VALUATION CONCEPTS

GENERAL UNDERSTANDING
OF VALUATION
Definition: Valuation is the process of determining the economic value of an asset,
business, or investment. It plays a crucial role in finance and business by providing
insights into the worth of assets, aiding decision-making processes.
Importance: Valuation is essential for various financial scenarios, such as mergers
and acquisitions, investment analysis, financial reporting, and strategic planning. It
helps stakeholders make informed decisions by assessing the fair value of assets.
Objectives: Key objectives of valuation in the business context include determining
fair market value, aiding in financial decision-making, facilitating transactions, and
supporting strategic planning.
COST APPROACH IN
VALUATION
Definition: The Cost Approach determines value by assessing the cost to replace or
reproduce an asset minus accumulated depreciation.
Components: Key components considered include replacement cost, reproduction
cost, and depreciation, both physical and functional.
Examples: Situations where the Cost Approach is appropriate include valuing unique
assets with no direct market comparables, such as specialized machinery or historical
buildings.
COST APPROACH IN
VALUATION
1.Replacement Cost:
•Definition: Replacement cost refers to the cost required to replace an asset with a
new one of similar utility, functionality, and performance.
•Application: This component considers the expense associated with obtaining a
substitute asset that serves the same purpose, often reflecting current market prices
for materials and labor.
•Scenario: Relevant when assessing the value of assets with no comparable
substitutes or when the goal is to determine the cost of obtaining an asset with
equivalent utility.
COST APPROACH IN
VALUATION
2. Reproduction Cost:
•Definition: Reproduction cost involves the estimation of the cost to recreate an exact
replica of the subject asset with the same materials, design, and specifications.
•Application: This component is used when the goal is to replicate the exact
characteristics of the asset, including its unique features and design.
•Scenario: Appropriate when valuing assets that have distinctive qualities or
historical significance, where an exact replica is desired.
COST APPROACH IN
VALUATION
2. Reproduction Cost:
•Definition: Reproduction cost involves the estimation of the cost to recreate an exact
replica of the subject asset with the same materials, design, and specifications.
•Application: This component is used when the goal is to replicate the exact
characteristics of the asset, including its unique features and design.
•Scenario: Appropriate when valuing assets that have distinctive qualities or
historical significance, where an exact replica is desired.
COST APPROACH IN
VALUATION
3. Depreciation (Physical and Functional):
•Physical Depreciation: Refers to the reduction in the value of an asset due to wear
and tear, aging, or physical deterioration over time.
• Application: Relevant when assessing the decline in value caused by tangible factors affecting
the physical condition of the asset.

•Functional Depreciation: Relates to the reduction in value due to changes in the

functional utility or efficiency of the asset, even if its physical condition is
maintained.
• Application: Considered when evaluating the loss of value resulting from changes in technology,
design, or functionality.

