Post on 04-Apr-2018
transcript
7/30/2019 Company Valution
1/26
www.bradford.ac.uk/management
Lecture 4
Company Valuation
http://www.bradford.ac.uk/managementhttp://www.bradford.ac.uk/management7/30/2019 Company Valution
2/26
Learning Objectives
Value a company and its shares using:
Net Assets Value method
Price:Earnings Ratio method
Discounted Cash Flow method
Discuss the limitations of these three methods
Reading: Pike and Neale: Ch 12
7/30/2019 Company Valution
3/26
Company Valuation
WHYdo we want to value companies?Armed with knowledge of valuation principles:
we can value acquisition candidates (and also assess
own firms value when defending!)valuation for privatisation
valuation for flotation (IPO - Initial Public Offerings)
7/30/2019 Company Valution
4/26
How Do We Value Companies?
Quoted Companies do we trust the market value?
is the stock market efficient?
Unquoted Companies use various techniques of valuation
7/30/2019 Company Valution
5/26
The Three Basic ValuationMethods
Net asset value (from the Balance Sheet)
Price-earning multiples (focus on the P&L)
Discounted cash flow /Shareholder value
analysis
7/30/2019 Company Valution
6/26
Remember Your Accounting!
What did the accounting equation say?
Assets dont grow on trees!
i.e. every asset has to be financed somehow
Total Assets = Total Financing
= [Equity + Debt]
Valuation methods tend to focus on equity value i.e. value ofnet assets:
Net Asset Value / Equity Value = [Total assets - total debts]
7/30/2019 Company Valution
7/26
Total Company Value vs.Equity Value
Total Company Value is also called Enterprise Value(= equity + debts)
How to acquire a firm:
a) to buy a whole company, ie, buy equity and pay off the
debt. It is usually more expensive.
b) to buy out the owners equity stake and to take
responsibility for the debt.
usually, carry the debt on (assume it)
7/30/2019 Company Valution
8/26
Net Asset Value (NAV)
NAV
Remember, NAV = Net Assets
= Value of Shareholders Stake
From the accounts:
NAV = Total AssetsTotal
Liabilities
Fixed Assets
+
Current Assets
Current
Liabilities
+
Long-term
Debt
=
7/30/2019 Company Valution
9/26
Illustrative Example
Shark vs. Minnow
Shark proposes to take over MinnowAssume:
Minnows depreciation charge = 0.3m p.a.
7/30/2019 Company Valution
10/26
Shark vs. Minnow extracts from accounts
Shark Minnow
m m
Fixed assets (net) 12.2 3.5
Current assets 7.3 3.7
Current liabilities (2.2) (1.1)
10% long-term loan stock(bonds) (3.5) (0.5)
Net assets 13.8 5.6Ordinary share capital (par value 1) 10.0 5.00
Share premium - 0.2
Profit and Loss Account 3.8 0.4
Shareholders funds 13.8 5.6
Profit after tax attributable to
ordinary shareholders 2.4 1.5
Current market price/share 2.40 n/a
EPS 24p 30p
P:E ratio 10:1 n/a
7/30/2019 Company Valution
11/26
NAV of Minnow
What is NAV of Minnow?
NAV = [FA + CA - CL - LTD]
= [3.5m + 3.7m - 1.1m - 0.5m]
= 5.6m
Or, in terms of value per share
NAV = 5.6m/5m = 1.12 per share
But what is the value of the whole company?
Total assets: 3.5 + 3.7 = 7.2m
7/30/2019 Company Valution
12/26
Problems with the NAV
Fixed Assets usually valued at Historic Cost
Some debtors may not be collected
Are there any off-balance sheet liabilities?
Are the accounts reliable?
