Bocconi University
20177 – Fair Value Accounting Reporting and Valuation
Equity Valuation - Introduction
Lecture 1
Course overview
 My email: francesco.momente@unibocconi.it
Office hour: Wednesday, 5.30 p.m. (by appointment)
 Teaching assistant (TA): leonardo.adessi@unibocconi.it
Office hour: Friday, 6.00 p.m. (by appointment)
 Aim of the course is to provide students with a sound knowledge of the valuation topics, not only
based on techniques but also on critical thinking and practical skills – JUDGEMENT BASED ON
FACTS AND CIRCUMSTANCES AND SUPPORTING DATA ANALYSIS ARE CRUCIAL IN VALUATION!
 Class program broadly similar to previous AY with some changes (More details later)
 IMPORTANT: Last year there were Group Valuation Projects on a voluntary basis. This year I need
to check the best solution with class representatives (time available could be short). I will inform
the class about the final decision.
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Exams

All exams will be written multiple-choice exams (with/without calculations and class-specific).

An Exam Direction will be provided before each Partial/General Exam (with specific indications
about structure, allocation of grades, topics included/excluded, duration).

Two basic options for (written) exams:
a)
General Exam after the end of the course (May 30, 2023 and later sessions)
b) Two Partial Exams
 1st Partial Exam (March 15, 2023)
 2nd Partial Exam or General Exam after the end of the course
 May 30, 2023 - 2nd partial exam (enrollment alternative to June 20) or General Exam
 June 20, 2023 - 2nd partial exam (alternative to May 30) or General Exam

Students passing the 1st Partial Exam can choose to book one of the two alternative dates
scheduled for the 2nd Partial Exam or to enroll in the General Exam

Students failing the 2nd Partial Exam or General Exam can only sit the General Exam later
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Tentative syllabus (1)
20177 - FAIR VALUE ACCOUNTING, REPORTING AND VALUATION
DETAILED SYLLABUS OF CLASS 13 (2022-23 AY)
Session
Timetable
FIRST PART
Textbook Pinto et al. (2020)
07/02/2023
14.45 - 16.15
Introduction - Equity valuation
2
08/02/2023
08.30 - 10.00
Market and Accounting Basics (Market cap, Price, types of
shares, adjustments for dilution, Income Statement and Balance
Sheet, etc.)
slides
3
09/02/2023
14.45 - 16.15
Accounting and Market Return concepts
Ch. 5
4
14/02/2023
14.45 - 16.15
Cost of capital
Ch. 5
5
15/02/2023
08.30 - 10.00
(cont.) Cost of capital
Ch. 5
6
16/02/2023
14.45 - 16.15
7
21/02/2023
14.45 - 16.15
8
22/02/2023
08.30 - 10.00
9
23/02/2023
14.45 - 16.15
10
28/02/2023
14.45 - 16.15
11
01/03/2023
08.30 - 10.00
12
02/03/2023
13
FINANCIAL ANALYS AND VALUATION
1
Ch. 1, pp. 1-8, 21-31 + Ch. 4
Dividend Discount Model (DDM)
Ch. 3 + Ch. 7
(cont.) DDM
Ch. 3 + Ch. 7
Asset and equity-side valuations and Free cash flow valuation
Ch. 8
(cont.) Free cash flow valuation
Ch. 8
(cont.) Valuation with bankruptcy costs
Residual income model
Ch. 10
14.45 - 16.15
(cont.) Residual income model
Ch. 10
07/03/2023
14.45 - 16.15
Market multiples
Ch. 9
14
08/03/2023
08.30 - 10.00
(cont.) Market multiples
Ch. 9
15
09/03/2023
14.45 - 16.15
First part of the course wrap up
1st Partial Exam (15/03/2023)
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Tentative syllabus (2)
Session
Timetable
SECOND PART
Textbook Zyla (2020)
21/03/2023
14.45 - 16.15
Purchase price allocation (PPA) in Business Combinations
17
22/03/2023
08.30 - 10.00
(cont.) PPA
Ch.2 + IFRS13
18
23/03/2023
14.45 - 16.15
Fair Value measurement
Ch.2 + IFRS13
19
28/03/2023
14.45 - 16.15
Fair value measurement, BEV and PPA
