ABSTRACT

Business Valuation is a process and a set of procedures used to estimate the economic

value of an owner`s interest in a business. Business valuation approaches are used for

calculating the fair value of the business. Valuation implies the task of estimating the worth

value of an asset. In Business valuation, the valuation is required not only of tangible assets

(such as plant and machinery, land and buildings, office equipment’s) but also of intangible

assets (like goodwill, trademark, and brands patents) as well as human resources that manage

the business.

In this project we tried to analyse the some of the major approaches to valuation of business

units (with focus on equity share valuation) of in a multi-product software company

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ContentsCHAPTER -1...........................................................................................................................................7

INTRODUCTION...................................................................................................................................8

Introduction..............................................................................................................................................8

CHAPTER 2..........................................................................................................................................26

Review of literature...............................................................................................................................27

CHAPTER 3..........................................................................................................................................34

COMPANY PROFILE........................................................................................................................34

CHAPTER-4..........................................................................................................................................40

DATA ANALYSIS................................................................................................................................40

FINDINGS.............................................................................................................................................44

SUGGESTIONS....................................................................................................................................45

CONCLUSION......................................................................................................................................47

BIBLOGRAPHY...................................................................................................................................48

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CHAPTER -1

INTRODUCTION

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Introduction

General introduction

Businesses need to be valued for a number of reasons such as their purchase and sale,

obtaining a listing. Generally, valuation difficulties are restricted to unlisted companies

because listed companies have a quoted share price. However, even listed companies can

present valuation challenges for example when one is trying to predict the effect of a takeover

on the share price.

Business valuation helps to know what a business is worth. Valuation approaches helps in

finding out the worth of the business.

Objectives of the study

There are a myriad of reasons to conduct a business valuation. The main reason is in

preparation for selling your manufacturing or distribution business. But knowing the

company’s value can be helpful when doing succession and estate planning and for other

business-related reasons.

i. It helps in understanding company`s value for the planning related to buying,

operating or selling a business

ii. The current value of the business is a bench mark for operating a business, it holds

the financial security for the owners

iii. If your business structure is changing — for example, converting from a company C

to an S corporation — a valuation may be necessary to establish a value basis for

company stock.

iv. Establishing business value is also important when structuring a buy-sell agreement’s

terms for buying back owner shares. Examples of occasions where buy-sell

agreements may apply include shareholder retirements or disputes, divorce

proceedings and legal division of assets, and disability or death of a shareholder.

v. If a company is facing any commercial litigation, a valuation can be useful in legal

contexts, such as an owner’s divorce, an economic damages claim, bankruptcy or a

shareholder dispute. A valuator can help the parties settle their differences out of court

or serve as an expert witness during trial.

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Need of the study

i. Those business, whose principal assets are intangible in nature such as copyrights,

patents, trademarks, or goodwill will need a specialized business valuation model

that can ascertain the worth or value of the company

ii. The business will need to conduct a business valuation model to compute a fair

price for selling shareholder`s stock

iii. Selling a business should first have it valued. By doing so, you’ll help ensure that

you don’t sell your company for less than it is worth.

iv. By knowing the fair value of the company, it helps preventing from, setting the

price and expectations on the value of company. This valuation method also helps

in selling a division, territory, or product line

LIMITATIONS

Cash flow reflects assets utilized by company

Unutilized and underutilized assets may not get reflected in the valuation

model

This may be overcome by adding value of unutilized assets to cash flow. The

value again may be on assumption of asset utilization or market value or a

combination of these.

Owner’s estimate is the least scientific method for valuing a business.

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Research Methodology

Data relating to MAGNAQUEST has been collected through primary sources as well as

secondary sources.

The primary source of data involves formal discussions with the company’s managing

director and other department heads.

The secondary source of data involves published documents pertaining to theorganization,

textbooks, journals and information available in various websites.

Tools used: Tables showing the valuation method of NPV over the period of study,

Types of BUSINESS VALUATION

A business valuation can serve as a reality check on how the business is progressing

and how much the owner can ask from investors. Unfortunately, because so many buy/sell

transactions go unnoticed and unreported, owners of small & mid-sized businesses have a

tough time determining the value of their investment

ASSET BASED APPROACH TO VALUATION

Definition

Asset based approach focuses on determining the value of net assets from the perspective of

Equity share valuation. What is the basis of assets valuation be, is the central issue of this

approach.

Meaning

This method should be determined whether the assets should be valued at the book, market,

replacement, liquidation value. More often that not, they should be valued at book value, that

is original acquisition cost minus accumulated depreciation, as assets are normally acquired

with the intent to be used in business and not for sale

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Scope

Methods under the asset-based approach determine value by adding the sum of the parts of

the business. Underlying question: How much was paid, or would be paid, for the assets of

the business? Adjusted book value and liquidation value are examples. This method is usually

not suitable for companies that have a significant amount of intangible assets (most services

companies fall into this case of book value, assets and category).

