Valuation

September 29, 2007
Presented by:
Kaushal Shah
Anup Agarwal
VALUATION TECHNIQUES
Page 2
Valuation Techniques
Index
Approach to Valuation Section I
Valuation Methods Section II
Practical Difficulties in Valuation Section III
Resources Section IV
Page 3
Section I: Approach to Valuation
Page 4
Approach to Valuation
Time
P
r
o
g
r
e
s
s
Understand the
business and
background of the
company and the
country and industry
in which it operates
Collect financial
projections,
market feedback
Develop an overall range of values,
based on certain underlying
assumption
Select an
appropriate
method for
valuation
Page 5
Background Information
Primary Source of Information: Undertake management
interviews and collect background documents/ information
on following:
Country of operations
Regulations impacting the operations of the industry in
general and the company in particular
Key products and services
Audited financial statements
- Ratio analysis (ROE, growth rate of earnings, margins,
Debt/Equity ratio, capital employed)
- Scan the financials to the maximum extent possible so as to
compute a trend which can be mapped or correlated with the
financials of competitors financials
The technology used, utilized capacity, human resources,
etc
Secondary source: Industry reports, research report,
newspapers and etc
Page 6
Future Projections
Why do we require to compute the future projections?
Understand the free cash flow generated from the investment made
Depending upon the growth rate and the ROE
The Explicit Forecast Period
Basic assumption being that a firm would grow at a rate higher than the industry
rate & earn a ROE higher than the industry rate
However, the law of economics would come in play over time
Returns to be in line with the industry rate and the growth to be lower than or
equal than the growth rate of the economy
To understand when the firm would hit the stable growth look for:
Size of the firm, relative to the market it serves (a new IT company can probably
grow at a rate of 80-100% per annum for the next 1 year, however, the same
cannot be expected from Infosys)
Competitive advantages & barriers to entry that give the firm its capacity for high
growth & high returns
Why do we require to compute the future projections?
Understand the free cash flow generated from the investment made
Depending upon the growth rate and the ROE
The Explicit Forecast Period
Basic assumption being that a firm would grow at a rate higher than the industry
rate & earn a ROE higher than the industry rate
However, the law of economics would come in play over time
Returns to be in line with the industry rate and the growth to be lower than or
equal than the growth rate of the economy
To understand when the firm would hit the stable growth look for:
Size of the firm, relative to the market it serves (a new IT company can probably
grow at a rate of 80-100% per annum for the next 1 year, however, the same
cannot be expected from Infosys)
Competitive advantages & barriers to entry that give the firm its capacity for high
growth & high returns
Page 7
Future Projections
While working out the future projections,
understand key assumptions underlying
each variable.
Some of the variables to that you should
pay attention to are:
Capacity Utilization
Volumes
Price trends
Cost of goods sold
Administration overheads
Selling & Marketing costs
EBITDA Margins
Tax workings and calculations
Capital expenditure
Working capital requirements
Following macro level issues should also
be considered while forecasting
projections:
Country
- Developed or a developing
economy Impacts the growth
and the risk assumptions
- Political and Economic scenario
- Inflation
Industry
- Rules and regulations applicable
- Growth cycle of the Industry
Page 8
Section II: Valuation Methods
Page 9
Methods for Valuation
Determine suitability of alternative methods to arrive at a
valuation
Valuation can be based on Earnings or Assets of the Company
Certain valuation methods can be applied universally; some are
specific to respective industry
Fundamental or
theoretical valuation
Estimates firms value by
discounting expected free
cash flows at a rate which
reflects the risk of the cash
flows
Terminal value based on
two methodologies
EBDITA multiple
Perpetuity
Discount the resulting
free cash flows at a cost
of capital that reflects
company specific risk
Discounted Cash Flow (DCF)
Analysis
Market valuation
Investors view on prospects
of an entire industry and
specific companies
Considerations for peer
group include similar size,
life of assets and similar
management quality
Difficult to establish peer
group on account of diverse
business activities.