Ch.2 + IFRS13
20
29/03/2023
08.30 - 10.00
21
30/03/2023
14.45 - 16.15
22
04/04/2023
14.45 - 16.15
23
05/04/2023
08.30 - 10.00
24
06/04/2023
14.45 - 16.15
25
18/04/2023
14.45 - 16.15
26
19/04/2023
08.30 - 10.00
27
20/04/2023
14.45 - 16.15
28
26/04/2023
08.30 - 10.00
29
27/04/2023
14.45 - 16.15
30
02/05/2023
14.45 - 16.15
(cont.) MPEEM: Example
slides
31
03/05/2023
08.30 - 10.00
ESG and valuation
slides
32
04/05/2023
14.45 - 16.15
Second part of the course wrap-up
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VALUATION FOR PPA AND IMPAIRMENT TEST
16
Ch. 4
Intangible assets and Remaining Useful Life estimation
Ch. 10
(cont.) Useful life of customer relationships
Ch. 10
(cont.) Useful life of customer relationships
Ch. 10
The cost approach
Ch. 6
Income approach
Ch.8
(cont.) Income approach
Ch.8
(cont.) Focus: Relief from royalty rate method
Ch.8
Valuing a PIGA (Primary Income Generating Asset) applying the
Multiperiod Excess Earnings Method (MPEEM)
Ch.8 + slides
(cont.) MPEEM
Ch.8 + slides
(cont.) MPEEM
Ch.8 + slides
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Course Materials
 Books

J.E. PINTO et al. (2020). Equity Asset Valuation.
4th edition, John Wiley & Sons, New Jersey.

M.L. ZYLA. (2020). Fair Value Measurements. Practical
Guidance and Implementation. 3rd ed. John Wiley & Sons,
New Jersey.
1st part
of the
course
2nd part
of the
course
 Lecture notes, supporting excel files and exercises with solutions
 Additional readings (research papers) uploaded on Blackboard (not mandatory)
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More advanced/complementary valuation courses:
Deal Design (20223) and Accounting for Value (20688)
 Fair Value (20177) is a “basic-to-advanced” course that deals with valuation topics related to business
combinations for financial reporting purposes.
 The MSc Elective course Deal Design & Valuation for Business Combinations and Joint Agreements (20223 –
Taught in Italian) provides a more in-depth examination of the structure and the effects of business
combinations (BC). In particular, it analyses how to structure a deal that can be profitable for the various
parties involved (e.g. seller and acquirer) by focusing on nine key elements:
1. Price (spot or contingent)
2. Perimeter (wide, narrow, possible pre-deal relationships between the parties)
3. Full control (achievable by owning the majority of company shares, by holding stock options, by
agreements stated in the by-law)
4. Payment method (stocks, cash, mixed)
5. Vendor financing (used or not)
6. Risks (indemnity assets, drag along and tag along clauses, veto rights)
7. Contractual agreements to manage the conflicts of interest among the parties
8. Accounting effects (on acquirer/seller and their parents)
9. Fiscal effects (asset deal vs stock deal, fiscal impacts on acquirer/seller)
 Another MSc Elective course Accounting for Value (20688 – Taught in English) develops a
systematic value investing methodology based on accounting numbers to understand value and
challenge the market price if it is different from the estimated fundamental value. This helps
avoid the “naive reliance on valuation multiples” and the greatest risk in investing, i.e “the RISK
OF PAYING TOO MUCH!”
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The two main valuation “perspectives”
 Valuation aims at estimating the “intrinsic” or “true” value of an asset, a business unit, or a company, relying on
the analysis of the available information about its fundamentals and characteristics.
 Valuation for investment/divestment decisions is based on the theoretical framework of Co. Finance
without specific restrictions.
