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Business Valuation
Approaches/Methods of
Valuation
There are four approaches to valuation of
business (with focus on equity share
valuation):
1)
2)
3)
4)
Assets based
Earnings based
Market value based
Fair value method
(6)
The P/E ratio may be derived given the MPS and EPS.
P/E ratio = MPS/EPS
(7)
Example
Company has future maintainable profits after taxes as Rs. 78 lakhs
(i) The company has 1,00,000 11% Preference shares of Rs 100 each,
fully paid-up.
(ii) The company has 4,00,000 Equity shares of Rs 100 each, fully paid- up.
(iii) P/E ratio is 8 times.
Solution
Determination of Market Price of Equity Share
Future maintainable profits after taxes
Less: Preference dividends (1,00,000 Rs 11)
Earnings available to equity-holders
Divided by number of equity shares
Earnings per share (Rs 67 lakh/4 lakh)
Multiplied by P/E ratio (times)
Market price per share (Rs 16.75 8)
Value of Business is MPS x no. of outstanding shares
Rs 78,00,000
11,00,000
67,00,000
4,00,000
16.75
8
Rs 134
Rs 536,00,000
Computation of Free-Cash
Flows to the firm
After tax operating earnings (including interest cost)
Plus: Depreciation & Other non-cash items
Less: Investment in long-term assets
Less: Investment in operating net working capital_______________________
Operating free cash flows (OFCF)
Plus: After-tax non-operating income/CF
Plus: Decrease in non-operating assets_______________________________
Free Cash flows to the firm (FCFF)
k
t 1
0
Value of Firm0
FCFF to equityholders t
Value of Equity 0
1 k e t
t 1
3.
4.
Example
Supreme Industries has an equity market capitalisation of Rs 3,400
crore in current year. Assume further that its equity share capital is Rs
2,000 crore and its retained earnings are Rs 600 crore. Determine the
MVA and interpret it.
Solution
MVA = (Rs 3,400 core Rs 2,600 crore) = Rs 800 crore.
The value of Rs 800 crore implies that the management of Supreme
Industries has created wealth/value to the extent of Rs 800 crore for
its equity shareholders.
Well managed companies, having good growth prospects, and
perceived so by the investors, have positive MVA. Investors may be
willing to pay more than the net worth. In contrast, companies
relatively less known or engaged in businesses that do not hold
future growth potentials may have negative MVA.
Example
Hypothetical Limited has equity market capitalisation of Rs 900 crore in
the current year. Its equity share capital and accumulated losses are of
Rs 1,200 crore and Rs 200 crore respectively. Determine the MVA of the
firm.
Solution
MVA = (Rs 900 crore Rs 1,000 crore) = (Rs 100 crore).
The firm has negative MVA of Rs 100 crore. The investors discount its
value/worth, as it is loss incurring firm.
The market value added approach reflects market expectations and is
essentially a future-oriented and forward looking approach. The
investors, willing to pay a different price (other than one suggested by
book value), are guided by the individual companys future prospects,
future growth rates, risk complexion of the firm, industry to which the
firm belongs, required rate of return and so on.
Thank You