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What is Valuation?
Valuation is the art/science of
determining what an assets/security
is worth.
The value of a security or asset
depends on the model,
assumptions and bias.
What is Valuation?
Valuation give a foundation for
deciding whether to buy, sell or held
When we compare the market price
against the value, we can say whether
a security is over or undervalue.
Issues on Valuation
IS VALUATION AN OBJECTIVE SEARCH FOR
TRUE VALUE?
All valuations are biased. The only question
is how much and in which direction.
The direction and magnitude of the bias in
your valuation is directly proportional to
who pays you and how much you are paid.
Issues on Valuation
IS IT TRUE THAT THE MORE INPUTS IN A
MODEL, THE BETTER THE VALUATION?
Simpler valuation models do much
better than complex ones.
Understanding valuation is inversely
proportional to the number of inputs
required for the model.
Issues on Valuation
DOES A GOOD VALUATION PROVIDES A
PRECISE VALUE?
There are no precise valuations, only good
or bad estimates.
A valuation without risk analysis is a bad
one.
Risk Analysis provides a range of possible
values (maximum, minimum, mean, standard
deviation, probability distributions)
LIQUIDATION METHOD
It considers the actual market value that could be
obtained if the firms assets are sold.
Then calculates the residual value after all debts are
paid.
The residual value is available for distribution to
shareholders
The value of a share is calculated by dividing the residual
value by the number of outstanding common shares.
This method does not take into account the earnings
potential of the firm.
V0 = Value
1
CF1
CF2
CF3
CFn
CF1
CF2
CFn
V0
...
1
2
(1 k) (1 k)
(1 k) n
CFt
V0
t
(1
k)
t 1
Where:
V= value of the firm
FCFOt= Free cash flow from operations in period t
TV t= Terminal value of investment in period t
k= weighted average cost of capital of the firm
FCF to shareholder shall be discounted at the cost of equity
This method has two assumptions: 1)all dividends are paid annually at
the end of each year, 2) risk is incorporated in the investors
required rate of return.
If shares are purchased at the beginning of the term and held for t
years the value as per DVM is :
n
P 0=
...
1
2
n
t
(1 k ) (1 k )
(1 k )
(
1
k
)
t 1
...
[ 7-6]
1
2
(1 k )
(1 k )
(1 k ) n