The Value of the net assets is contingent upon the measure of value adopted for the purpose

of valuation of assets and liabilities. In the case of book value, assets and liabilities are taken

at their balance sheet values. In market value measures, assets shown in the balance sheet are

revalued at the current market prices. For the purpose of valuing the assets and liabilities it

will be useful for a finance manager\valuer to accord special attention to following points

i. While valuing tangible assets, such as plant and machinery, he should consider

aspects related to technological and capital improvements made in the recent years.

depreciation adjustment may also be needed in case the company is following

unsound depreciation policy in this regard

ii. Is the valuation of goodwill satisfactory, given the amounts of profits, capital

employed and average rate of return available on such businesses?

iii. With respect to current asset, are additional provisions required for unrealisability of

debtors? likewise , are adjustments required for unsalable stores and stocks

iv. With respect to liabilities, there is a need for careful examination of contingent

liabilities in particular where there is a mention of them in the auditor’s report, with a

view to assess what portion of such liabilities may fructify. Similarly adjustments may

be required on account of guarantees invoked, income tax, sales tax, and other

liabilities

Importance

An asset-based valuation approach is commonly used when a business has a very low or

negative value as a going concern. For example, consider the value of an airline company that

has few routes, high labour and other operating costs, and is losing millions of dollars each

year.

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Using the other valuation approaches, the company may have a negative value. However, to

one or more of the company's existing competitors, the company's routes, landing rights,

leases of airport facilities, and its ground equipment and airplanes may have substantial

value. An asset-based approach to valuing this company would value the company's assets

separately and aside from the money-losing business in which they are presently being

utilized.

The asset-based valuation approach will typically result in the lowest valuation of the three

approaches for a profitable company, but it nevertheless may result in an appropriate value

depending on the circumstances.

Advantages

i. Data required to perform the valuation are usually easily available.

ii. Allows for adjustments (up and down) in estimating FMV.

iii. Suitable for firms with heavy tangible investments (e.g. equipment, land).

iv. Helpful when the firm’s future is in question or where the firm has a brief or volatile

earnings record.

Limitations

i. Can understate the value of intangible assets such as copyrights or goodwill.

ii. Does not take into account future changes (up or down) in sales or income.

iii. Balance sheet may not accurately reflect all assets

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Method of ASSET BASED APPROACH

I. NET ASSETS METHOD

Valuation of net assets is calculated with reference to the historical cost of the assets owned

by the company. Such value usually represents the minimum value or a support value of a

going concern. It is usual to ignore market value of the operating assets for the simple reason

that under the going concern valuation, it is not the intention to sell the assets on a piece meal

basis.

While the historical cost is adopted in respect of the assets that are to continue as a part of the

going concern, it is necessary to adjust the market value of non-operating assets like unused

land which are capable of being easily disposed of without affecting the operations of the

company.

Net Assets Method may be adopted in the following cases:

In case of start-up companies (which are capital intensive in nature), where the commercial

production has not yet started.

In case of Investment Companies as Earnings Value based on its income in the form of

dividend and/or interest may not reflect its true value. In case of companies, which do not

have a sustainable track record of profits and has no prospects of earning profits in future?

In case of manufacturing companies, where fixed assets has greater relevance for earning

revenues. It would also be appropriate to use Net Assets Method for valuation in case of

companies operating in the industry, which is capital intensive and is relevant to revenues in

an industry, where norms are related to the capital cost per unit.

In case of companies, where there is an intention to liquidate it and to realise the assets and

distribute the net proceeds.

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Methodology

The value as per Net Assets Method is arrived at as follows:

Net Assets value represents equity value which is arrived at after reducing all external

liabilities and preference shareholders claims, if any, from the aggregate value of all assets, as

valued and stated in the Balance Sheet as on valuation date.

Net Assets Value = Total Assets (excluding Miscellaneous Expenditure & Debit balance of

Profit & Loss account) – Total Liabilities

Or

Net Assets Value = Share Capital + Reserves (excluding revaluation reserves) —

Miscellaneous Expenditure – Debit Balance of Profit & Loss Account

Adjustments to NAV

The Net Asset Value (NAV) as arrived at by using the above-mentioned formula may be

adjusted depending upon circumstances of a particular case. The list given below showcases

some of the adjustments commonly made:

Contingent Liabilities

The amount of Contingent Liabilities as disclosed in the financial statements of the entity

needs to be adjusted from the value of net assets. The management’s perception of such

liability materialising should be considered. If necessary, legal opinion regarding

sustainability of claims or contingent liabilities should be called for.

Some examples of Contingent liabilities are:

Income tax demands 2. Excise demands 3. Sales tax/ Entry Tax demands 4. Entertainment tax

Investments

Investments, whether trade or non-trade should be considered at their Market value while

arriving at the Adjusted Net Assets value as they can be sold in the market on a piece meal

basis without affecting the operations of the company. For this, notional adjustment should be

made for any appreciation/ depreciation in the ]value of investments on a net of tax basis.

Surplus Assets

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The market value of surplus assets such as land and building not used for the business of the

company should be considered. The appreciation or depreciation in the value of surplus assets

adjusted for the tax liability or the tax shield on such appreciation or depreciation would be

added/deducted from the Net Assets Value.

This is more of a notional adjustment. Market value of such assets could be based on the

report of a technical valuer or on the estimates of the Management. Care should be taken if

the title of the assets is not clear or the possession of the property under consideration is not

with the owner.

Contingent Assets

If the company has made escalation claims, insurance claims or other similar claims, then the

possibility of their recovery should be carefully made on a fair basis, particularly having

regard to the time frame in which they are likely to be recovered. The likely cost to be

incurred for realizing the amount needs to be adjusted.