•Scenario: Both types of depreciation are crucial for estimating the overall decline in
value and determining the net worth of the asset in the Cost Approach.
COST APPROACH IN
VALUATION
In summary, replacement cost focuses on obtaining a new asset with similar utility,
reproduction cost emphasizes recreating an exact replica of the asset, and
depreciation accounts for the decline in value due to physical wear, functional
changes, or both. These components collectively contribute to the comprehensive
assessment of an asset's value in the Cost Approach.
MARKET APPROACH IN
VALUATION
Definition: The Market Approach uses market data, comparing the asset or business
to similar entities that have been sold or valued recently.
Methods: Main methods include comparable company analysis (CCA) and precedent
transactions. It relies on market multiples like price-to-earnings ratios.
Advantages: Provides a real-world benchmark, easy to understand. Limitations:
Requires comparable data, may not capture unique aspects of the business.
MARKET APPROACH IN
VALUATION
1. Comparable Company Analysis (CCA):
•Definition: CCA involves evaluating the value of a target company by comparing it
to similar publicly traded companies.
•Application: CCA looks at financial metrics and multiples of comparable companies
to assess the relative valuation of the target company.
•Data Source: Relies on financial statements, market prices, and other performance
metrics of publicly traded companies in the same industry or sector.
•Scenario: Commonly used when there is a robust set of comparable companies with
similar business models, operations, and market conditions.
MARKET APPROACH IN
VALUATION
2. Precedent Transactions:
•Definition: Precedent transactions involve valuing a target company based on the
prices paid in recent acquisitions of similar companies.
•Application: Examines the historical transactions in the market to assess the
valuation multiples paid for companies similar to the one being valued.
•Data Source: Requires access to information on past mergers and acquisitions,
including transaction values, deal structures, and the financial health of the acquired
companies.
•Scenario: Appropriate when there are relevant and recent transaction data available,
providing insights into how the market has valued similar businesses.
MARKET APPROACH IN
VALUATION
3. Market Multiples (e.g., Price-to-Earnings Ratios):
•Definition: Market multiples are financial metrics used to compare the valuation of a
company to its financial performance. Examples include Price-to-Earnings (P/E)
ratios.
•Application: Multiples like P/E ratios provide a quick way to compare a company's
stock price to its earnings, helping assess its relative valuation in the market.
•Data Source: Relies on financial statements and market data to calculate multiples
based on metrics like earnings, revenue, or book value.
•Scenario: Market multiples are used in both CCA and precedent transactions to
normalize valuation metrics and make comparisons across companies or
transactions.
MARKET APPROACH IN
VALUATION
In summary, Comparable Company Analysis (CCA) and Precedent Transactions are
methods within the Market Approach that leverage different sets of data to assess the
value of a target company. Market multiples, such as Price-to-Earnings ratios, are
common tools in both methods, providing a standardized way to compare valuation
across different companies or transactions.
DISCOUNTED CASH FLOW
(DCF) METHOD
Definition: DCF assesses the present value of future cash flows by discounting them
back to their current value using a chosen discount rate.
Steps: Involves forecasting future cash flows, determining the discount rate, and
discounting cash flows back to their present value.
Significance: The discount rate is crucial, impacting the valuation result. It reflects
the time value of money and the risk associated with future cash flows.
DISCOUNTED CASH FLOW
(DCF) METHOD
As an entrepreneur, you're considering investing ₱80,000 in a new venture that promises
future profits. Let's break down the steps:
1.Forecasting Future Cash Flows:
1. Scenario: You anticipate making ₱100,000 in profit from the venture each year for the next two
years.

2.Determining the Discount Rate:

1. Scenario: You set a discount rate of 8% to account for the risks and alternative opportunities in the
business landscape.

3.Discounting Cash Flows Back to Present Value:

1. Scenario: Using the formula PV = Future Cash Flow / (1 + Discount Rate)^Number of Years, you
find the present value of each year's profit:
1. Year 1: ₱100,000 / (1 + 0.08)^1 = ₱92,592.59
2. Year 2: ₱100,000 / (1 + 0.08)^2 = ₱85,734.69
DISCOUNTED CASH FLOW
(DCF) METHOD
4.Calculating Total Present Value:
1. Scenario: Add up the present values of both years to get the total present value.
1. Total PV = ₱92,592.59 + ₱85,734.69 = ₱178,327.28

5. Comparing Against Investment Cost:

2. Scenario: With an investment cost of ₱80,000, you compare it to the total present value.
1. ₱178,327.28 (Total PV) > ₱80,000 (Investment Cost)

Business Decision: Given that the total present value is greater

than the investment cost, this suggests that the potential
returns, adjusted for risk and time, are favorable. In business
terms, this might be seen as a good investment opportunity.
DISCOUNTED CASH FLOW
(DCF) METHOD
Determining the Discount Rate:
1.Risk Assessment:
1. Explanation: The discount rate reflects the risk associated with the investment. Higher-risk ventures usually warrant a
higher discount rate to compensate for the uncertainty.
2. Example: If the new venture is in a stable industry with predictable cash flows, you might opt for a lower discount rate.
However, if it's a risky, unproven market, a higher discount rate is prudent.