 Valuation for other specific purposes - Financial Reporting, Tax, or Litigation purposes – must also comply
with other guidelines/rules than Co. Finance principles (e.g., Accounting Principles)
Valuation for investment/
divestment decisions
Examples:
Valuation of a share or an equity interest
Valuation of a business for a M&A operation
Valuation of an asset: a brand
Valuation of an investment/ divestment project
Valuation of the value created by a strategy
Valuation for Financial
Reporting purposes
Examples:
Valuation of an equity interest in a non-listed
firm
FV estimates for Purchase Price Allocation (PPA)
purposes following a business combination
Impairment test of intangible assets
Goodwill allocation to one or more CGU
Same objects of valuation, but different perspectives and restrictions
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Valuation skills can serve different purposes
 The reference book by Pinto et al. 2020 mainly considers the valuation of equity securities mainly from an
investment management perspective
 However, the same basic theoretical framework and valuation approaches are useful to support many
company’s and shareholders’ purposes related to:
 Market expectation extraction
 Firm strategy and event evaluation
 Financial reporting
 Shareholder communications
 Fairness opinions
 Private firm valuation
 Compensation
 Settlement of litigations or disputes among shareholders
 Our focus will be on the application of the financial valuation skills to assess business units, entire companies
and even specific intangible asset for PPA and impairment test purposes.
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Intrinsic Value
 Intrinsic value (or fundamental value): estimate of value of the asset by an hypothetical investor
that could have a complete understanding of the asset’s investment characteristics (e.g., risk and
future cash flows). An investor’s estimate of intrinsic value reflects his or her view of the “true” or
“real” value of an asset (Note: this definition is taken from the reference book by Pinto et. , 2020.
There may be different definitions of intrinsic value around…)
 If one assumed that the market price of an equity security perfectly reflected its intrinsic value,
“valuation” would simply require looking at the market price (strong efficient markets hypothesis).
 Grossman–Stiglitz paradox: If assets were always correctly priced, then analysts would not have an
incentive to find undervalued stocks. In a rational efficient market, in fact, investors should expect to
be rewarded for the costs of information gathering and analysis by higher gross returns.
 An analyst estimating intrinsic value is implicitly questioning the market’s estimate of value:
 If the market price > Intrinsic value  Asset is overvalued
 If the market price < Intrinsic value Asset is undervalued
 Active investors seek to exploit market mispricing. They must believe that the market will correct
itself within the investment horizon. Because of the uncertainties involved in valuation, analysts use
a variety of models and inputs to estimate intrinsic value and may require that value estimates differ
markedly from market price before concluding that a misvaluation exists.
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Why is a good valuation important?
 Prices indicate how much the investors are willing
to pay for the specific security. They are observable
but are only biased indicators of Value
 The “true values” (V) are not observable on the
market, and need to be estimated (VE)
P ≠V
VE ≠ V
 VE estimation inevitably involves a measurement
error
VE − P = (V − P ) + (VE − V )
mispricing
measurement error
The scope of the first
part of the course is
learning how to
minimize this error
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The causes of the mispricing
(V − P )
Mispricing (noise)
 Traditional rational explanation: Market imperfections
 Direct transaction costs (buying and selling costs, including fees and taxes)
 Indirect transaction costs (cost of holding the position until the price converges to the true
value)
 Information costs and uncertainty (costs of producing high-quality fundamental analysis
and limited capacity to forecast future events)
 Behavioral and irrational explanations
 Investors’ short-termism and psychology-based theories to explain market
outcomes and anomalies (e.g. herding behavior)
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Mispricing example
P = 100
The fundamental analysis leads to an estimated value per share of 120 (VE).
According to the forecast, the market price should converge to its fundamental value (True value = V)
within the next 12 months (time t+1)  VE ≅ V ≅ E(Pt+1) = 120.
The opportunity cost of capital is 10%.
But:
 Direct costs = Buying and selling fees (0,5%); taxes on capital gains (10%)
 Indirect costs = Initial investment x [(1+ opportunity cost of capital) periods to converge – 1]
 Information costs= Cost per share of the best fundamental analysis (that implies VE ≅ V ≅ Pt+1) = 6 (at
the current time, t0)
Is buying the share a good investment ?
Current time
Share purchase
Purchasing fees
After one year the forecast comes true
Share sale
Selling fees
Taxes on capital gains
First margin
Opportunity cost of capital
Cost of the fundamental analysis
Net margin
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-100 = P
-0,5 = 0,5% * purchase price
120
-0,6
-2
16,9
-10,7
-6
+0,2
= VE (=V)
= 0,5% selling price
= 10% of the capital gain equal to 20
= (-100-0,5)+(120-0,6 – 2)
= 10% * (initial price + research + purchasing fees)
= 10%* (100 + 6 + 0,5)
Information costs are one of the major causes of financial market
inefficiency. This is the reason why the standard setters’ ultimate goal is to
maximise the value relevance of the accounting information. The higher the
value relevance of the accounting information, the lower the information costs
for investors.