Trading Multiples
Acquisition related
valuation
Applies multiples of related
industry transactions to the
valuation of a business
Measures premium paid for
acquiring control and places
value on intangible strategic
factors
Transaction Multiples
Acquisition related
valuation
Useful when the historical
costs of assets purchased is
not comparable to its
current market value
NAV is based on expected
future cash flows the
market expects from the
asset
Two methods
Replacement Cost
Future cash flows
Net Asset Value (NAV)
Page 10
Discounted Cash Flow (Contd.)
The Discounted Cash Flow (DCF) method is universally accepted as the most
fundamental valuation technique
DCF has its foundation in the Present Value (PV) rule, where the value of any asset is
the PV of the expected future cash flows
Investment of Rs. 1 lacs in a project today gives a return of 12% p.a till infinity
How to compute the total cash flow received from this project ? Find out what would
Rs. 12,000 earned say after 1 year, 3 years or 5 years would be worth today, i.e., find out the
NPV of the cash flows
DCF is based on the principles of Free Cash Flow to the firm and to the Shareholders
Free Cash Flow to Firm method of DCF valuation (FCFF)
Free Cash Flow to Equity method of DCF valuation (FCFE)
In DCF, the valuation of the firm is a combination of two factors:
Valuation based free cash flows in the explicit forecasted period, lets say 5 or 10 years
Terminal value of the firm beyond the explicit forecasted period
- Company is assumed to be operating after the explicit forecasted period till perpetuity -
Concept of Ongoing concern
The Discounted Cash Flow (DCF) method is universally accepted as the most
fundamental valuation technique
DCF has its foundation in the Present Value (PV) rule, where the value of any asset is
the PV of the expected future cash flows
Investment of Rs. 1 lacs in a project today gives a return of 12% p.a till infinity
How to compute the total cash flow received from this project ? Find out what would
Rs. 12,000 earned say after 1 year, 3 years or 5 years would be worth today, i.e., find out the
NPV of the cash flows
DCF is based on the principles of Free Cash Flow to the firm and to the Shareholders
Free Cash Flow to Firm method of DCF valuation (FCFF)
Free Cash Flow to Equity method of DCF valuation (FCFE)
In DCF, the valuation of the firm is a combination of two factors:
Valuation based free cash flows in the explicit forecasted period, lets say 5 or 10 years
Terminal value of the firm beyond the explicit forecasted period
- Company is assumed to be operating after the explicit forecasted period till perpetuity -
Concept of Ongoing concern
Page 11
Steps followed in applying this approach include:
Step 1: Projecting the free cash flows of the business over the selected period of estimation
forecasted period
FCFF is arrived at as follows:
Earnings before interest, tax, depreciation and amortisation (EBITDA)
(-) / + Adjustment for non-cash expenditure or income
(-) Adjusted taxes on EBITDA
(-) Planned capital expenditure
(-)/ + (Increase)/ Decrease in net working capital
FCFF can also be derived from PAT
FCFE is derived as follows:
Profit After Tax
(+) Depreciation
(-)/ + Scheduled repayment of loans
Steps followed in applying this approach include:
Step 1: Projecting the free cash flows of the business over the selected period of estimation
forecasted period
FCFF is arrived at as follows:
Earnings before interest, tax, depreciation and amortisation (EBITDA)
(-) Adjusted taxes on EBITDA
FCFF can also be derived from PAT
FCFE is derived as follows:
Profit After Tax
(+) Depreciation
(-)/ + Scheduled repayment of loans
Page 12
The forecasted period is the period post which the growth of the business is stable
A firm is in stable growth when
It is growing at a rate less than or equal to the growth rate of the economy in which
it operates
Its risk characteristics and leverage resemble those of a stable growth firm in that
market.
Its returns on capital converge towards the industry average (or the cost of capital)
All firms will become stable growth firms at some point
Because no firm can grow at a rate higher than that of the economy forever
Size becomes an enemy
The forecasted period is the period post which the growth of the business is stable
A firm is in stable growth when
It is growing at a rate less than or equal to the growth rate of the economy in which
it operates
Its risk characteristics and leverage resemble those of a stable growth firm in that
market.
Its returns on capital converge towards the industry average (or the cost of capital)
All firms will become stable growth firms at some point
Because no firm can grow at a rate higher than that of the economy forever
Size becomes an enemy
Page 13
The impact of inflation - Nominal cash flows and real cash flows
Lets take an example: In case the price of a particular commodity increase by 8% in a
year in an economy which has 5% inflation. In that case the real growth rate has
actually been only 3% and not 8%. In the sense the price has grown in real terms by
3% only
Normally valuations are done taking nominal cash flows as the basis which includes
inflation.