2.Opportunity Cost:
1. Explanation: The discount rate also considers the returns you could earn elsewhere. If you have alternative investment
opportunities with higher returns, you might use a higher discount rate.
2. Example: If there's a safer investment option offering a guaranteed return of 15%, you might set the discount rate at 15%
to ensure your chosen venture offers a return that compensates for the risk.

3.Time Value of Money:

1. Explanation: The time value of money acknowledges that having money sooner is generally more valuable. The discount
rate incorporates this principle.
2. Example: If you had the choice between ₱100 today or ₱100 a year from now, you'd likely choose ₱100 today. The
discount rate quantifies this preference for present money.
DISCOUNTED CASH FLOW
(DCF) METHOD
Why 8% and Not 20% or 50%?
1.Consideration of Risk:
1. Example: If you're starting a tech business with an uncertain market, a 50% discount rate might be too
high, as it could make even potentially successful ventures seem unattractive. Conversely, a 20%
discount rate might be too low for a risky venture, potentially underestimating the risk involved.

2.Opportunity Cost Perspective:

1. Example: If the best alternative investment offers a 20% return, setting a 50% discount rate might
make your venture appear less appealing than it actually is. Conversely, a 20% discount rate might not
adequately reflect the foregone opportunities.

3.Balancing Time Value:

1. Example: Setting a 50% discount rate could imply an extreme preference for immediate returns,
which may not align with common business practices. An 8% rate balances the preference for present
money with the need to account for risk and opportunity cost.
DISCOUNTED CASH FLOW
(DCF) METHOD
Business Decision Implications:
•Higher Discount Rate (e.g., 20%): This could make the investment seem riskier or
less attractive, potentially leading to missed opportunities.
•Lower Discount Rate (e.g., 5%): While it might make the investment appear more
appealing, it might not adequately account for the risks and opportunity costs
involved.
Conclusion:
Choosing the discount rate is a delicate balance between acknowledging the risk,
considering alternative opportunities, and recognizing the time value of money. The
8% rate, in this case, was chosen to strike that balance, but the specific rate would
depend on a detailed analysis of the specific venture and market conditions.
COMPARATIVE ANALYSIS OF
VALUATION METHODS
Scenarios: Cost Approach for unique assets, Market Approach for publicly traded
companies, DCF for companies with predictable cash flows.
Variability: The choice of valuation method varies based on the type of asset or
business, considering factors like availability of data, industry norms, and the nature
of the asset.
Qualitative Factors: Emphasize the importance of considering qualitative factors
alongside quantitative methods to capture the full picture of value.
COMPARATIVE ANALYSIS OF
VALUATION METHODS (EXAMPLES)
1.Unique Real Estate Property:
1. Nature of Asset: A historic mansion with unique architectural features.
2. Valuation Approach: Cost Approach
3. Reasoning: The Cost Approach is suitable for unique assets with no direct comparables. In this case,
assessing the cost to reproduce or replace the property, accounting for depreciation, would provide a
relevant valuation.

2.Software Development Company:

1. Nature of Asset: Intellectual property, skilled workforce, and proprietary software.
2. Valuation Approach: Discounted Cash Flow (DCF)
3. Reasoning: DCF is ideal for companies with predictable cash flows, especially in the technology sector. It
captures the future earnings potential of the company, considering its intellectual property and skilled
workforce.
COMPARATIVE ANALYSIS OF
VALUATION METHODS (EXAMPLES)
1.Fast-Food Franchise:
1. Nature of Asset: Established brand, standardized processes, and stable cash flows.
2. Valuation Approach: Market Approach
3. Reasoning: The Market Approach is suitable for publicly traded companies with comparable data
available. In this case, assessing the franchise's value based on market multiples like price-to-earnings
ratios of similar franchises would provide a relevant valuation.