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Focus on the main mispricing causes
1. Taxes are one of the causes of market inefficiency  this is why private transactions (M&A) show higher
mispricing.
Example:
Company A owns the asset X that generates a certain level of cash flow that implies a value in use of 100.
Company B is considering purchasing the asset for a price of 120. However, Company A is not willing to
close the deal, as asset X has a book value (amortized/depreciated cost) of 50, because Company A
should pay taxes for 21, which is 30% of the “gross” capital gain [= (120 – 50) x 30% = 21]. The after-tax
proceeds from the asset sale for Company A would be equal to 99 (=120 – 21) < 100.
In this case, even before taking into account transaction costs (e.g. investment banks fees), the asset
disposal is not profitable for the potential seller (Company A).
2. Information costs are one of the causes of market inefficiency  this is why standard setters aim at
improving the value relevance of the accounting information. When the value relevance is higher
(=accounting data helps in increasing the accuracy of estimates), information costs for investors are
lower.
Example:
Company X operates in the biotech industry: it expenses its R&D costs and doesn’t disclose the
pipeline of its research projects;
 Company Y is a financial holding company: its shareholding interests are recognized at market value
(mark-to-market) in its balance sheet.
If you were an investor interested in evaluating these companies, which one do you think would require
higher information costs?

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Empirical evidence (1): the P/V index
Internet
bubble
 V = estimated
fundamental(“true”) value of
the Dow Index
 P = market value of the Dow
Index (weighted average market
cap of all equity securities
included in the index)
 P/V ≅ 1 if V and P are very
close each other
Even though in the long run
market value converges to the
“true” value (V), at any given
time they may not be equal
Source: C. Lee and B. Swaminathan, “Valuing the
Dow: a Bottom-Up Approach”, Financial Analysts
Journal, September/October 1999.
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Empirical evidence (2): Rai Way Public Tender
Offer launched by EI Towers
EI Towers announces the launch of an hostile Takeover bid on Rai Way (subsequently withdrawn)
Market stats
Average stock Price
Pre Tender Offer
Post Tender Offer
Rai Way
3,29
4,50
EI Towers
42,61
54,79
Implied premium
37,0%
28,6%
Tender Offer premium vs
last traded price (24/02/2015)
22,0%
Date of Takeover Bid:
26 February 2015
Leakage
Rai Way Stock price perfomance
Average Rai Way stock price pre vs post takeover bid
EI Towers Stock price perfomance (rebased on Rai Way stock)
Average EI Towers stock price pre vs post takeover bid
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The sources of the measurement error
(VE − V )
measurement error
 3 main points to look at for improving the value estimates:



choice of the basis of value/valuation perspective
choice of the valuation model
conversion of the estimates in value
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Bases of value (1)
 The basis of value is chosen considering the purpose of valuation (value for whom?). The main
bases of value are:
 Intrinsic value (or fundamental value): an estimate of the value of the asset by a hypothetical
investor that could have a complete understanding of the asset’s fundamentals and
characteristics (e.g., risk and future cash flows). An investor’s estimate of intrinsic value reflects
his or her view of the “true” or “real” value of an asset and that estimate is used to ascertain the
accuracy of the market price.
 Market Value: The International Valuation Standards Committee (IVSC) defines market value as
“the estimated amount for which a property should exchange on the date of valuation between a
willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein
the parties had each acted knowledgeably, prudently, and without compulsion.” [value for market
participants]
 Fair market value (FMV): price at which an asset/liability would change hands between an
independent willing buyer and a willing seller when the former is not under any compulsion to
buy and the latter is not under any compulsion to sell and both are knowledgeable subjects.
Very important for tax purposes. [value for market participants]
Fair value IFRS: accounting “definition” of FMV with the specific requirements prescribed by IFRS
13  will be analyzed in the second part of the course
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Bases of value (2)
 Investment value = estimate of the present value of the future benefits expected by a specific
subject (it includes the synergies that a specific subject is able to realize with his/her own assets
 value for a specific entity)
Value in use IFRS = accounting “definition” of investment value for the current owner with the
specific requirements prescribed by IAS 36.
