Business Valuation - Appunti

3 main methodologies to value a company or any asset + 2

• Income approach: The value equals to the present value of all the future benefits. The risk factors are included (al denominatore) and it has a long term view. However it excludes past benefits and the present balance sheet. The main approaches are: DCF Asset side (FCFO) & Equity Side (FCFE); APV (FCFO + TS).
• Market approach: The value of my assets equals to the value of comparable assets with respect to a driver (multiple → stock market (trading multiples) or M&A (deal multiples). It assumes there are market prices of comparable assets. It is a benchmarking approach.
• Cost approach: Each item is revalued at value of all individual items on the balance sheet. Current conditions. It has limited applications: going concern or liquidation. It includes the Net Asset Value (VAN), the Liquidation Value and the Sum of the parts (break-up analysis).
• Economic profit (hybrid) approach: It includes the Economic Value Added (EVA) and the residual income approaches. It is a mix between the Income approach (future cash flows) and the cost approach (value of investments).
• Other methods: Current market value (Market Cap).

Discounted cash flow

Discounted Cash Flow: the value of an asset is the present value of the expected cash flows.

The model requires:

• Cash flows (FCFE and FCFO) → current and forecast.
• A discount rate (Ke lev and WACC).
• A time horizon.

An important step is to estimate when the firm will reach stable growth and what characteristics (risk and cash flow) it will have when it does.

• The value of a company is the result of the sum of the business unit’s value (surplus assets are valued separately).
• The value of the growth opportunities can be separated from the value of existing businesses: the net present value of growth opportunities.
• Standalone value differs from the investment/acquisition value.
• When the company is financed by debt and the capital structure changes over time, the enterprise value is better observed as the sum of the unlevered value and of the value of tax benefits (APV).

Pros: DCF valuation is based on asset’s fundamentals, therefore it should be less exposed to market moods and perceptions. What’s more it forces to think about the underlying characteristics of the firm and understand its business.

Cons: It requires far more inputs and informations (difficult to estimate and that can be manipulated by analysts) than other valuation methods.

Market approach = relative valuation

The value of an asset or a company can be estimated by looking at how the market prices similar of comparable assets. The philosophical basis: the market is efficient and the value of an asset is whatever the market is willing to pay for it.

It requires:

• A group of comparable or similar assets.
• A standardized measure of value (by dividing the price by a common variable, such as earnings or book values).
• If the assets are not perfectly comparable, it needs variables to offset the differences.

Methods: market multiples and deal multiples.

Pros: Simple and easy to relate to, as it usually requires less informations than DCF. It is also able to reflect market moods better than the DCF and it can be an advantage when it is important to set a price that reflects these perceptions (as in the case of an IPO).

Cons: Multiples are easy to misuse and manipulate and given that no firms are exactly alike in terms of risk and growth, the definition of comparable firms is subjective. What’s more: a tendency to pro-cyclicality: if a market overvalues a certain category of firms, using the average P/E ratio of these firms to value an IPO will lead to an overvaluation of the company going public.

Economic profit model

The value of a business is the (adjusted) sum of the book value of its invested capital as of today and the present value of the excess returns: earnings beyond a base level, considering the cost of capital.

As the DCF it can be modeled:

• Asset-side: economic value added.
• Equity-side: residual income.

Asset-based methods cost approach

The value comes from a careful estimate of the value of each asset (tangible and intangible) and liability that represent the invested capital of the firm.

It may lead to the same DCF value if the firm has no growth assets and the market assessment of value reflect the expected cash flows.

It is mostly used for valuing real estate assets and holding companies (NAV).

Value and uncertainty risk

Cash flow modeling is influenced by different risks and uncertainties among companies.

A process to deal with risk:

• Assess the business model (internal analysis).
• Analyze competition and the market (Porter).
• Analyze the risk factors.
• Build eventual different scenarios.
• Develop a cash flow model.

The choice of the valuation standpoint is divided in:

• Static standpoint.
• Dynamic standpoint (different scenarios).

The choice depends on:

• The level of uncertainty.
• The managerial flexibility to react to risk.

Generally: D: moderate risk and moderate managerial flexibility → tourism, industries (moderate uncertainty = single dominant likely scenario = one business plan).

B: high uncertainty and low managerial flexibility → fashion industries that operate through licenses (have small own brand + big part of the revenue comes from producing for other brands).

C: high managerial flexibility and low uncertainty → tech companies or public utilities.

Second case: High uncertainty scenario; we make two business plans (worst-case and best-case) and then make an average based on probability.

Third case: Risks are embedded in the managerial strategy: Event decision tree: (successful) or base-case value in a standalone scenario + value generated by new choices and opportunities.

Value of a new venture:

Modigliani & Miller e DCF

ROE = ROI + (ROI - i) * payment * D/E.

M&M I without taxes

The value of the company is not influenced by the financial structure of a company.

EV lev = EV unlev.

M&M II with taxes

Assumptions:

• Growth 0.
• Maintenance investments (no Capex).
• Income (C.E.) and CF are constant and perpetual.
• Interests are tax-deducible.

The value of a company depends on its financial structure and increases if the company increases its financial debts because of higher future tax shields.

EV lev = EV unlev + T * D.

Wacc ovviamente rimane uguale a sopra.

Cash flow statement.

Adjusted present value valuation in perpetuity without debt

If we assume that the Income Statement (CE) = CF Statement, then total CF = Net Income.

If the Cash Flows are constant and infinite, value is a perpetuity.

Keu = rf + Bu * MRP.

KeL = rf + Blev * MRP.

Adjusted present value valuation in perpetuity with debt

Using APV is more flexible because you value the taxation separately.

EV = EVu + Vts.

DCF method

Asset side

Asset side: Ricorda!! Con il metodo del DCF, al posto di E = FCFO / WACC → market value of CE EV devo usare EqV, calcolato quindi con il metodo = EV - D EqV APV oppure se è quotata uso la Market Cap.

Equity side

Equity side: = FCFE / KeL → market value of equity EqV = EqV + D EV.

Real life scenario

In real life there is growth.

FCFE and FCFO will depend on a business plan for a few first years and will be independently discounted. Years beyond will be valued through a synthetic terminal value.

Generally WACC is constant across periods.

No growth investments, only inertial growth.

TV represents a steady state:

DCF

DCF:

APV

APV:

• = Uso CF dell’anno 2026 (es), ma il TV è all’anno 2025 (precedente). (TV) Growth rate (g) cannot exceed the growth rate of the economy and could also be negative, if we assume that the firm will disappear in time.
• To calculate the TV, FCFO should be normalized to represent a steady state (equilibrium). The steady state is when: no changes in WC, Capex = D&A → FCFO = NOPAT.
• CA (maintenance investments only and fixed assets) grows as much as the long term growth rate.