2.Specialized Manufacturing Equipment:

1. Nature of Asset: Custom-built machinery with limited market comparables.
2. Valuation Approach: Cost Approach
3. Reasoning: When dealing with unique or specialized machinery, the Cost Approach is effective. Evaluating
the replacement or reproduction cost of the equipment adjusted for depreciation provides a reasonable
estimate.
COMPARATIVE ANALYSIS OF
VALUATION METHODS (EXAMPLES)
1.Biotechnology Start-up with No Earnings:
1. Nature of Asset: Intellectual property, research capabilities, but no current earnings.
2. Valuation Approach: Cost Approach
3. Reasoning: In the absence of earnings, the Cost Approach can be applied by estimating the costs
invested in research, development, and intellectual property. It helps assess the investment made in
creating the business.

2.Chain of Retail Stores:

1. Nature of Asset: Established brand, widespread presence, and stable cash flows.
2. Valuation Approach: Market Approach
3. Reasoning: For a publicly traded retail chain, the Market Approach is appropriate. Comparing it to
similar companies in the market using multiples like price-to-earnings ratios helps determine its value.
COMPARATIVE ANALYSIS OF
VALUATION METHODS
Qualitative Factors in Valuation:
1.Brand Reputation:
1. Explanation: The strength of a brand can significantly impact a company's value. A well-
established and trusted brand can command higher prices and customer loyalty.
2. Example: Consider a tech company with a strong brand recognized for innovation. Investors
might perceive this positively, leading to a higher valuation. If the brand has faced recent
controversies, it could influence the valuation negatively.

2.Market Positioning:
1. Explanation: How a company positions itself in the market affects its competitiveness. Being a
market leader or niche player can impact long-term success.
2. Example: A retail chain dominating a specific market segment may have a competitive edge.
Investors might assign a higher value to a company with a unique market position.
COMPARATIVE ANALYSIS OF
VALUATION METHODS
Qualitative Factors in Valuation:
1.Management Team:
1. Explanation: Competent and experienced leadership contributes to a company's success. The
ability to execute strategies and adapt to market changes is crucial.
2. Example: If a company's management has a track record of successful ventures, investors may
perceive it as less risky, potentially leading to a higher valuation.

2.Intellectual Property and Innovation:

1. Explanation: Companies with valuable patents, proprietary technology, or a culture of
innovation can have a significant advantage.
2. Example: A pharmaceutical company holding a patent for a groundbreaking drug may be valued
higher due to the potential for future revenue streams and a competitive edge.
COMPARATIVE ANALYSIS OF
VALUATION METHODS
Qualitative Factors in Valuation:
1.Customer Relationships:
1. Explanation: Long-term relationships with customers contribute to revenue stability. Customer
loyalty and satisfaction can impact a company's valuation.
2. Example: A subscription-based business with a high customer retention rate may be valued
higher, reflecting the predictability of future cash flows.