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Example of investment value: premiums on M&A
transactions (1)
• Investment value represents an upper limit to how much a specific potential acquirer will be
willing to pay for an asset
• Quite evident in Worldwide M&A transactions: on average, in 2015 acquirers of publicly trading
companies have paid a 28% premium in excess of the unaffected share price (share price prior to
the first rumor).
Acquisition
premium
Source: Factset
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Example of investment value: premiums on
M&A transactions (2)
 Acquisition premiums
decline as capital markets
progressively move from a
period of general
undervaluation to a more
euphoric period with prices
aligned with or greater than
intrinsic values.
 In 2012, in a bearish phase of
capital markets, average
acquisition premiums
recorded were about 40% (vs
2015 average premium of
28%)
Source: MergerStat
* Premiums calculated vs unaffected share prices.
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Valuation premises
 The value of an asset/business can be estimated based on two different perspectives
(value premises):
 Going-concern  the value is a function of the expected future benefits obtainable
by the asset.
 In liquidation  assumes that the company’s assets are sold individually and
separately. The liquidation value of an asset is a function of its degree of liquidity (=
capacity of the asset to be promptly converted into cash without material costs)
and specificity/convertibility (= capacity of the asset to be reconverted to other
uses).
 Going concern value > Liquidation value
 Management exploits its skills to create value by synergistically organizing the
company’s assets and pursuing strategies that generate a sustainable competitive
advantage.
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The dispersion of the bases of value
Price/
Value
Investment value
Intrinsic value
For an intangible intensive firm
(e.g. a brand intensive company)
the various configurations of value
can differ significantly.
Cash
Fair market value
Fair value
For cash,
price = value
Liquidation price
Receivables
Stock /
Inventory
Tangible
fixed assets
Intangible
assets
The dispersion among the different bases of value decreases with the asset level of liquidity and increases
with its specificity / idiosyncratic nature
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Unit of valuation vs Object of valuation
Unit of valutation
% equity
interest
0%
Individual
Share
Object of valuation
= An equity stake
Vshare x Num. shares
Minority
stake
Vstake without control (Is this ok?)
Majority
stake
Vstake with control (Is this ok?)
100% Equity
V 100% Equity x %interest
100%
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The valuation model has to be consistent with the
unit of valuation
The valuation model needs to be suitable for the unit of valuation:
Comparison between the DDM criterium and the liquidation value of the net assets
Net asset book value= 100
Liquidation value (=Net Asset Value (NAV) representing the potential selling price) = 150
Tax rate = 30%
Expected annual income (constant forever) = 10
Expected income growth rate (forever) = 0
Cost of equity capital (coe) = 10%
UNIT OF VALUATION = MINORITY INTEREST
Appropriate valuation model from a minority shareholder perspective:
DDM (Hp. Expected income = Expected dividend)  Steady state
V = DIV/coe = Earnings/coe = 10/ 10% = 100
UNIT OF VALUATION = CONTROL INTEREST
Valuation model from the perspective of the controlling shareholder (liquidation value, since the controlling
shareholder can dispose of the assets):
Simple Net Asset Value (NAV) method
V = 150 – (150 – 100) x 30% = 135
Tax on
capital gain
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Holding discount example:
Italmobiliare and CIR
 Market evidence: market
prices embed a Holding
Discount respect to NAV
(partly due to holding
structure costs and agency
risks)
NAV Discount (Market)
Fonte: "Europe: multi-sector holdings",
GS, 04.06.2014
Aker ASA
C. Dior
CIR
Corp Financiera Alba
Eurazeo
Heineken Holding
Industrivarden AB
Investor AB
Italmobiliare SpA
Kinnevik Investment AB
Lundbergforetagen
Orkla ASA
Rallye SA
Ratos AB
Reinet
Sacyr Vallehermoso SA
Schibsted
Semapa
Societe FFP
Sonae SGPS SA
Wendel
Average
Median
Monoholding
Polyholding
33,80%
17,20%
52,40%
34,00%
17,80%
7,10%
14,70%
17,40%
40,10%
33,00%
11,50%
17,00%
28,20%
-14,00%
22,10%
21,60%
42,90%
22,50%
49,40%
29,40%
24,00%
19,96%
21,85%
27,88%
33,00%
* Monoholdings = Holding con Gross Asset Value investito in first major listed holding > 60%
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Converting Forecasts to a Valuation
 Sum-of-the-parts valuation (or breakup value or private market value)
 value a firm as the sum of its individual operating segments. When a firm’s operating segments have
distinct economic influences and/or the operating segments have different sets of relevant
competitor firms an analyst would develop separate valuations using each segment’s earnings and
then add them up.