Window dressing/creative accounting
Fundamental Problem:
Ignores Earning Power of the Assets
7/30/2019 Company Valution
13/26
Price:Earnings Multiples
Remember, P:E ratio = Price per share
Earnings per Share
EPS (Earnings per Share)= Profit after Tax / No of
(ord.) Shares
For example,Suppose EPS = 20p and a share price = 2
P:E ratio = 2 / 0.2 = 10:1
7/30/2019 Company Valution
14/26
Price:Earnings Multiples
Indicates how the market values each 1 of firms
profits
Suggests how quickly firm will recover its currentshare price via earnings
High PER indicates good growth potential
7/30/2019 Company Valution
15/26
Price:Earnings Multiples
Alternatively, P:E ratio = Value of equityProfit after tax
( value of equity = share price xno of shares)
Value of equity = [Profit after tax] x [P:E ratio]
7/30/2019 Company Valution
16/26
P:E Valuation of an UnquotedCompany
Take the P:E Ratio for a comparable quoted company- Shark? ie, P : E = 10
Apply to maintainableprofits of target firm
Minnow:
Value of equity = [Profit after tax] x P:E ratio
= 1.5m x 10
= 15m
Value per share = 15m / 5m = 3
Lower the P:E ratio, lower the valuation
-- e.g. if P:E = 6,
value of equity = 1.5 * 6 = 9m
7/30/2019 Company Valution
17/26
Problems with the P:E Approach
Uses accounting profits as a basis, with all itsdistortions
e.g. inter-company comparisons suspect
How close a fit is the surrogate?
different mgt. ability, markets, products, etc
i.e. different growth capacities
Comparability of quoted and unquoted companies
stock market awards a premium for size, stabilityand marketability
7/30/2019 Company Valution
18/26
EBITDA
Earnings (profit) Before Interest, Tax Depreciationand Amortisation
A more cash-oriented yardstick
Rough guide to operational cash flow
Often combined with capital employed to yield CashFlow Return on Investment
CFROI = EBITDA/Capital Employed
Used on a comparative basis i.eas a cross- check onvalue
7/30/2019 Company Valution
19/26
Discounted Cash Flow (DCF)
The DCF model states that the value of the owners
stake in a company is the sum of future discounted free
cash flows:
WhereFCF = Free Cash Flow
r = the rate of return required by shareholders.
n
n
r
FCF
r
FCFr
FCFV)1(
...)1()1(2
210
7/30/2019 Company Valution
20/26
What is Free Cash Flow?
Free cash flow cash left in the company after meeting
all operating expenditures, all mandatory expenditures
such as tax payments and investment expenditure.
Free cash flow (FCF) =
Operating profit + Depreciation Interests Taxes
Investment expenditure
7/30/2019 Company Valution
21/26
Discounted Cash Flow (DCF)
Predict future cash flows from operations
Roughly, profit after tax, plus depreciation
Adjust for known investment needs
e.g. to replace worn-out equipment, expansion Result is FREE CASH FLOW
Discount at shareholders required return
Value of equity = Sum of discounted FCFs
7/30/2019 Company Valution
22/26
Minnows Cash Flows
How much is the cash flow?CF = Profit after tax + Depreciation (roughly)
= [1.5m + 0.3m] = 1.8m
How much investment is required to replace worn-outassets (replacement expenditure)?
assume this expenditure = depreciation charge
FCF = [1.8m - 0.3m] = 1.5m
7/30/2019 Company Valution
23/26
Minnows Value Lifetime of company?
-- Assume perpetuity
Recall the formula for calculating PV of a perpetuity
Value = Free Cash Flow / Discount rate
-- Assume investors require 15% return
Value of equity = 1.5m / 15%
= 10m
Value per share = 10m / 5m = 2
r
CperpetuityPV
7/30/2019 Company Valution
24/26
Problems with the DCF Approach
Still based on accounting figures i.e. PAT
Can the future investment be accurately predicted?
Assessing the required return
Assessing the relevant time horizon
if less than perpetual, what to assume for later years?No further cash flows??
7/30/2019 Company Valution
25/26
So what have we learned??
How to value a company by applying
- NAV
- P:E ratio and- DCF
The limitation of each method.
7/30/2019 Company Valution
26/26
Thank you !