2.Regulatory Environment:
1. Explanation: The regulatory landscape can impact a company's operations and potential
liabilities. Compliance with regulations is crucial.
2. Example: A healthcare company complying with stringent industry regulations may be
perceived as less risky, positively influencing its valuation.
COMPARATIVE ANALYSIS OF
VALUATION METHODS
Illustrative Scenario in Pesos:
Consider two technology startups seeking investment:
•Company A: Has a strong brand, an experienced management team, and a
reputation for innovation. Their valuation is ₱50 million.
•Company B: Lacks a recognizable brand, has less experienced leadership, and a
history of legal issues. Their valuation is ₱30 million.
In this scenario, the qualitative factors of Company A contribute to a higher
valuation. Investors recognize the brand strength, skilled management, and
innovative culture, deeming it a more attractive investment despite both companies
having similar financial metrics.
CHALLENGES AND
CRITICISMS
Challenges: Common challenges include lack of reliable data for Market Approach,
subjectivity in Cost Approach, and predicting future cash flows accurately in DCF.
Addressing Challenges: Emphasize the importance of thorough research, expert
judgment, and sensitivity analysis to address challenges associated with each
method.
CHALLENGES AND
CRITICISMS
Challenges in Valuation:
1.Lack of Reliable Data for Market Approach:
 Explanation: The Market Approach relies on comparable data from similar transactions or publicly
traded companies. If such data is scarce or not reliable, it can pose a challenge.
 Illustration: Consider valuing a small local tech startup. If there are few similar companies in the
market, finding accurate comparable data becomes challenging.
 Example in Pesos: A local software development company might lack direct competitors in the stock
market, making it difficult to find relevant market multiples for valuation.
CHALLENGES AND
CRITICISMS
Challenges in Valuation:
2. Subjectivity in Cost Approach:
•Explanation: The Cost Approach involves estimating the cost to reproduce or
replace an asset. Subjectivity can arise in determining depreciation rates or the level
of obsolescence.
•Illustration: When valuing a specialized piece of machinery, subjective decisions on
the extent of wear and tear can impact the final valuation.
•Example in Pesos: If valuing a custom-built manufacturing machine, determining
the rate of functional obsolescence (how outdated the machine is) involves
subjective judgment, affecting the overall valuation.
CHALLENGES AND
CRITICISMS
Challenges in Valuation:
3. Predicting Future Cash Flows Accurately in DCF:
•Explanation: The Discounted Cash Flow (DCF) method relies on predicting future
cash flows. This is inherently uncertain and subject to changes in market conditions.
•Illustration: Forecasting the future sales of a startup involves assumptions about
market demand, competition, and economic conditions.
•Example in Pesos: If valuing a tech startup, accurately predicting its future cash
flows can be challenging due to the rapidly changing nature of the industry and
unpredictable shifts in user preferences.
CHALLENGES AND
CRITICISMS
Illustrative Scenario in Pesos:
Consider a scenario where two companies in the same industry are being valued:
•Company X: Reliable market data is available because it's a well-established, publicly
traded company. The Market Approach yields a valuation of ₱120 million.
•Company Y: A smaller startup in the same industry with limited market data available.
The Market Approach is challenging due to a lack of comparable transactions. The Cost
Approach, however, provides a valuation of ₱80 million based on replacement cost.
In this scenario, Company Y faces the challenge of insufficient data for the Market
Approach. The valuation is determined using the Cost Approach, which involves more
subjectivity. Company X, with reliable market data, has a valuation based on actual
market transactions.
ASSUMPTIONS IN
VALUATION
Role: Discuss the significant role assumptions play in valuation and how they can
influence the accuracy of the valuation result.
Importance: Acknowledge that clear documentation of assumptions is crucial for
transparency and understanding the limitations of the valuation.
ASSUMPTIONS IN
VALUATION
1.Role of Assumptions:
1. Explanation: In the business valuation game, assumptions act as our crystal ball, allowing us to
make informed bets on a company's future. They're like calculated gambles on aspects such as
growth rates, potential risks, and market trends.
2. Illustration: Picture a retail startup. We might assume a 10% annual sales growth because we
foresee increased consumer demand and effective marketing strategies.
3. Example in Pesos: If we're valuing the startup at ₱20 million today, our assumptions about its
future growth will dictate our estimate of what it might be worth in a few years.
ASSUMPTIONS IN
VALUATION
2. Influence on Accuracy:
•Explanation: Think of assumptions as the steering wheel of our valuation vehicle. If
we turn it too sharply or not enough, we might end up off course. Overly optimistic
assumptions can inflate our valuation, while conservative ones might undervalue a
business.
•Illustration: Imagine assuming our retail startup will capture 30% of the market