However, a firm can also be valued on a real cash flow basis by adjusting the impact
of inflation not only on the cash flows but also in the Discounting Factor . This is so
because the Discounting Factor is calculated taking into account the risk free returns
which is nothing but the return on government securities which includes inflation.
The numerator and the denominator should be on same terms
However, the valuation arrived at either from the nominal cash flows or the real cash
flows would always be same
The impact of inflation - Nominal cash flows and real cash flows
Lets take an example: In case the price of a particular commodity increase by 8% in a
year in an economy which has 5% inflation. In that case the real growth rate has
actually been only 3% and not 8%. In the sense the price has grown in real terms by
3% only
Normally valuations are done taking nominal cash flows as the basis which includes
inflation.
However, a firm can also be valued on a real cash flow basis by adjusting the impact
of inflation not only on the cash flows but also in the Discounting Factor . This is so
because the Discounting Factor is calculated taking into account the risk free returns
which is nothing but the return on government securities which includes inflation.
The numerator and the denominator should be on same terms
However, the valuation arrived at either from the nominal cash flows or the real cash
flows would always be same
Page 14
Step 2: Converting these free cash flows into present value through discounting
The discounting factor is the expected return from the investment at a particular level
of risk; Alternatively it is the cost of funds or the opportunity cost of capital
Assuming an investment of Rs. 100 gives a return of 10% p.a. However, if there is an
option to lend the money to a friend at an interest rate of 12% p.a. Would you invest
or lend?
Discounting factor is based on a simple principle that higher the risk of a project (risk
of achieving a projected cash flow of the project) higher would be the return
expectation of an investor and vice versa
Discounting factor could either be a cost of equity (Equity Valuation) or a cost of
capital (Firm Valuation)
Various factors to be considered while computing the discounted rate, assuming
WACC are:
Cost of Equity (Ke)
Cost of Debt (Kd)
Target Debt Equity Ratio
Step 2: Converting these free cash flows into present value through discounting
The discounting factor is the expected return from the investment at a particular level
of risk; Alternatively it is the cost of funds or the opportunity cost of capital
Assuming an investment of Rs. 100 gives a return of 10% p.a. However, if there is an
option to lend the money to a friend at an interest rate of 12% p.a. Would you invest
or lend?
Discounting factor is based on a simple principle that higher the risk of a project (risk
of achieving a projected cash flow of the project) higher would be the return
expectation of an investor and vice versa
Discounting factor could either be a cost of equity (Equity Valuation) or a cost of
capital (Firm Valuation)
Various factors to be considered while computing the discounted rate, assuming
WACC are:
Cost of Equity (Ke)
Cost of Debt (Kd)
Page 15
Cost of Equity (Ke)
Several methods available to compute Ke. However, Capital Assets Pricing Model is the most
universally accepted method.
As per CAPM, Ke = Rf + (Rm Rf)*b = Rf + (equity risk premium) * firm specific risk
- Rf Risk free rate of return government securities for the maximum possible period or
the project period
- Rm Expected return on market index (Market provides the best return at a particular
level of risk)
- b Beta
In simple words, Rmdenotes the returns from an asset class in addition the risk free return or an
incentive that an investor would look at for investing in a particular class of asset (say equity)
which is riskier than investing in a risk free asset (say government securities)
Currently, a 6-7% market risk premium is assumed while calculating the cost of equity for
investments in Indian equity markets
Beta calculates the risk which is specific to the company in direct correlation to the market index.
When beta is less than 1, it means the risk of the security is less than the market risk
Can be calculated by regression of the stock price returns with the Index returns
Can be sourced from Bloomberg, Yahoo or from research agencies like Dun & Bradstreet
Cost of Equity (Ke)
Several methods available to compute Ke. However, Capital Assets Pricing Model is the most
universally accepted method.
