Valuation Methods 1

Prof. Karolina Mazur

• A standard of value - a definition of the type of value being sought

• A premise of value - an assumption as to the set of actual or hypothetical transactional circumstances applicable to the subject of valuation

Value standards

Interested parts Parts not interested

Personalized value

Fair Market Value Fair Value

Impartial

Investment Value Fundamental Value

3 dr hab. inż. K. Mazur, prof. UZ

Standards of Value • Fair market value

• Market value

• Fair value

• Investment value

• Intrinsic value

Fair Market Value (FMV) • “the amount at which property would change hands

between a willing seller and a willing buyer when neither is acting under compulsion and when both have reasonable knowledge of the relevant facts.” – (American Society of Appraisers, Business Valuation Standards—

Definitions)

• The price that a given property or asset would fetch in the marketplace,

• The price is subject to the following conditions: – Prospective buyers and sellers are reasonably knowledgeable

about the asset; they are behaving in their own best interests and are free of undue pressure to trade.

– A reasonable time period is given for the transaction to be completed

– Given these conditions, an asset's fair market value should represent an accurate valuation or assessment of its worth

– (http://www.investopedia.com/terms/f/fairmarketvalue.asp)

Market Value • The most probable price which a property should bring in a

competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.

• Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:

1. Buyer and seller are typically motivated 2. Both parties are well informed or well advised, and acting in what

the consider their best interests 3. A reasonable time is allowed for exposure in the open market 4. Payment is made in terms of cash 5. The price represents the normal consideration for the property

sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale – (Pratt, Niculita, 2008, p. 42-43)

Fair Value

• Usually a legally created standard of value that applies to certain specific transactions

– (Pratt, Niculita, 2008, p. 45)

Investment Value

• “the specific value of an investment to a particular investor or class of investors based on individual investment requirements; distinguished from market value, which is impersonal and detached.” (Pratt, Niculita, 2008, p. 43)

Intrinsic Value (Fundamental Value) • „represents an analytical judgment of value based on the

perceived characteristics inherent in the investment, not tempered by characteristics peculiar to any one investor, but rather tempered by how these perceived characteristics are interpreted by one analyst versus another” – (Pratt, Niculita, 2008, s. 43)

• The value that an individual may place on the asset based on their own preferences and circumstances

• The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors.

• It may or may not be the same as the current market value. – http://www.investopedia.com/terms/i/intrinsicvalue.asp

Purpose of the Valuation and Standards

Purpose Standard

Gift, estate, and inheritance taxes and charitable contributions

Fair market value.

Purchase or sale Generally fair market value, but in many instances investment value, reflecting unique circumstances or motivations of a particular buyer or seller.

Buy-sell agreements Parties can do anything they want. Very important that all parties to the agreement understand the valuation implications of the wording in the agreement

Dissenting stockholder actions Fair value with some state interpretation

Going private Fair value in most states; governed by state statutes.

Financial reporting Fair value

Going-Concern versus Liquidation Premise of Value

1. Value as a going concern—Value in continued use, as a set of income-producing assets

2. Value as an assemblage of assets—Value in place, as part of a set of assets, but not in current use in the production of income, and not as a going-concern business enterprise

3. Value as an orderly disposition—Value in exchange, on a piecemeal (partial) basis (not part of a mass assemblage of assets), as part of an orderly disposition (liquidation) - all of the assets of the business enterprise will be sold individually, and that they will enjoy normal exposure to their appropriate secondary market

4. Value as a forced liquidation—Value in exchange, on a piecemeal basis (not part of a mass assemblage of assets), as part of a forced liquidation - this premise assumes that the assets of the business enterprise will be sold individually and that they will experience less than normal exposure to their appropriate secondary market.

Definition of Valuation

• The process of determining the current worth of an asset or company (http://www.investopedia.com/terms/v/valuation.asp)

Valuation Methods

Asset Approach

Book Value

Liquidation method

Replacement Cost

Income Approach

Cash Flow

Dividend

Market Approach

Multiplies

Other

Mixed methods

Real options

Asset Approach

• The asset-based approach provides an indication of the value of the business enterprise by developing a fair market value balance sheet.

• All of the assets of the business are identified and listed on the balance sheet

• Types:

– Book Value

– Liquidation method

– Replacement Cost

Income methods

The income methods determine fair market value by dividing the benefit stream generated by the subject or target company times a discount or capitalization rate.

Market approach

• the business appraiser will seek data on transactions of comparable businesses

Basic Elements of the Valuation Assignment

1. Name of the client and of the appraiser 2. Definition of the legal interest or interests to be appraised 3. Valuation date(s) (the date as of which the appraiser’s opinion of

value applies) 4. Purpose or purposes of the appraisal (the use to which the

valuation exercise is expected to be put) 5. Applicable standard (or definition) of value 6. Going-concern versus liquidation premise of value 7. Description of the specific ownership characteristics:

a) Size of interest relative to total b) Degree of marketability (e.g., public, private, and related matters)