annually. If this is too ambitious, our valuation might paint a rosier picture than
reality.
•Example in Pesos: With such ambitious assumptions, our estimated value might soar
to ₱50 million, but if market conditions don't align, investors could be in for a
surprise.
ASSUMPTIONS IN
VALUATION
3. Importance of Documentation:
•Explanation: Documenting assumptions is akin to leaving a map for others
navigating the valuation terrain. It's a way of saying, "Here's how we pieced together
this puzzle." Clear documentation is essential for others to follow our reasoning.
•Illustration: Let's say we assume the success of our retail startup is closely tied to a
stable economic climate. Documenting this assumption helps stakeholders
understand the factors influencing our valuation.
•Example in Pesos: Clearly stating that we assume steady economic conditions
provides a roadmap for our valuation, ensuring that stakeholders comprehend the
logic behind our estimated value of ₱50 million.
ASSUMPTIONS IN
VALUATION
Illustrative Scenario in Pesos:
Consider a valuation scenario for a technology services company:
•Assumption 1: Annual Revenue Growth: Assuming a 12% growth rate, considering
industry trends and potential client acquisitions.
•Assumption 2: Market Competitiveness: Assuming a 15% annual increase in market
share due to the company's innovative solutions.
•Assumption 3: Discount Rate: Assuming a 14% discount rate to account for the
competitive nature of the industry.
If these assumptions align with the reality of the company's prospects, the valuation
might be ₱80 million. However, if the assumptions are too optimistic or fail to consider
market challenges, the valuation could be significantly different.
COMBINATION OF
VALUATION METHODS
Situations: Highlight scenarios where a combination of valuation methods might be
more appropriate than relying on a single method, such as a hybrid approach in
complex valuations.
Benefits: Combining methods can provide a more comprehensive and robust
valuation, mitigating the limitations of individual methods.
COMBINATION OF
VALUATION METHODS
Situations:
•Illustration: Let's take a scenario where you're tasked with valuing a tech company
that not only develops software but also owns a valuable patent. The Cost Approach
could be used to value the physical assets and reproduction cost of the software,
while the Income Approach, like DCF, could capture the future cash flows generated
by the patented technology.
•Example in Pesos: If the Cost Approach values the software at ₱30 million and the
DCF estimates the patent's future cash flows at ₱50 million, a combination of both
methods might suggest a total valuation of ₱80 million, providing a more holistic
view.
COMBINATION OF
VALUATION METHODS
Benefits:
•Illustration: Consider a manufacturing business with a strong brand. The Market
Approach could be applied by comparing it to similar publicly traded companies.
However, if the market comparables are limited, the Cost Approach could be
employed to assess the replacement cost of its specialized machinery.
•Example in Pesos: The Market Approach might value the business at ₱60 million,
while the Cost Approach estimates the replacement cost at ₱50 million. Combining
both methods helps arrive at a valuation of ₱55 million, offering a more balanced
perspective.
COMBINATION OF
VALUATION METHODS
Illustrative Scenario in Pesos:
Imagine a scenario where you're tasked with valuing a growing e-commerce
business:
•Market Approach: The Market Approach compares the e-commerce company to
similar publicly traded firms. However, finding exact matches is challenging due to
its unique business model. The Market Approach estimates the value at ₱70 million.
•DCF (Discounted Cash Flow): DCF is employed to capture the company's future
cash flows, considering its rapid growth and potential market expansion. It estimates
the value at ₱90 million.
•Cost Approach: The Cost Approach assesses the replacement cost of the e-
commerce platform and technology infrastructure, valuing it at ₱50 million.
COMBINATION OF
VALUATION METHODS
By combining these methods, you're not relying solely on one approach. Instead,
you're incorporating different aspects of the business, arriving at a more balanced
valuation estimate of ₱80 million. This approach considers market trends, future
cash flows, and the tangible assets of the business, offering a well-rounded
perspective to potential investors or stakeholders.
REAL-WORLD APPLICATION
(COST APPROACH)
Scenario: Imagine you're tasked with valuing a small manufacturing company that
specializes in crafting custom-made furniture. The business owns a unique piece of
machinery critical to its operations.
Step-by-Step Calculation:
1.Identify the Asset:
1. Business Context: The unique machinery used for crafting custom-made furniture.
2. Calculation: Assess the current market value of the machinery.
REAL-WORLD APPLICATION
(COST APPROACH)
2. Replacement Cost:
1. Business Context: The specialized machinery is not readily available in the market.
2. Calculation: Estimate the cost to replace the machinery with a new one of similar capability,
accounting for technological advancements.
3. Example in Pesos: If a similar piece of machinery, adjusted for technological improvements,
would cost ₱2 million, this becomes our replacement cost.