As per CAPM, Ke = Rf + (Rm Rf)*b = Rf + (equity risk premium) * firm specific risk
- Rf Risk free rate of return government securities for the maximum possible period or
the project period
- Rm Expected return on market index (Market provides the best return at a particular
level of risk)
- b Beta
In simple words, Rmdenotes the returns from an asset class in addition the risk free return or an
incentive that an investor would look at for investing in a particular class of asset (say equity)
which is riskier than investing in a risk free asset (say government securities)
Currently, a 6-7% market risk premium is assumed while calculating the cost of equity for
investments in Indian equity markets
Beta calculates the risk which is specific to the company in direct correlation to the market index.
When beta is less than 1, it means the risk of the security is less than the market risk
Can be calculated by regression of the stock price returns with the Index returns
Can be sourced from Bloomberg, Yahoo or from research agencies like Dun & Bradstreet
Page 16
Discounted Cash Flow(Contd.)
Beta calculates the risk factor of a particular asset (say risk of investing in Reliance) with
reference to a basket of assets (say investing in Sensex)
Risks can be classified as Systematic risks and Unsystematic risks.
- Unsystematic risks:
These are risks that are unique to a firm or industry and unknown.
- Systematic risks:
These are risks associated with the economic, political, sociological and other macro-level
changes. They affect the entire market as a whole and cannot be controlled or eliminated
merely by diversifying one's portfolio.
The degree to which different portfolios are affected by these systematic risks as compared to the
effect on the market as a whole, is different and is measured by Beta.
Beta can be based on leveraged or de-leveraged Beta
Beta calculates the risk factor of a particular asset (say risk of investing in Reliance) with
reference to a basket of assets (say investing in Sensex)
Risks can be classified as Systematic risks and Unsystematic risks.
- Unsystematic risks:
These are risks that are unique to a firm or industry and unknown.
- Systematic risks:
These are risks associated with the economic, political, sociological and other macro-level
changes. They affect the entire market as a whole and cannot be controlled or eliminated
merely by diversifying one's portfolio.
The degree to which different portfolios are affected by these systematic risks as compared to the
effect on the market as a whole, is different and is measured by Beta.
Beta can be based on leveraged or de-leveraged Beta
Mah Gesco 1.45 HLL 0.98 TCS 0.92
Unitech 1.1 Marico 0.92 Wipro 1.07
Ansal 1.49 Dabur 0.94 Infosys 0.97
Last 2 years adjusted Beta from Bloomberg
IT FMCG Real Estate
Page 17
Cost of Debt is considered on a post tax basis
Cost of recent loans taken by the company
Cost based on the ratings of the company
- ICRA, CARE, CRISIL
Cost of Debt would be default spread over and above the risk free rate of return
from government securities
Government Securities to be considered for the longest maturity available and the
security should be liquid to determine the actual value
- Generally a security of 10 year maturity considered
Based on the ratio of debt as would be expected in future
Proportion of Debt and Equity becomes the weight for deriving the WACC
Cost of Debt is considered on a post tax basis
Cost of recent loans taken by the company
Cost based on the ratings of the company
- ICRA, CARE, CRISIL
Cost of Debt would be default spread over and above the risk free rate of return
from government securities
Government Securities to be considered for the longest maturity available and the
security should be liquid to determine the actual value
- Generally a security of 10 year maturity considered
Based on the ratio of debt as would be expected in future
Proportion of Debt and Equity becomes the weight for deriving the WACC
Page 18
Step 3: Terminal Value Terminal value is
the value of the business at the end of/
beyond the explicit forecasted period, i.e., the
period where it is assumed that the ROE or
the growth rate is assumed to be higher than
the industry rates
The formula for calculate terminal value is:
The growth rate used for calculating the
terminal value is the rate at which the cash
flows are expected to increase beyond the
explicit forecast period till infinity
You may also use a various exit multiples to the free cash flow of the terminal year for
computing the terminal value; P/E, P/B or multiple on EBITDA
Terminal growth is the rate the firm would grow after it reaches the steady state growth phase
A firm which is presently growing at 22%, in a industry which is growing at 10%, is unlikely to
grow at that rate once it has reached a stable growth, because it has exhausted some or all of the
differential advantage that gave it the high margin
Growth trend
Terminal Value =
(FCFn(1+g)
(WACC - g)
FCFn = free cash flow of the last year of the
forecasted period
g = growth rate beyond the explicit forecasted
period
WACC = weighted average cost of capital
Page 19
Discounted Cashflow Valuation
FCFF
n
FCFF
5
FCFF
4
FCFF
3
FCFF
2
FCFF
1
Forever
Discount at WACC =Cost of Equity (Equity/(Debt +Equity)) +Cost of Debt (Debt/Debt +Equity))
Value of Operating Assets
+Cash & Non-op Assets
=Value of Firm
Value of Debt
=Value of Equity
..