NET REALISABLE VALUE METHOD

This method is generally used in case of liquidation. Where the business of the company is

being liquidated, its assets have to be valued as if they were individually sold and not on a

going concern basis. Liabilities are deducted from the liquidation value of the assets to

determine the liquidation value of the business. One should also consider liabilities which

will arise on closure such as retrenchment compensation, termination of critical contracts, etc.

Regard should also be made to the tax consequences of liquidation. Any distribution to the

shareholders of the company on its liquidation, to the extent of accumulated profits of the

company is regarded as deemed dividend. Dividend Distribution tax will have to be captured

for such valuation.

REPLACEMENT VALUE METHOD

Replacement value is different from Net Assets Value as it uses the replacement value of

assets, which is usually higher than the book valuation. The term replacement cost refers to

the amount that a company would have to pay, at the present time, to replace any one of its

existing assets. Net replacement value of the assets indicates the value of an asset similar to

the original whose life is equal to the residual life of the existing asset. Replacement value

includes not only the cost of acquiring or replicating the assets, but also all the relevant costs

associated with replacement.

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Liabilities are deducted from the replacement value of the assets to determine the net

replacement value of the business.

Asset Based Method may not be relevant in case of companies operating in an industry where

human knowledge and creativity are more relevant as compared to physical assets in value

creation. In such cases, the Earnings Based Methods may be adopted

Terminology-

Book value: The book value of asset refers to the amount at which an asset is shown in the

balance sheet of a firm. Book value of a business refers to the total book value of all valuable

assets (excluding fictitious assets)

Market value: Market value refers to the price at which an asset can be sold in the market;

Market value of a business refers to the aggregate market value (as per stock market

quotation) of all equity shares outstanding

Economic value: The economic value of an asset is equal to the present value of the

incremental future cash inflows likely to accrue due to the acquisition of the asset; discounted

at the appropriate required rate of return (applicable to the specific asset intended to be

purchased)

Liquidation value: liquidation value refers to the price at which each individual asset can be

sold if business operations are discounted in the wake of liquidation of the firm, the

liquidation value of a business is equal to the sum of (is) realisable value of assets and (ii)

cash and bank balances minus the payments required to discharge all external liabilities

Replacement value: the replacement value is the cost of acquiring a new asset of equal utility

and usefulness. It is normally useful in valuing tangible assets such as office equipment and

furniture and fixtures

Salvage value: salvage value represents the scrap value on the disposal of assets after the

expiry of their economic useful life. It may be employed to value assets such as plant and

machinery

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Value of goodwill: A business firm can be said to have real goodwill in case it earns a rate of

return (ROR) on invested funds higher than the ROR earned by similar firms (with the same

level of risk). In operational terms, goodwill results when the firm excess (super) profits.

Fair value: Fair value is the average of book value, market value and intrinsic value

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Market value Based Approach to Valuation

Definition

A method of determining the appraisal value of an asset based on the selling price of similar

items. The market approach is a business valuation method that can be used to calculate the

value of property or as part of the valuation process for a closely held business. Additionally,

the market approach can be used to determine the value of a business ownership interest,

security or intangible asset. Regardless of what asset is being valued, the market approach

studies recent sales of similar assets, making adjustments for differences in size, quantity or

quality.

For example, if the subject company has EBIT of $ I million in the most recent fiscal year,

and comparable companies have been sold recently for an average of 5x EBIT, the subject

company's value should be about $5 million.

Scope

The variables in the market-based approach include, first, which aspects of the companies

should be compared, and second, which companies to select as comparables. As for

comparable companies, it may be easy to select several public companies that are in the same

or similar industry as the subject company to be valued, but if the subject company is not

publicly-traded and/or is much smaller than the public companies, the comparisons may have

limited usefulness. There are, however, a number of commercially available databases with

statistics on companies (both public and private) that have recently been acquired such as

Pratt's Stats, Mergerstat, and BizComps. Obviously, the more recent the data, and the more

similar the companies to be compared (in terms of size and industry), the more useful the

comparisons may be.

As for which aspects of the companies to compare, the most commonly compared aspect is

some form of earnings, but in some cases, total revenue or book value may be a more

appropriate aspect for comparison. Any number of other financial or other criteria may be

more or less useful to compare. For earnings, it is important to compare apples to apples.

Since taxable income may vary widely depending on financial and accounting considerations,

one commonly used earnings calculation, at least for smaller businesses, is net income before

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taxes, depreciation and amortization (EBITDA) plus the value of the owner's salary and

fringe benefits, sometimes collectively referred to as seller's discretionary earnings, or SDE.

Once the particular aspects to be compared are selected, the market-based approach provides

the value of the subject company by relating the value of the comparable companies on the

basis of the particular aspects compared. For example, if comparable companies have

recently sold for 5x EBIT, the subject company's value should be about 5x its EBIT, and if

comparable companies have recently sold for 2x book value, the subject company's value

should be about 2x its book value.

Methods of Market value based approach

I. MARKET PRICE METHOD

i. The Market Price Method evaluates the value on the basis of prices quoted on the

stock exchange. Average of quoted price is considered as indicative of the value

perception of the company by investors operating under free market conditions. To

avoid chances of speculative pressures, it is suggested to adopt the average quotations

of sufficiently longer period. The valuer will have to consider the effect of issue of

bonus shares or rights shares during the period chosen for average

ii. Market Price Method is not relevant in the following cases:

Valuation of a division of a company

Where the share are not listed or are thinly traded

In the case of a merger, where the shares of one of the companies under consideration

are not listed on any stock exchange

In case of companies, where there is an intention to liquidate it and to realise the

assets and distribute the net proceeds.

iii. In case of significant and unusual fluctuations in market price the market price may

not be indicative of the true value of the share. At times, the valuer may also want to

ignore this value, if according to the valuer; the market price is not a fair reflection of

the company’s underlying assets or profitability status. The Market Price Method may

also be used as a backup for supporting the value arrived at by using the other

methods.