3. Consideration of Depreciation:
4. Business Context: The machinery has been in use for five years.
5. Calculation: Apply depreciation based on the machinery's useful life and current condition.
6. Example in Pesos: If the machinery has a useful life of 10 years and has depreciated by 20%,
the depreciation would be ₱400,000 (₱2 million * 20%).
REAL-WORLD APPLICATION
(COST APPROACH)
5. Functional Obsolescence:
1. Business Context: Technological advancements may have made the current machinery less
efficient.
2. Calculation: Assess the impact of functional obsolescence on the machinery's value.
3. Example in Pesos: If technological advancements have made the current machinery 10% less
efficient, functional obsolescence would be ₱200,000 (₱2 million * 10%).

6. Final Valuation:
4. Calculation: Subtract the depreciation and functional obsolescence from the replacement cost.
5. Example in Pesos: Final valuation = Replacement Cost - Depreciation - Functional
Obsolescence Final valuation = ₱2 million - ₱400,000 - ₱200,000 Final valuation = ₱1.4 million
REAL-WORLD APPLICATION
(COST APPROACH)
Assumptions, Risks, and Considerations:
•Assumptions: We assume that the replacement cost accurately reflects the current
market value and that the useful life and depreciation rate align with industry norms.
•Risks: The risk lies in accurately estimating depreciation and functional obsolescence.
Overestimating or underestimating these factors can impact the final valuation.
•Economic Environment Impact: If there are significant changes in the economic
environment, such as a sudden increase in the cost of materials, it can influence the
replacement cost and, consequently, the final valuation.
•Industry Trends Impact: If there are advancements in machinery technology specific
to the furniture manufacturing industry, it may impact the functional obsolescence
factor, requiring a reassessment of the valuation.
REAL-WORLD APPLICATION
(MARKET APPROACH)
Scenario: Let's dive into the valuation of a small software development company
specializing in mobile applications. This privately held company is seeking its value
using the Market Approach.
Step-by-Step Calculation:
1.Identify Comparable Companies:
1. Business Context: Focus on the mobile application development sector.
2. Calculation: Identify publicly traded companies comparable to the target, such as Company A,
B, and C.
3. Example in Pesos: Three comparable companies are identified based on their business model,
market focus, and size.
REAL-WORLD APPLICATION
(MARKET APPROACH)
2. Collect Market Data:
1. Business Context: Gather relevant financial data for the comparable companies.
2. Calculation: Acquire key metrics like market capitalization, earnings, and revenue multiples for
each of the identified companies.
3. Example in Pesos: Company A has a market capitalization of ₱500 million, Company B has an
earnings multiple of 15, and Company C has a revenue multiple of 2.

3. Calculate Valuation Multiples:

4. Business Context: Apply the identified multiples to the financial metrics of the target company.
5. Calculation: If Company B has an earnings multiple of 15 and the target company has earnings
of ₱10 million, the implied valuation is 15×₱10million=₱150million.
6. Example in Pesos: If the target company's revenue is ₱20 million and Company C has a revenue
multiple of 2, the implied valuation would be 2×₱20million=₱40million.
REAL-WORLD APPLICATION
(MARKET APPROACH)
4. Assign Weights to Comparable Companies:
1. Business Context: Give weights based on the similarity of comparable companies to the target.
2. Calculation: Assign weights such as 40%40%, 30%30%, and 30%30% to Company A, B, and
C, respectively.
3. Example in Pesos: If Company A is deemed more similar, assign a 40%40% weight to its
multiples in the calculation.