Terminal Value =FCFF
n +1
/(r-g
n
)
Firm is in stable growth:
Grows at constant rate
forever
Cashflow to Firm
EBIT (1-t)
- Cap Ex Depr)
- Change in WC
=FCFF
Expected Growth
Reinvestment Rate *
Return on Capital
Riskfree Rate:
- No default risk
- No reinvestment risk
- In same currency and in
same terms (real or nominal
as cash flow)
+
x
Beta
- Measures market risk
Risk Premium
- Premium for average
risk investment
Types of
Business
Operating
Leverage
Financial
Leverage
Base Equity
Premium
Country Risk
Premium
Cost of Debt
(Riskfree Rate +
Default Spread) (1-t)
Cost of Equity
Page 20
Free Cash Flows & Enterprise Value Rs. lakhs
Particulars Year 1 Year 2 Year3 Year 4 Year 5 Year 6 Year 7 Year 8
EBITDA 4,485 5,119 5,038 4,927 4,810 4,687 4,558 4,423
Less: Adjusted Taxes as per workings
(227) (353) (1,124) (1,198) (1,241) (1,260) (1,262) (1,251)
Cash Flows from operating activities 4,258 4,766 3,914 3,729 3,569 3,427 3,296 3,172
Less (Increase)/ Add Decrease in W/C (1,006) (561) (22) (14) (15) (15) (16) (17)
Less: Capex (2,552) (1,311) (1,100) (950) (750) (500) (500) (500)
Free Cash Flows for the year 701 2,893 2,792 2,765 2,805 2,911 2,780 2,655
Terminal Value Calculation Rs. Lakhs
Terminal Growth Rate 3.0%
Terminal Value (in Rs Lakhs) 39,468 31,607
Discount Rate 9.9% (18,181)
PV of Terminal Value (in Rs Lakhs) 18,506 13,426
NPV of Free Cash Flows for xxplicit forecast period 115.59
Discount Rate 9.9% 116.16
NPV as on 31-Dec-06 (in Rs. Lakhs) 13,101
Number of equity shares in lakhs
Value per share (fully paid-up)
Calculation of Value Per Share
Gross Enterprise Value
Less: Debt as on 31-Dec-06
Equity Value of the Company
Page 21
Discounted Cash Flow (Contd.) Scenario/ Sensitivity Analysis
Sensitivity Analysis is generally done on key factors to gauge the range of values
WACC and Terminal growth rate are the key drivers of the firm value
Sensitivity Analysis is generally done on key factors to gauge the range of values
WACC and Terminal growth rate are the key drivers of the firm value
Sensitivity Summary Current 1 2 3 4 5 6
Values
Changing Cells:
Rupee Depreciation* 0% 5.00% 0% 0% 0% 0% 0%
Change in Selling Price 0% 0% -1.00% 0% 0% 0% 0%
Change in Cost of Material 0% 0% 0% 1.00% 0% 0% 0%
R/M as % of sales 49% 49% 49% 49% 50% 49% 49%
WACC (Weighted Average Cost of Capital) 9.44% 9.44% 9.44% 9.44% 9.44% 10.44% 9.44%
WACC (Weighted Average Cost of Capital) 9.44% 9.44% 9.44% 9.44% 9.44% 9.44% 8.44%
Result Cells:
Share price Rs 26.3 Rs 33.3 Rs 24.2 Rs 25.2 Rs 24.0 Rs 21.8 Rs 31.9
Change in share price Rs 7.0 -Rs 2.1 -Rs 1.1 -Rs 2.3 -Rs 4.5 Rs 5.6
% change in share price 27% -8% -4% -9% -17% 21%
Page 22
Market Multiples
Valuation parameter is based on the valuation driver
Valuation multiples of the domestic and international peers are applied to the financial results of
the company to derive the company valuation
Adjustment to be made as regards the country, size, growth etc
Valuation based on one year forward multiples
Valuation parameter is based on the valuation driver
Valuation multiples of the domestic and international peers are applied to the financial results of
the company to derive the company valuation
Adjustment to be made as regards the country, size, growth etc
Valuation based on one year forward multiples
As a multiple of operating asset
Per tonne for Cement, steel etc
Per square feet for retail
Sum of Parts
Diversified companies
Synergy value may be an addition
EV/EBITDAR
Airline companies
Lease value forms a significant
portion
PEG
Retail, Media and Entertainment, IT
High growth companies
Net Asset Value/Replacement Value
Real Estate, Shipping companies
Fixed assets are the valuation driver
As a multiple of Book Value
Banks
Assets suggest true value of
business