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iv. It is important to note that Regulatory bodies have often considered market value as

one of the very important basis — Preferential allotment, Buyback, Open offer price

calculation under the Takeover Code.

v. In earlier days due to non-availability of data, while calculating the value under the

market price method, high and low of monthly share prices were considered. Now

with the support of technology, detailed data is available for stock prices. It is now a

usual practice to consider weighted average market price considering volume and

value of each transaction reported at the stock exchange.

vi. If the period for which prices are considered also has impact on account of Bonus

shares, Rights Issue, etc., the valuer needs to adjust the market prices for such

corporate events.

MARKET COMPARABLES

This method is generally, applied in case of unlisted entities. This method estimates value by

relating the same to underlying elements of similar companies for past years. It is based on

market multiples of ‘comparable companies’. For example

Earnings/Revenue Multiples (Valuation of Pharmaceutical Brands)

Book Value Multiples (Valuation of Financial Institution or Banks)

Industry Specific Multiples (Valuation of cement companies based on Production

capacities

Though this method is easy to understand and quick to compute, it may not capture the

intrinsic value and may give a distorted picture in case of short term volatility in the markets.

There may often be difficulty in identifying the comparable companies.

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Terminology-

Book value: The book value of asset refers to the amount at which an asset is shown in the

balance sheet of a firm. Book value of a business refers to the total book value of all valuable

assets (excluding fictitious assets)

Market value: Market value refers to the price at which an asset can be sold in the market;

Market value of a business refers to the aggregate market value (as per stock market

quotation) of all equity shares outstanding

Economic value: The economic value of an asset is equal to the present value of the

incremental future cash inflows likely to accrue due to the acquisition of the asset; discounted

at the appropriate required rate of return (applicable to the specific asset intended to be

purchased)

Liquidation value: liquidation value refers to the price at which each individual asset can be

sold if business operations are discounted in the wake of liquidation of the firm, the

liquidation value of a business is equal to the sum of (is) realisable value of assets and (ii)

cash and bank balances minus the payments required to discharge all external liabilities

Replacement value: the replacement value is the cost of acquiring a new asset of equal utility

and usefulness. It is normally useful in valuing tangible assets such as office equipment and

furniture and fixtures

Salvage value: salvage value represents the scrap value on the disposal of assets after the

expiry of their economic useful life. It may be employed to value assets such as plant and

machinery

Value of goodwill: A business firm can be said to have real goodwill in case it earns a rate of

return (ROR) on invested funds higher than the ROR earned by similar firms (with the same

level of risk). In operational terms, goodwill results when the firm excess (super) profits.

Fair value: Fair value is the average of book value, market value and intrinsic value

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FAIR MARET VALUE BASED APPROACH

Definition

1. The estimated value of all assets and liabilities of an acquired company used to consolidate

the financial statements of both companies.

2. In the futures market, fair value is the equilibrium price for a futures contract. This is equal

to the spot price after taking into account compounded interest (and dividends lost because

the investor owns the futures contract rather than the physical stocks) over a certain period of

time.

FAIR VALUE CONCEPT

Standard setters define fair value as the amount for which an asset or liability can be

exchanged between knowledgeable, willing parties in an arm's length transaction. In an active

market, fair value equals observed market price. If there is no active market, fair value is an

estimate of value in use. The FASB distinguishes between three levels for estimating fair

value:

Using quoted prices for identical assets or liabilities in active markets whenever that

information is available (market values);

If quoted prices are not available for identical assets or liabilities, fair value should be

estimated using quoted prices of similar assets or liabilities (market equivalents);

If quoted prices of identical or similar assets or liabilities are not available or not

objectively determinable, fair value should be estimated using valuation methods

based on present value techniques of future earnings, or cash flows and valuation

techniques

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ADVANTAGES AND DISADVANTAGES OF FAIR MARKET VALUE METHOD

Advantages

Fair market value is a financial concept relating to company assets. Current accounting

principles require companies to set asset values on current market information. Market value

is the price an individual or business pays with reasonable knowledge about the item in the

open market free from collusion or undue pressure (also known as arms-length transaction).

Fair market value accounting is a change from the historical cost companies have used in

years past when recording assets on financial statements. The fair market value process offers

advantages.

Financial Statement Improvements

Fair market value can increase the company s asset value listed on its balance sheet. This

increase is the result of assets appreciating in value under current economic market

conditions. Asset increases improve a company’s total economic value added from business

operations. Economic value added is the result of taking total assets minus total liabilities

plus owner equity. This added value represents the true wealth a business owner has created

with his company.

Asset increases can also improve a company financial ratios. Financial leverage ratios

provide business owners with information about their company long-term solvency. The debt

ratio is a common financial leverage calculation. The debt ratio is total debt divided by total

assets; the calculations result indicates what percent of assets are financed by outside debt. A

lower percentage will result if assets are valued higher using fair market value principles.

