset Based Valuation (Going Concern and Liquidation)

Illustrative Example:

Next, the liabilities should be deducted from these to arrive at the liquidation
value (or net asset value).

Liquidation value per share should be considered together with other quantitative
(e.g. current share price, going concern DCF) and qualitative metrics to justify
business decisions to be made.

Asset Based Valuation (Going Concern and Liquidation)

Uses of Liquidation Value Method
For analysts, liquidation value method can be used for making investment
decisions. If the company is profitable and industry is growing too, the
company’s liquidation value will normally be much lower than the share price,
since share price factors growth aspect which liquidation value does not.

For companies going through a decline phase or if the industry is dying, the
share price may be lower than the liquidation value; this would logically mean
that the company should shut business. To have arbitrage benefits, smart
corporate raiders usually are on a lookout for these kinds of companies. Since the
liquidation value is higher than the market share price, they can buy out the
company stock at a lower price and then sell off the company to make risk-free
arbitrage profit.

Asset Based Valuation (Going Concern and Liquidation)

Limitations of Liquidation Value
Summing up the concept, liquidation value reflects the base price for the company.
However, this may not be a very wise tool to measure a profitable company as it ignores
the future growth potential. Nonetheless, this method can be considered to evaluate a
dying company as a potential takeover and sell down for profit making.
For companies with proprietorship or partnership model; there may be a high
dependence of profitability on the partners. It may be because of the key partners (their
skill, ability, knowledge, network, etc.) that the business enjoys profitability; and their
liquidation value may not reflect true value unless we value the impact of these key
personnel on business profitability. This leads to a need to calculate the goodwill impact
which is built up by the key personnel to arrive at fair liquidation value. This is model of
valuation is suitable only for such special cases where liquidation is the motive.
However, it is to be noted that this method is far more realistic compared to the book
value method.

Asset Based Valuation (Going Concern and Liquidation)

END
“I do not think that there is any other quality so essential to
success of any kind as the quality of perseverance. It
overcomes almost everything, even nature.”
- John D. Rockefeller
Thank you
And
keep safe