As a multiple of Sales
Start-ups
Net profit and operating profit not
the right parameters due to initial
stages of business
As a multiple of operating profit
Globally Accepted valuation
parameter
Financial jugglery and capex below
the operating profit levels distorts
the P/E
As a multiple of EPS
Globally Accepted valuation
parameter
Directly related to the profits,
which is supposed to be
distributed to the shareholders
Page 23
Case Study of XYZ Limited Valuation Basket
8.9 10.3 13.9 13.4 15.5 23.7 Average
6.1 3.5 2.6 11.8 8.2 6.8 584 251 164 9,500 7,250 6,281 E
9.9 12.3 13.7 12.7 15.5 27.3 9.8 8.9 6.4 15.9 14.5 15.9 1,925 1,540 910 19,662 17,315 14,218 24,859 405 D
7.6 7.5 9.6 12.2 12.4 18.2 11.1 12.4 8.2 25.6 29.8 24.1 2,212 2,177 1,385 19,977 17,503 16,887 27,018 129 C
8.4 8.4 17.2 15.2 16.3 30.3 6.8 7.5 9.1 18.6 21.3 23.6 641 623 328 9,417 8,252 3,617 9,628 133 B
9.6 13.0 15.0 13.6 17.6 18.9 6.1 6.0 5.5 9.5 9.0 9.6 687 531 396 11,314 8,795 7,198 9,367 545 A
FY07 FY06 FY05 FY07 FY06 FY05 FY07 FY06 FY05 FY07 FY06 FY05 FY07 FY06 FY05 FY07 FY06 FY05 MCap
Market
Price
Rs mn
EV/EBITDA PE PAT Margins EBITDA Margins PAT Sales
Valuation matrix of Domestic companies
EV/EBITDA (X) P/E
4.6 5.6 8.4 10.3 Average
3.2 4.1 3.7 4.7 157.1 2.2 K
3.2 4.1 5.9 5.9 121.4 2.7 J
4.2 4.7 12.3 13.7 435.1 3.4 I
6.6 7.7 10.7 12.7 999.5 5.9 H
6.6 8.8 10.4 16.0 386.2 3.8 G
3.4 4.0 7.4 8.8 1,144.8 10.2 F
FY07/CY06 FY06/CY05 FY07/CY06 FY06/CY05
Market Cap
(US$ mn)
Share price
(Local currency)
Valuation matrix of International companies
Page 24
Net Realizable Value or the Net Asset Value
In the Net Asset Value (NAV) method, the net realizable value of the assets is
computed based on the valuation date
The genesis of this method of valuation lies in the total assets that the company owns
The values of intangible assets are excluded
Any reserves that have not been created out of genuine profits are not taken into
account
Loan funds are deducted
Contingent liabilities, to the extent that they impair the net worth of the company,
are also deducted
The resultant figure represents the net worth of the company on the given day
However, this method is against the concept of going concern
Shipping companies generally follow this method
In the Net Asset Value (NAV) method, the net realizable value of the assets is
computed based on the valuation date
The genesis of this method of valuation lies in the total assets that the company owns
The values of intangible assets are excluded
Any reserves that have not been created out of genuine profits are not taken into
account
Loan funds are deducted
Contingent liabilities, to the extent that they impair the net worth of the company,
are also deducted
The resultant figure represents the net worth of the company on the given day
However, this method is against the concept of going concern
Shipping companies generally follow this method
Page 25
Valuation Methodology Real Estate
Net Asset Value: Value of Ongoing Projects + Value of Land Bank
DCF for the projects being executed
- Assets sold
- Assets leased
Capitalization rate of 10%, based on a market yield of 10% on the commercial
property
- Price and cost escalation is considered to derive at a future sale value
Price escalation is generally considered @ 5%-7%
Cost escalation is generally considered @ 3%-5%
Value of the Land Bank
- Replacement Value
- Value derived from the surrounding developed property less the Construction cost,
other expenses and the Developers margin
Interest cost and taxation is a debatable issue since many consider the
valuation at the EBITDA level
Page 26
Profit Earnings Capacity Value - PECV
In the Profit Earnings Capacity Value (PECV) method, the value of the business is
determined as follows:
Determine average earnings based on the past 3 to 5 years of earnings
Make adjustments for exceptional transactions or items of a non-recurring nature
Capitalize the adjusted average earnings at an appropriate capitalization rate to
compute the value of the business. (what is the correct capitalization rate has been
discussed in WACC)
The erstwhile CCI guidelines provided the following indicative capitalization rate:
Manufacturing companies 15%
Trading companies 20%
Manufacturing and trading companies 17.50%
In the Profit Earnings Capacity Value (PECV) method, the value of the business is
determined as follows:
Determine average earnings based on the past 3 to 5 years of earnings
Make adjustments for exceptional transactions or items of a non-recurring nature
Capitalize the adjusted average earnings at an appropriate capitalization rate to
compute the value of the business. (what is the correct capitalization rate has been
discussed in WACC)
The erstwhile CCI guidelines provided the following indicative capitalization rate:
Manufacturing companies 15%
Trading companies 20%
Manufacturing and trading companies 17.50%
Page 27
Other Valuation Methods
Option valuation based on the Black Scholes formula
Applicable for biotech, pharma companies and companies involved in R&D
Dividend growth model
Internal Rate of Return (IRR)
Applicable for projects
Option valuation based on the Black Scholes formula
Applicable for biotech, pharma companies and companies involved in R&D
Dividend growth model
Internal Rate of Return (IRR)
Applicable for projects
Page 28
Finalise the Working
Develop an overall range of values based on the above
considerations and any other strategic factors
Page 29
Section III: Practical Difficulties in Valuation
Page 30
Practical Considerations
Valuation is a science and an art varies from one person to another
Assumptions and sources used in valuation
Different accounting policies
Premium or discount for Other Factors that impacts the valuation
Control 30% premium
Stock Liquidity
Covenants in agreements
Existing capital markets bull or bear phase
Push or Pull strategy Distresses asset sale is at a considerable discount
Legal requirements Floor price requirements
Limitation on IT systems complex structures and voluminous data may not be feasible on a
worksheet
System crashes are common
Valuation is a science and an art varies from one person to another
Assumptions and sources used in valuation
Different accounting policies
Premium or discount for Other Factors that impacts the valuation
Control 30% premium
Stock Liquidity
Covenants in agreements
Existing capital markets bull or bear phase
Push or Pull strategy Distresses asset sale is at a considerable discount
Legal requirements Floor price requirements
Limitation on IT systems complex structures and voluminous data may not be feasible on a
worksheet
System crashes are common
Page 31
Section IV: Resources
Page 32
Resources
Beta www.nse-india.com, Bloomberg
Books
Valuation Concepts by Copeland
Dark Side of Valuation Damodaran
The Intelligent Investor - Benjamin Graham
The Warren Buffett Way - Robert Hagstrom
The Little Book that Beats the Market - Joel Greenblatt
The Little Book of Value Investing - Christopher Browne
Financials, script prices, ratios, CAPITALINE
Beta www.nse-india.com, Bloomberg
Books
Valuation Concepts by Copeland
Dark Side of Valuation Damodaran
The Intelligent Investor - Benjamin Graham
The Warren Buffett Way - Robert Hagstrom
The Little Book that Beats the Market - Joel Greenblatt
The Little Book of Value Investing - Christopher Browne
Financials, script prices, ratios, CAPITALINE

Valuation

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September 29, 2007

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