8. Form and extent of written and/or oral report 9. Special requirements, contingent or limiting conditions, or special

instructions for the professional appraiser

Process of Valuation

1. Planning and preparation

2. Adjusting the financial statements and strategic data

3. Choosing the business valuation methods

4. Applying the selected valuation methods

5. Reaching the business value conclusion

NAVCA Professional Standards

• PREAMBLE, GENERAL, AND ETHICAL STANDARDS • 1.1 Preamble • 1.2 General and Ethical Standards • MEMBER SERVICES • 2.1 Valuation Services • 2.2 Other Services • DEVELOPMENT STANDARDS • 3.1 General • 3.2 Expression of Value • 3.3 Identification • 3.4 Fundamental Analysis • 3.5 Scope Limitations • 3.6 Use of Specialist • 3.7 Valuation Approaches and Methods • 3.8 Rule of Thumb • 3.9 Financial Statement Adjustments • 3.10 Earnings Determination • 3.11 Capitalization/Discount Rate • 3.12 Marketability, Control, and Other Premiums

and Discounts • 3.13 Documentation

• REPORTING STANDARDS • 4.1 General • 4.2 Form of Report • 4.3 Contents of Report • 4.4 Litigation Engagements Reporting Standards • OTHER GUIDELINES AND REQUIREMENTS • 5.1 Other Requirements • 5.2 International Glossary of Business Valuation

Terms • EFFECTIVE DATE • 6.1 Effective Date • APPENDIX

NACVA, National Association of Certified Valuation Analyst, Professional Standards: http://www.nacva.com

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INCOME APPROACH

Procedure of DCF method

• Financial Analysis

• Strategic Analysis Stage 1

• Estimation of free cash-flow Stage 2

• Estimation of doscount rate Stage 3 • Calculation of PV of CF

• Calculation of PV of TV Stage 4

• Interpretation of results Stage 5

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Major income methods

Income/cash-flow

For Equity

Model FCFE

Discounted dividends

For Firm

Model FCFF

Model CFF

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Decisions…

Types of methods by stage Model Description

One stage Stable growth 𝐷𝐶𝐹 =𝐶𝐹

𝑟−𝑔 or 𝐷𝐶𝐹 =

𝐶𝐹

𝑟

Two stage Stage 1 – high growth Stage 2 – stable growth

𝐷𝐶𝐹 = 𝐶𝐹𝑖1 + 𝑟 𝑖

+𝐶𝐹6𝑟 − 𝑔

5

𝑖=1

×1

(1 + 𝑟)6

or:

𝐷𝐶𝐹 = 𝐶𝐹𝑖1 + 𝑟 𝑖

+𝐶𝐹6𝑟

5

𝑖=1

×1

(1 + 𝑟)6

Three stage Stage 1- high growth, Stage 2 - transition Stage 3 – stable growth

𝐷𝐶𝐹 = 𝐶𝐹𝑖1 + 𝑟 𝑖

+

3

𝑖=1

𝐶𝐹𝑖1 + 𝑟 𝑖

+𝐶𝐹9𝑟 − 𝑔

8

𝑖=4

×1

(1 + 𝑟)9

or:

𝐷𝐶𝐹 = 𝐶𝐹𝑖1 + 𝑟 𝑖

+

3

𝑖=1

𝐶𝐹𝑖1 + 𝑟 𝑖

+𝐶𝐹9𝑟

8

𝑖=4

×1

(1 + 𝑟)9

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FCFE

• Net Income +/_

• Depreciation +

• Investment expenditure -

• The change of net working capital -

• Financial in-flows +

• Financial ou-tflows -

• FCFE =

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FCFF

• EBIT

• Adjusted Tax -

• NOPLAT (Net Operating Profit Less Adjusted Tax) =

• Depreciation +

• Investment expenditure -

• The change of net working capital -

• FCFF =

dr hab. inż. K. Mazur, prof. UZ 27

The assesment of TV

• Time of forecast min 75 years, TV=0 • The Gordon Model

𝑇𝑉 =𝐹𝐶𝐹𝑇(1 + 𝑔)

𝑟 − 𝑔

FCFT- CF in last year of forecast, g- growth rate, FCF, r-discount rate, g<r • Model with factors of value creation

𝑇𝑉 =𝑁𝑂𝑃𝐿𝐴𝑇𝑇+1(1 −

𝑔𝑅𝑂𝑁𝐼𝐶

)

𝑊𝐴𝐶𝐶 − 𝑔

NOPLAT- net operating profit less adjusted tax , WACC – Weighted Average Cost of Capital, RONIC-ecpested rate of return of new inwestment, oczekiwana stopa zwrotu z nowych inwestycji (kapitał własny księgowy i kapitał obcy odsetkowy) , g- growth rate of NOPLAT • Model based on economic income

𝑇𝑉 =𝐸𝑃𝑇+1𝑊𝐴𝐶𝐶

+𝑁𝑂𝑃𝐿𝐴𝑇𝑇+1

𝑞𝑅𝑂𝑁𝐼𝐶

𝑅𝑂𝑁𝐼𝐶 −𝑊𝐴𝐶𝐶

𝑊𝐴𝐶𝐶 𝑊𝐴𝐶𝐶 − 𝑞

EPT+1 – normalized economic income in the first year of particular forecast • Liquidation model –Liquidation value • Others inne

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