Tax Benefits

Fair market value can provide companies with a few tax benefits. A decrease in an assets

value may be carried over to the company needs-to-come statement. This reduction results in

a loss from the fair market revaluation. A significant loss reduces the company overall

income for the accounting period and reduces the company income tax liability. Lower asset

values may also result in lower tangible property taxes at the state, county or local level.

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Individual Asset Benefits

Companies may find fair market value calculations provide specific benefits for individual

assets. Many companies invest in securities or other financial instruments that require them to

use fair market value accounting principles. Fair market value may result in a significant

increase in an asset value. Business owners can choose to sell this asset to take advantage of

the capital gain from the asset increase in value. Although the sale can result in additional tax

liability, selling the asset may be more prudent than holding onto it for an extended period of

time.

A primary advantage of fair value accounting is that it provides accurate asset and liability

valuation on an ongoing basis to users of a company’s reported financial information. When

the price of an asset or liability has increased or is expected to increase, the company marks

up the value of the asset or liability to its current market price to reflect what it would receive

if it sold the asset or would have to pay to relieve itself from the liability. Conversely, the

company marks down the value of an asset or liability to reflect any decrease in the market

price.

Disadvantages

True Income

Fair value accounting limits a company’s ability to potentially manipulate its reported net

income. Sometimes management may purposely arrange certain asset sales, for example, to

use gains or losses from the sales to increase or decrease net income as reported at its desired

time. Using fair value accounting, gains or losses from any price change for an asset or

liability are reported in the period in which they occur. While an increase in asset value or a

decrease in liability value adds to net income, a decrease in asset value or an increase in

liability value reduces net income

Value Reversal

Fair value accounting can also present challenges to companies and users of their reported

financial information. Conditions of the markets in which certain assets and liabilities are

traded may fluctuate often and even become volatile at times. Applying fair value accounting,

companies revaluate the current value of certain assets and liabilities even in volatile market

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conditions, potentially creating large swings in the value of those assets and liabilities.

However, as markets stabilize, such value changes likely reverse back to their previous

normal levels, making any reported losses or gains temporary, which means fair value

accounting may have provided misleading information at the time.

Market Effects

The use of fair value accounting may further affect a down market adversely. For example,

after an asset has been revalued downward because of drops in the current market trading

prices, the lower value of the asset could trigger greater selling of the asset at a potentially

even more depressed price. Without valuation markdown as required by fair value

accounting, companies may not feel the need to sell an asset in a down market to prevent

potentially further downward valuation of the asset. Absent additional selling pressures, the

market may stabilize over time, which would help preserve the value of the asset

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CHAPTER 2

Review of literature

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NPV (NET PRESENT VALUE) METHOD

Net present value is the present value of net cash inflows generated by a project including

salvage value, if any, less the initial investment on the project. It is one of the most reliable

measures used in capital budgeting because it accounts for time by using discounted cash

inflows.

Before calculating NPV, a target rate of return is set which is used to discount the net cash

inflows from a project. Net cash inflow equals total cash inflow during a period less the

expenses directly incurred on generating the cash inflow.

In simple words, NPV can be described as the “difference amount” between the sums of

discounted: cash inflows and cash outflows. It compares the present value of money today to

the present value of money in the future, taking inflation and returns into account.

Calculation Methods and Formulas

The first step involved in the calculation of NPV is the determination of the present value of

net cash inflows from a project or asset. The net cash flows may be even (i.e. equal cash

inflows in different periods) or uneven (i.e. different cash flows in different periods). When

they are even, present value can be easily calculated by using the present value formula of

annuity. However, if they are uneven, we need to calculate the present value of each

individual net cash inflow separately.

In the second step we subtract the initial investment on the project from the total present

value of inflows to arrive at net present value.

Thus we have the following two formulas for the calculation of NPV:

When cash inflows are even:

NPV = R ×1 − (1 + i)-n

− Initial InvestmentI

In the above formula, R is the net cash inflow expected to be received each period; i is the required rate of return per period; n are the number of periods during which the project is expected to operate and generate cash inflows.

When cash inflows are uneven:

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NPV =R1

+R2

+R3

+ ... − Initial Investment(1 + i)1 (1 + i)2 (1 + i)3

Where, i is the target rate of return per period; R1 is the net cash inflow during the first period; R2 is the net cash inflow during the second period; R3 is the net cash inflow during the third period, and so on...

Decision Rule

Accept the project only if it’s NPV is positive or zero. Reject the project having negative NPV. While comparing two or more exclusive projects having positive NPVs, accept the one with highest NPV.

Positive NPV:

If present value of cash inflows is greater than the present value of the cash outflows, the net present value is said to be positive and the investment proposal is considered to be acceptable.

Zero NPV:

If present value of cash inflow is equal to present value of cash outflow, the net present value is said to be zero and the investment proposal is considered to be acceptable.

Negative NPV:

If present value of cash inflow is less than present value of cash outflow, the net present value is said to be negative and the investment proposal is rejected.

The summary of the concept explained so far is given below:

Present value of cash inflow > Present value of cash outflow

Positive net present value

Project is acceptable

Present value of cash inflow = Present value of cash outflow

Zero net present value

Project is acceptable

Present value of cash inflow < Present value of cash outflow

Negative net present value

Project is not acceptable

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How It Works/Example:

The formula for NPV is:

NPV = (Cash inflows from investment) – (cash outflows or costs of investment)

Let's assume Company XYZ wants to buy Company ABC. It takes a careful look at Company ABC's projections for the next 10 years. It discounts those projected cash inflows back to the present using its weighted average cost of capital (WACC) and then subtracts the cost of purchasing Company ABC.