5. Calculate Weighted Average Multiples:

 Business Context: Compute the weighted average of the multiples for the final valuation.
 Formula:
Weighted Average Earnings Multiple=(WeightA​×MultipleA​)+(WeightB​×MultipleB​)
+(WeightC​×MultipleC​)
 Example in Pesos: If the weighted average earnings multiple is 18, and the target company's earnings
are ₱10 million, the final valuation would be 18×₱10million=₱180million.
REAL-WORLD APPLICATION
(MARKET APPROACH)
Assumptions, Risks, and Considerations:
•Assumptions: Assumes that selected comparable companies accurately represent the
market sentiment, and chosen multiples are suitable for the target company.
•Risks: Risk lies in selecting inaccurate or insufficiently similar comparable companies.
Rapid changes in the market environment may render historical multiples outdated.
•Economic Environment Impact: Changes in the economic environment, like industry-
wide economic downturns, can impact valuation multiples and the target company's final
market value.
•Industry Trends Impact: Shifts in industry trends, such as sudden changes in mobile
application demand, can influence valuation multiples and the overall Market Approach.
REAL-WORLD APPLICATION
(DCF APPROACH)
Scenario: Let's explore the valuation of a startup tech company focusing on
innovative healthcare solutions. The company is determining its value using the
Discounted Cash Flow (DCF) Approach.
Step-by-Step Calculation:
1.Forecast Future Cash Flows:
1. Business Context: Predict the cash flows the company is expected to generate in the future.
2. Calculation: Estimate future cash inflows and outflows, considering sales projections, operating
costs, and capital expenditures.
3. Example in Pesos: If the startup is projected to generate ₱5 million in cash inflows annually for
the next five years, the forecasted cash flows would be ₱5 million each year.
REAL-WORLD APPLICATION
(DCF APPROACH)
2. Determine the Discount Rate (WACC):
1. Business Context: Establish the discount rate, often the Weighted Average Cost of Capital
(WACC), reflecting the risk associated with the investment.
2. Calculation: Consider the cost of equity, cost of debt, and their respective weights in the overall
capital structure.
3. Example in Pesos: If the cost of equity is 10%, the cost of debt is 5%, and the equity-to-debt
ratio is 70:30, the WACC would be (0.10×0.70)+(0.05×0.30)=8.5(0.10×0.70)+(0.05×0.30)=8.5.

3. Discount Future Cash Flows:

4. Business Context: Discount each forecasted cash flow back to its present value.
5. Formula: ​

 Example in Pesos: If the cash inflow in year 1 is ₱5 million and the discount rate is 8.5%, the present
value would be ₱5/(1+0.085)1=₱4.62million.
REAL-WORLD APPLICATION
(DCF APPROACH)
Sum Present Values:
•Business Context: Sum all present values of future cash flows to determine the total
present value.
•Formula: Present Value=
•Example in Pesos: Summing the present values for each year gives the total present
value.
•Example Calculation:
REAL-WORLD APPLICATION
(DCF APPROACH)
5. Subtract Initial Investment:
•Business Context: Deduct any initial investment made to realize the net present value
(NPV).
•Formula: NPV=Total Present Value−Initial Investment
•Example in Pesos: If the initial investment is ₱10 million, subtract this from the total
present value to get the Net Present Value.
•Example Calculation: NPV=₱19.80million−₱10million=₱9.80million
REAL-WORLD APPLICATION
(DCF APPROACH)
Assumptions, Risks, and Considerations:
•Assumptions: Assumes accurate forecasting of future cash flows and a reliable
discount rate.
•Risks: Risk lies in unforeseen changes in the industry or economic landscape
affecting the accuracy of forecasts.
•Economic Environment Impact: Changes in interest rates or economic conditions
can impact the discount rate and, consequently, the DCF valuation.
•Industry Trends Impact: Rapid changes in healthcare regulations or technology
trends can influence the startup's cash flow projections.