 Sometimes a conglomerate discount is applied to firms that have multiple, unrelated segments
because conglomerates can be inefficient and poorly managed.
 Sensitivity analysis
 An analyst will usually want to determine how equity valuation changes given a change in discount
rates, in the firm’s competitive environment, or some other variable. This approach provides a range
of valuations that can be used to make investment decisions.
 Situational adjustments: Different situations call for different adjustments to the equity valuation.
 A control premium is added if the investor will buy enough of the firm to control it.
 A marketability discount is an extra return to investors to compensate for the lack of a public market
or lack of marketability.
 An illiquidity discount is applied if the stock is publicly traded but not very liquid.
 A blockage factor discount is applied if the investor is going to sell a block of shares that is large
relative to the stock’s average trading volume.
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Explicit forecast for 10 years +
perpetuity with 0,5% growth
Explicit forecast for 3 years +
perpetuity with 2% growth
Perpetuity
with zero
growth
Conversion of estimates in value (1)
Years
Dividend = earnings per share
g
coe
Price per share
0%
10%
 Issue: length of the forecast horizon and g
rate
20
Years
Dividend = earnings per share
g
g in the Terminal Value
coe
TV
Discount factor
PV (dividends)
Sum PV (dividends)
PV (TV)
1
2,00
2%
10%
6
24
2
2,20
10%
3
2,55
16%
0,9091 0,8264 0,7513
1,82 1,82 1,92
DDM: the estimated value ranges from 20 to
37 depending on the length of the explicit
forecast horizon (in this example: 1, 3 or 10
years) and the g rate assumed
TV
2,60
32,51
30
Price per share
Years
Dividend = earnings per share
g
g in the Terminal Value
coe
TV
Discount factor
PV (dividends)
Sum PV (dividends)
PV (TV)
1
2,00
1
2,00
0,50%
10%
Price per share
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19
2
2,20
10%
3
2,55
16%
4
2,91
14%
5
3,26
12%
6
3,58
10%
7
3,87
8%
8
4,10
6%
9
4,27
4%
10
4,35
2%
0,9091 0,8264 0,7513 0,6830 0,6209 0,5645 0,5132 0,4665 0,4241 0,3855
1,82 1,82 1,92 1,99 2,02 2,02 1,99 1,91 1,81 1,68
TV
4,37
46
37
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Conversion of estimates in value (2)
 Issue: target financial structure
 Mistakes in the estimation of value may be due to the identification of a wrong target financial
structure. Example of asset side steady state valuation with wacc varying between 7,30% and 10%:
Sensibility of the asset side value of a company to the variation of the target financial structure (Modigliani - Miller
without financial distress costs)
Unleverad cost of capital (ku)
10%
Tax Rate
30%
Target financial structure (D/EV)
(D/V)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Wacc = ku*(1-tc*D/V)
10,00% 9,70% 9,40% 9,10% 8,80% 8,50% 8,20% 7,90% 7,60% 7,30%
(1 – Tc x D/EV)
EBIT
NOPAT
EV= NOPAT/Wacc
143
100
1000
1031
1064
1099
1136
1176
1220
1266
1316
1370
Value comprised between 1.000 and 1.370
The Modigliani-Miller (MM) model with taxes states that the total value (Enterprise Value) of a company
always increases with the financial leverage…
… but there is a limit to the application of the model: what is the maximum sustainable financial debt?
Bocconi University – Accounting department
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Conclusions: summary of the valuation process
1. Understanding the Business
Industry and competitive analysis
Financial statement analysis
2. Forecasting Company Performance
Forecast sales, earnings, dividends, and financial position
3. Selecting the Appropriate Valuation Model
Base selection on company characteristics
4. Valuation Model implementation
Inputs selection
5. Applying the Valuation opinion
Investment recommendations
Fair value estimates in the financial statements
Valuation opinion builds on the appraiser’s judgement based on the analyses of
the industry dynamics, the firm’s specific characteristics and all the relevant facts
and circumstances.
Bocconi University – Accounting department
30