Cost to purchase Company ABC today: $1,000,000

Present value (PV) of cash flows from acquiring Company ABC:

Year 1: $200,000

Year 2: $150,000

Year 3: $100,000

Year 4: $75,000

Year 5: $70,000

Year 6: $55,000

Year 7: $50,000

Year 8: $45,000

Year 9: $30,000

Year 10: $10,000

Total: $785,000

Now that we know the total cash flow for the next 10 years (the total cash inflows from the investment), along with total cost of the investment in Company ABC, we can use the formula to calculate NPV:

Net Present Value (NPV) = $785,000 - $1,000,000 = -$215,000

At this point, management for Company XYZ would use the net present value rule to decide whether or not to pursue the acquisition of Company ABC. Because the NPV is negative, they should say, “No.”

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Advantage and Disadvantage of NPV

Advantages:

Net present value accounts for time value of money. Thus it is more reliable than other investment appraisal techniques which do not discount future cash flows such payback period and accounting rate of return.

NPV is choosing an appropriate discount rate. Using different discount rates might favour one investment versus another. The best way to deal with this is try multiple discount rates within a range of possibilities to determine the sensitivity of the answer to the discount rate.

When NPV is positive, the investment is worthwhile; On the other hand, when it is negative, it should not be undertaken; and when it is 0, there is no difference in the present values of the cash outflows and inflows. In theory, an investor should undertake positive NPV investments, and never undertake negative NPV investments .Thus, NPV makes the decision making process relatively straight forward

NPV method is that it allows for easy comparisons of potential investments. As long as the NPV of all options are taken at the same point in time, the investor can compare the magnitude of each option. When presented with the NPVs of multiple options, the investor will simply choose the option with the highest NPV because it will provide the most additional value for the firm. However, if none of the options has a positive NPV, the investor will not choose any of them; none of the investments will add value to the firm, so the firm is better off not investing.

NPV is customizable so that it accurately reflects the financial concerns and demands of the firm. For example, the discount rate can be adjusted to reflect things such as risk, opportunity cost, and changing yield curve premiums on long-term debt.

Disadvantage: 

It is based on estimated future cash flows of the project and estimates may be far from actual results

NPV is based on future cash flows and the discount rate, both of which are hard to estimate with 100% accuracy.

There is an opportunity cost to making an investment which is not built into the NPV calculation.

The biggest disadvantage to the calculation of NPV is its sensitivity to discount rates After all, NPV computations are really just a summation of multiple discounted cash flows both positive and negative - converted into present value terms for the same point in time (usually when the cash flows begin). As such, the discount rate used in the denominators of each present value (PV) computation is critical in determining what the final NPV number will turn out to be. A small increase or decrease in the discount rate will have a considerable effect on the final output.

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NPV is only as accurate as the inputted information. It requires that the investor know the exact discount rate, the size of each cash flow, and when each cash flow will occur. Often, this is impossible to determine. For example, when developing a new product, such as a new medicine, the NPV is based on estimates of costs and revenues .The cost of developing the drug is unknown and the revenues from the sale of the drug can be hard to estimate, especially many years in the future.

IMPORTANCE:

NPV is used to analyse an investment decision and give company management a clear way to tell if the investment will add value to the company. Typically, if an investment has a positive net present value, it will add value to the company and benefit company shareholders.

Net present value calculations can be used for either acquisitions (as shown in the example above) or future capital projects. For example, if a company decides to open a new product line, they can use NPV to find out if the projected future cash inflows cover the future costs of starting and running the project. If the project has a positive NPV, it adds value to the company and therefore should be considered.

TERMINOLOGY

Discounted cash flows: In finance, discounted cash flow (DCF) analysis is a method of valuing a project, company, or asset using the concepts of the time value of money. All future cash flows are estimated and discounted to give their present values (PVs)—the sum of all future cash flows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cash flows in question. Present value may also be expressed as a number of years' purchase of the future undiscounted annual cash flows expected to arise.

Using DCF analysis to compute the NPV takes as input cash flows and a discount rate and gives as output a price; the opposite process—taking cash flows and a price and inferring a discount rate—is called the yield. Discounted cash flow analysis is widely used in investment finance, real estate development, corporate financial management and patent valuation

Book value: The book value of asset refers to the amount at which an asset is shown in the balance sheet of a firm. Book value of a business refers to the total book value of all valuable assets (excluding fictitious assets)

Market value: Market value refers to the price at which an asset can be sold in the market; Market value of a business refers to the aggregate market value (as per stock market quotation) of all equity shares outstanding

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Economic value: The economic value of an asset is equal to the present value of the incremental future cash inflows likely to accrue due to the acquisition of the asset; discounted at the appropriate required rate of return (applicable to the specific asset intended to be purchased)

Liquidation value: liquidation value refers to the price at which each individual asset can be sold if business operations are discounted in the wake of liquidation of the firm, the liquidation value of a business is equal to the sum of (is) realisable value of assets and (ii) cash and bank balances minus the payments required to discharge all external liabilities

Replacement value: the replacement value is the cost of acquiring a new asset of equal utility and usefulness. It is normally useful in valuing tangible assets such as office equipment and furniture and fixtures

Salvage value: salvage value represents the scrap value on the disposal of assets after the expiry of their economic useful life. It may be employed to value assets such as plant and machinery

Value of goodwill: A business firm can be said to have real goodwill in case it earns a rate of return (ROR) on invested funds higher than the ROR earned by similar firms (with the same level of risk). In operational terms, goodwill results when the firm excess (super) profits.

