Business Valuation is defined as a process used to determine the value of a business, company or corporation by a process of estimation regarding the company's present and future outlook. The Earning Method (P / E ratio method) is a common method of valuing a controlling interest in a company, where the owner can decide on dividend and retentions policy. The accounting return method (acr method) relates accounting return to a share's value.
Business Valuation is defined as a process used to determine the value of a business, company or corporation by a process of estimation regarding the company's present and future outlook. The Earning Method (P / E ratio method) is a common method of valuing a controlling interest in a company, where the owner can decide on dividend and retentions policy. The accounting return method (acr method) relates accounting return to a share's value.
Business Valuation is defined as a process used to determine the value of a business, company or corporation by a process of estimation regarding the company's present and future outlook. The Earning Method (P / E ratio method) is a common method of valuing a controlling interest in a company, where the owner can decide on dividend and retentions policy. The accounting return method (acr method) relates accounting return to a share's value.
University of Jaffna FMG 3235 Strategic Financial Management Date: 28.05.2012 Lecturer: Miss. S. Sivasubramaniam Business Valuation Learning outcomes: Define the term valuation of business. Identify the reasons for the business valuation of the organization. Calculate the value of shares by using different possible methods.
Introduction An accurate, defensible business valuation plays a critical role in many business situations. This can be an indispensable tool in establishing prices, justifying positions to stockholders and satisfying governmental concerns in the course of corporate mergers, acquisitions, refinancing and restructuring. Business Valuation is defined as a process used to determine the value of a business, company or corporation by a process of estimation regarding the companys present and future outlook.
Reasons for Business Valuations The business valuation is necessary for many reasons. They are, A. For quoted companies When there is a takeover bid and the offer price is an estimated fair value in excess of the current market price of the shares.
B. For un quoted companies, when: (i) The company wishes to go public and must fix an issue price for its shares; (ii) There is a scheme of merger, and a value of shares for each company involved in the merger must be assessed. 2
(iii) Shares are sold (iv) Shares need to be valued for the purpose of taxation. (v) Shares are pledged as collateral for a loan;
C. For subsidiary companies, when the groups holding is negotiating the sale of the subsidiary to a management buyout team or to an external buyer.
Methods of Valuing Shares The following methods are used for valuing shares, 1. The earning method (P/E ratio method) 2. The accounting return method 3. The net assets method 4. The dividend yield method 5. The super profit method 6. DCF-based valuations.
The Earning Method (P/E ratio method) This is a common method of valuing a controlling interest in a company, where the owner can decide on dividend and retentions policy. The P/E ratio relates earning per share to a shares value. The P/E ratio =
Market value per share = EPS* P/E ratio
The P/E ratio can be used to make an earning-based valuation of shares. This is done by deciding a suitable P/E ratio and multiplying this by the EPS for the shares, which are being valued.
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For example: Spider plc is considering the takeover of an unquoted company, Fly Ltd.Spiders shares are quoted on the stock Exchange at a price of Rs. 3.20 and since the most recent published EPS of the company is 20 cents, the companys P/E ratio is 16. Fly Ltd is a company with 100,000 shares and current earnings of Rs. 50,000, 50 cents per share. How might Spider plc decide on an offer price?
The Accounting Rate of Return (ARR) method The accounting rate of return of return will be required from the company whose shares are to be valued. It is therefore distinct from the P/E ratio method, which is concerned with the market rate of return required. The following formula should be used. Value =
For example: Champers Ltd is considering acquiring Hall ltd. At present Hall Ltd is earning, on average, Rs. 480,000 after tax. The directors of Chambers ltd feel that after reorganization, this figure could be increased to Rs. 600 000. All the companies in the chambers group are expected to yield a post-tax accounting return of 15% on capital employed. What should Hall Ltd be valued at?
The Net assets Method Using this method of valuation, the value of share in a particular class is equal to the net tangible assets attributable to that class, divided by the number of shares in the class. Intangible assets (including goodwill) should be excluded, unless they have a market value (for example patents and copyrights, which could be sold).
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For example: The summary balance sheet of J amuna Ltd is as follows. Fixed assets Rs Rs Rs Land and Buildings 160 000 Plant and machinery 80 000 Motor vehicles 20 000 260 000 Goodwill 20 000
Ordinary shares of Rs 1 80 000 Reserves 140 000 220 000 4.9% preference shares of Rs1 50 000 270 000 What is the value of an ordinary share using the net assets basis of valuation?
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The Dividend Yield Method The dividend yield method of share valuation is suitable for the valuation of small shareholdings in unquoted companies. It is based on the principle that small shareholdings are mainly interested in dividends, since they cannot control decisions affecting the companys profits and earnings. The simplest dividend capitalization technique is based on the assumption that the level of dividends in the future will be constant. A dividend yield valuation would be: Value =
%
It may be possible to use expected future dividends for a share valuation and to predict dividend growth. The dividend growth model for share valuation can be expressed as follows, P o = ( ) ( )
Where P o - Current market value ex dividend d o - Current dividend g - Expected annual growth in dividend, so (1+g) is the expected dividend next year r - Return required For example: A company expects to pay no dividends in year 1,2 or 3, but a dividend of 7.8 cents per share each year from the year 4 in perpetuity. Value its shares on a dividend yield basis, assuming a required yield of 12%.
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The Super-profits Method This method starts by applying a fair return to the net tangible assets and comparing the result with the expected profits. Any excess of profits (super-profits) is used to calculate goodwill. The goodwill is normally taken as a fixed number of years super-profits. The goodwill is then added to the value of the target companys tangible assets to arrive a value for the business. For example: Light Ltd has net tangible assets of Rs. 120 000 and present earnings of Rs 20 000. Doppler Ltd wants to takeover Light ltd and considers that a fair return for this type of industry is 12%, and decides to value Light Ltd taking goodwill at three years super-profits. Discounted future profits Method This method of share valuation may be appropriate when one company intends to buy the assets of another company and to make further investments in order to improve profits in the future. For example: Dal Ltd wishes to make a bid for Tadpole Ltd makes after-tax profits of Rs.40 000 a year. Dal Ltd believes that if further money is spent on additional investments, the after-tax cash flows (ignoring the purchase consideration) Year Cash flow (net of tax) Rs 0 (100 000) 1 (80 000) 2 60 000 3 100 000 4 150 000 5 150 000
The after-tax cost of capital of Dal Ltd is 15% and the company expects all its investments to pay back, in discounted terms, within five years. What is the maximum price that the company should be willing to pay for the shares of Tadpole Ltd?