Two opposing theories in income-based valuation.
Market approach categories
Dividend irrelevance theory Empirical /statistical approach
Bird-in-hand theory Heuristic
Certain factors that can be considered to properly value the assets. Combination of these methods
Earning accretion/dilution Empirical/statistical approaches 3 methods
Equity control premium Comparative private company sales data
Precedent transactions Guideline public company data
Cost of capital computed through. Prior transactions method
Weighted Average Cost of Capital A majority stake in a large well established should be valued relative to either
Capital Asset pricing model A prior transaction of the same company involving a majority stake or
Income-based valuation approaches. Guideline transaction involving a majority stake involving a comparable company
Economic Value Added Comparable company analysis
Capitalization of earnings method Price earning ratio
Discounted cash flow method Book to market
The elements that must be considered in EVA. Dividend yield
Reasonableness of earnings or returns EBITDA multiple
Appropriate cost of capital CHAPTER 7
Capitalization of earnings method provides for the relationship of the Other Concepts and Valuation Techniques
Estimated earnings of the company Due diligence is an investigation, audit, or review performed to confirm the facts of a matter under consideration.
Expected yield or the required rate of return TYPES OF DUE DILIGENCE (DD)
Estimated equity value - Corporate DD
Capitalization of earnings method limitation - Private DD
This does may not fully account for the future return or cash flows thereby resulting to over or undervaluation - Government DD
Inability to incorporate the contingencies DD according to SUBJECT
Assumptions made to the returns or cashflows may not hold true since projections are based on a limited time horizon - Hard DD – concerned w/ numbers
Net Cash flow should be used - Soft DD – concerned w/ people
the company does not pay dividends Factors to be Considered in DD Process
the company pays dividends, but the amount paid significantly differs from its capacity to pay dividends
Net cash flows and profits are aligned within a reasonable forecast period
An investor has a control perspective. If an investor can exert control over the company, the dividends - Market Capitalization
can be adjusted based on the decision of the controlling investor
- Performance Trend Analysis
Cash flows and their sources help us understand the following (QRS).
- External Environmental Analysis
Quality of earnings
- Management And Share Ownership
Reliance on debt financing
- Financial Statements
Sources of financing for needed investment
- Stock Price History
Two levels of cash flows.
- Stock Dilution Possibilities
Net cash flows to the firm
- Market Expectation
Net cash flows to the equity
- Long- And Short-Term Risks
Net cash flows to the firm can be computed using the following approach.
FIVE STAGES OF MERGER AND CONSOLIDATION (M&A) (PIVNI)
Based from net income
1. Pre-Acquisition Review
From statement of cash flows
2. Investment Opportunities Scanning
From EBITDA
3. Valuation Of Target Investment
Basis of terminal value.
4. Negotiation
Liquidation value
5. Integration
Estimated perpetual value
Reasons for the failure of M&A
Constant growth
- Poor Strategic Fit
Scientific estimates
- Poorly Executed And Ill Managed Integration Phase
DCF is most applicable to use when the following are present
- Inadequate Due Diligence
Validated operational and financial information
- Too Aggressive Projections And Estimates
Reasonable appropriated cost of capital or required rate of return
Major Valuation Methods Used In M&A
New quantifiable information
- Discounted Cash Flows Method
Develop financial models, following steps.
- Comparable Company Analysis
Gather historical information and references
- Comparable Transaction Analysis
Establish drivers for growth and assumptions
Divestiture or divestments refer to the disposal of the assets of an entity or business segment often via sale to the
Determine the reasonable cost of capital party.
Apply the formula to compute for the value Types of divestiture
Make scenarios and sensitivity analysis based on the results 1. partial sell offs
2. equity carve out
3. spin off
OTHER VALUATION TECHNIQUES
- ROI-based Valuation
- Dividend Payout