Fair value: Fair value is the average of book value, market value and intrinsic value

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CHAPTER 3

COMPANY PROFILE

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MAGNAQUEST COMPANY OVER VIEW

About

Magnaquest Technologies Limited is a trend-setting and fascinating innovative Enterprise

Product-based Solutions Company, which has established its leadership over 15 years, in

three broad lines of businesses.

We serve over 250 enterprise customers across 36 countries with business critical solutions.

Our products, applications, solutions, and consulting practices enable improved processes and

substantial business gains for our customers.

As a philosophy, Magnaquest is a pure product-based Solutions company; focused upon

niche market segments and developing countries for its clientele in particular in Africa, Asia

and South America.

We have a mission to service and add value to three global trends: Subscription-Lifecycle-

Management, Identity-based Outcomes and Customer Engagement.

We have three matured product lines for each business eco-system (Subscription, Identity and

Customer Engagement).

Each is represented by a separate brand (SURE / I.Am / OptCulture)

As a DNA, we work with high-value, long-term customers in these three areas characterized

by high demand and tremendous global opportunity.

We have development centers in India, the UAE, Malaysia, the USA, and Zambia; supported

by a sales network spanning the globe.

Growing at nearly 100% over last two years, Magnaquest is amongst the fastest growing mid-

sized software B2B solution enterprises in Asia.

Lines of Business

SUBSCRIPTION LIFECYCLE MANAGEMENT (SURE!)

Solutions for multiple verticals – Media & Entertainment, Broadband & Telecom, Utilities,

Cloud Infrastructure and On-Demand with end-to-end feature set including Billing, CRM,

BSS & OSS, Customer Care, and Service Fulfilment.

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IDENTITY AND ACCESS MANAGEMENT (I.AM)

Solutions to ensure Security, Governance, Compliance, and Guarantees (SGCG) in Delivery

of Social Benefits and Citizen Services for Governments and Corporations.

As a strategy, Magnaquest focuses upon under-served markets of emerging economies in

Africa, Asia and South America catering to Media, Entertainment, Broadband and Mid-

segment Telecom Verticals. These countries also are a critical focus area for our Identity line

of business. In developed economies of North America and Europe, we focus on niche

market segments of Cloud Computing, Municipalities, Smart Cities and Utilities (in

Subscription).

CUSTOMER ENGAGEMENT (OptCulture)

OptCulture assists businesses and organizations in connecting with their customers

nationwide via communication through multiple mediums.

While supporting a variety of business types, we’ve developed our platform to operate with a

retailers perspective. Our functionality, process and paradigm are driven from our experience

in helping companies grow their customer base in multiple mediums of advertising. SMS

based advertising is an extremely powerful and effective medium to use in conjunction with

other mediums or as a stand-alone platform.

Vision

Our vision is to build a lasting entrepreneurial organization, beyond our lifetime and

generation.

Business Approach

• Build Products with Solutions orientation

• Focus on Niche and Emerging Markets

• Strong Differentiators through choice of under-served markets in select geographies,

solution orientation, strategic partnerships, price advantage and localization of

solutions

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• Our opportunity map (Interspersing Solutions offering and Markets), is characterized

by few competitors, with possibility of significant market-share and a fast growing

niche-segment

Magnaquest has displayed marked risk-taking, maturity and strategic foresight from

inception, with a strong preference to solutions and products over services.

We built our success with outcome-based revenues to effort-based pricing.

We have been at the forefront of newer delivery models and focused-frugal innovations.

We are the global pioneers in cutting-edge technologies and business waves; like Cloud

Computing, AGILE methodology and test-oriented development.

THE SUBSCRIPTION ERA

Globally, businesses across verticals ranging from Telecom, Broadband, Media &

Entertainment, Utilities and Cloud Computing are transforming their customer engagement

models to become Subscription-based.

SURE!

(A Subscription Lifecycle Management Product)

Solutions for multiple verticals: Media & Entertainment, Broadband & Telecom,

Utilities, Cloud & On-Demand Solutions

End-to-end solutions, including Billing, CRM, BSS & OSS, Customer Care, and

Fulfillment

Opportunities

The total market size for subscription management software (relevant to SURE!) is

projected to be around US $23 billion annually.

Road Ahead: Subscribed!

• Businesses Moving to Subscription Model Globally because Clients Want It

• Spans across Industries: Media & Entertainment, Cloud Computing, Broadband &

Telecom, Energy & Utilities, Government Services, Insurance, Finance, et al

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• Enabled by Internet technologies

• Business response to global cyclic patterns of economy

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The Identity Wave

I.Am

(Identity, Governance and Compliance Management Solutions)

Solutions include National ID Integrated Compliance, ID & Access Management (IAM),

Integrated Governance & Compliance Management, Information & Event Management

(SIEM), ID integrated Electronic Benefit Transfer (EBT) and integrated citizen services.

Opportunities

• 60+ countries at different stages of eID issuance and adoption

• More than 1 billion eID holders by 2015

• $11 billion annual eID issuance market

• Estimated $25-30 billion annual post-issuance eID solutions market

• The market size for Identity and Access Management (IAM) integrated Governance

and Compliance Management solutions is projected to be US$ 13 billion in coming

five years (Gartner & Forrester).

• Market size for EBT Solutions predicted to be in range of US$ 16-20 billion

Customer Engagement

OptCulture

Solutions include POS-integrated Business Intelligence, Email Marketing, SMS Marketing,

Customer Loyalty Programs, Digital Receipts and Social Media Marketing.

Opportunities

The retail market where OptCulture can make relevant contribution to businesses is over $10

Billion over the next 5 years

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Progress and Achievements

We have 15+ years of experience of working with operators offering different services on

subscription model, especially in the context of Broadband, PayTV and Cloud services.

During this journey, we have gained experience of implementing our Business Support

Systems (BSS) / Operation Support Systems (OSS) solutions in multiple customer segments,

ranging from a subscriber base of 5K to market leaders with subscriber bases as high as 500K

to 800K.

The experience has given us tremendous understanding on various aspects of the market,

which in turn enabled us to formulate and implement right technology, products and solutions

strategies.

Based on the work done so far, we are presently trying to penetrate more into the emerging

markets in LATAM, Africa, APAC with our solutions for Broadband, Telecom and PayTV

players. With SURE! Cloud, we are aiming to penetrate into the developed nations like the

USA and Europe.

Awards and Industry Compliance

SURE! Awarded 4th BCS Ratna Outstanding Software Tech Award at BCS Ratna

Awards for 2013, an award instituted to recognize, reward and celebrate innovation,

excellence and achievement in Indian Broadcasting & Cable TV industry

High-end performance and scalability: SURE! was Certified by a joint benchmarking

exercise carried out in collaboration with HP as a product that can support 10 million

subscribers

SURE! for Cloud Players recognized among the Top Global Cloud Billing Systems

by Forrester

Magnaquest ranked in Top 40 among software vendors by PWC

Magnaquest is certified for ISO 9001:2008

Magnaquest is certified for PCI DSS standard

Top Product Software Exporter by HYSEA

 

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CHAPTER-4

DATA ANALYSIS

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Project the sales conservatively. Figure out the enterprise Value after four years. Discount to get current value out.

From this we can figure out share swap ratio

SALES

IN LAST FIVE YEARS In 1000 USD

years 2008 2009 2010 2011 2012

Sales of EVAPT

56 100 500 1000 2000

SALES OF MQ

3101 6600 13400 24600 38000

We will assume that the enterprise value is x times sale in 2012. Say 5 times

A value of 5 is justifiable if there is continued growth of 20% and a net margin of 25%

Next we take the NPV, with the specified risk rate, discounting over roughly four years.

Current value [2000*5 / (1+36) /(1+36) / (1+36) (1+36)]

= 2923

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Risk rate of EVAPT

36%

Current value 2923

PV Factors: Year 1 = 1 ÷ (1 + 20%) ^1 ≈ 0.833Year 2 = 1 ÷ (1 + 20%) ^2 ≈ 0.6889Year 3 = 1 ÷ (1 + 20%) ^3 ≈ 0.5717Year 4 = 1 ÷ (1 + 20%) ^4 ≈ 0.4745

Year5 = 1 ÷(1 + 20%) ^ 5 ≈ 0.3939

Year 2008-09 2009 2010 2011 2012

Cash flow 3101 6600 13400 24600 38000

Total cash flow * P.V FACTOR

3101*0.833 6600*0.6889 13400*0.5717

24600*0.4745 38000*0.3939

PV of cash flows

2583.13 4546.74 7660.78 11672.7 14968.2

Total PV cash flows

41431.43

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Again we have to take 50% of value, as achieving the number depends on additional money, company stability, and product depth.

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50% of Total cash flows

-Investment

20715

-2931

NPV 17784

FINDINGS

In Asset-based business valuations can be done on a going concern or on a liquidation

basis.

Earning Value Approach is the most popular business valuation method, for most

businesses, some combination of business valuation methods will be the fairest way to

set a selling price.

Valuation changes quickly, based on external factors like the economy and the

industry, and internal factors like the customer base, advertising, and ownership. Here

is a description of the most common business valuation methods

In NPV, There is an opportunity cost to making an investment which is not built into the NPV calculation.

SUGGESTIONS

Investor has to think to use NPV method, as it is based on estimated future cash flows of the project and estimates may be far from actual results

Establishing business value is also important when structuring a buy-sell agreement’s terms for buying back owner shares.

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A primary advantage of fair value accounting is that it provides accurate asset and liability valuation on an ongoing basis to users of a company’s reported financial information

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CONCLUSION

Business valuation professionals provide independent, unbiased opinions of value for

business concerns of multiple natures and sizes. They also value intangible business assets

such as copyrights, employment agreements, trademarks, securities and goodwill. These

professional appraisers prepare merger and acquisition studies, employee stock ownership

plan feasibility analyses and other similar financial studies. They may be involved in

appraisals performed for estate and gift tax returns, buy-sell agreements, securities litigation,

equitable distribution in matrimonial matters and many other purposes.

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BIBLOGRAPHY

Business appraisals and the IRS (Michael Gregory oct-2010)

The market approach then and now (2012)

Fair value measurements 2nd edition (MARK.L ZYLA)

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