lOMoARcPSD|5768396 Valuation Concepts and Methods Accountancy (Polytechnic University of the Philippines) Studocu is not sponsored or endorsed by any college or university Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Republic of the Philippines POLYTECHNIC UNIVERSITY OF THE PHILIPPINES OFFICE OF THE VICE PRESIDENT FOR BRANCHES AND CAMPUSES MARAGONDON BRANCH INSTRUCTIONAL MATERIALS FOR ACCO 40013 VALUATION CONCEPTS AND METHODS Compiled by: Cielo Amor E. Diquit Faculty Date: August 18, 2020 Approved by: Dr. Agnes Y. Gonzaga Assoc. Prof. Denise A. Abril Head, Academic Programs Director Date: _________________ Date: __________________ i SUBJECT: ACCO 30033 – ACCOUNTING FOR GOVERNMENT AND NOT-FOR-PROFIT ORGANIZATIONS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 INTRODUCTION Shalom, dear students! Welcome to this online class where learning never stops and continuous fun learning is at hand. As the community of university continue to adopt this new way of learning, you are encouraged to keep your spirits high up and make the most of the time you could allot in learning at home using this instructional material. This may be difficult at first, but through persistence and God within you, you can do this! THE POLYTECHNIC UNIVERSITY OF THE PHILIPPINES VISION PUP: The National Polytechnic University MISSION Ensuring inclusive and equitable quality education and promoting lifelong learning opportunities through a re-engineered polytechnic university by committing to: ∙ provide democratized access to educational opportunities for the holistic development of individuals with global perspective ∙ offer industry-oriented curricula that produce highly-skilled professionals with managerial and technical capabilities and a strong sense of public service for nation building ∙ embed a culture of research and innovation ∙ continuously develop faculty and employees with the highest level of professionalism ∙ engage public and private institutions and other stakeholders for the attainment of social development goal ∙ establish a strong presence and impact in the international academic community PHILOSOPHY As a state university, the Polytechnic University of the Philippines believes that: ∙ Education is an instrument for the development of the citizenry and for the enhancement of nation building; and ∙ That meaningful growth and transmission of the country are best achieved in an atmosphere of brotherhood, peace, freedom, justice and nationalist-oriented education imbued with the spirit of humanist internationalism. TEN PILLARS Pillar 1: Dynamic, Transformational, and Responsible Leadership Pillar 2: Responsive and Innovative Curricula and Instruction Pillar 3: Enabling and Productive Learning Environment Pillar 4: Holistic Student Development and Engagement Pillar 5: Empowered Faculty Members and Employees Pillar 6: Vigorous Research Production and Utilization ii Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Pillar 7: Global Academic Standards and Excellence Pillar 8: Synergistic, Productive, Strategic Networks and Partnerships Pillar 9: Active and Sustained Stakeholders’ Engagement Pillar 10: Sustainable Social Development Programs and Projects SHARED VALUES AND PRINCIPLES ∙ Integrity and Accountability ∙ Nationalism ∙S pirituality ∙ Passion for Learning and Innovation ∙ I nclusivity ∙ Respect for Human Rights and The Environment ∙ Excellence ∙ Democracy POLYTECHNIC UNIVERSITY OF THE PHILIPPINES MARAGONDON BRANCH GOALS ∙ Quality and excellent graduates ∙ Empowered faculty members ∙ Relevant curricula ∙ Efficient administration ∙ Development – oriented researches ∙ State-of-the-art physical facilities and laboratories ∙ Profitable income – generating programs ∙ Innovative instruction ∙ ICT – driven library ∙ Strong local and international linkage PROGRAM OBJECTIVES The College of Accountancy aims to: 1. Provide the highest quality of accountancy education that meets international standards and broaden opportunities to poor/marginalized but highly intelligent students. 2. Generate and diffuse knowledge through intensive research and extension to make accountancy education both relevant and responsive to contemporary and future demands of national and global development. 3. Enhance the competencies of its faculty and administrative staff through information and communications technology, continuing professional education in services trainings and International exposures. Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 iii SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA ACCO 40013 VALUATION CONCEPT AND METHODS COURSE DESCRIPTION COURSE TITLE : VALUATION CONCEPTS AND METHODS COURSE CODE : ACCO 40013 COURSE CREDIT : 3 UNITS PRE-REQUISITE : ACCO 20123 This course will provide the students with practical tools and methods to value a broad range of assets within business entity. It covers business valuation, equity valuation, fixed income valuation, and option valuation. Students should be able to utilize various captial and investment management and techniques in making long-term business decisions. Students should be able to differentiate the types and measurement of risk and apply their relationships with the rate of returns. COURSE OBJECTIVES Institutional Learning Outcomes Programs Outcomes 1. Creative and Critical Thinking Students will be able to know different methodologies used in determining business and equity valuation with the broad range of assets 2. Effective Communication Students will be able to articulate and describe the different valuation methodologies and communicate the results, or its potential at the very least. 3. Strong Service Orientation Students will be able to create opportunities on providing consultative services, particularly on financial modelling. 4. Passion to Life-Long Learning Students will be exposed with various methodologies that will open the gateway to explore and innovate techniques to evaluate series of business assumptions and estimates. 5. Sense of Personal and Professional Ethics Students must demonstrate a capable management consultant and will affect the top or senior management long term decision. Course Outcomes Upon completion of the course, the students will be able to: a. Describe the different methodologies and technique in valuation. b. Use different tools using IT platforms c. Recommend the most suitable technique on valuation d. Determine and recommend best option among the set of alternative available for the investors. Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 6. Sense of Nationalism and Global Responsiveness Students must participate through contributing the skills earned by allowing them to be part of contributors of growth in the industry through the provision of quality financial management through financial markets. 7. Community Engagement Students must understand the relevance of the services in the development of their communities, particularly the advice that they can extend to the stakeholders. 8. Adeptness in the Responsible Use of Students must know how to the use of iv SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Technology technology in financial modelling and business valuation. 9. High Level of Leadership and Organization Skills Student is expected to form part of the leadership team, advisory at the very least, of the firm they will engage in the future and make strategic business directions. The maturity is expected to be further demonstrated at all times. COURSE REQUIREMENTS The course requirements are as follows: 1. Students are highly encouraged to attend the class sessions regularly to maximize learning and ensure requirements are complied with by both online and offline students. 2. The course is expected to have a minimum of four (4) quizzes and two (2) major examination (Midterm and Final Examination). 3. All output such as graded recitation, quizzes and major examination must be sent only to mrsdiquitpup@gmail.com. GRADING SYSTEM The grading system will determine if the student passed or failed the course. There will be two grading periods: Midterm and Final Period. Each period has components of: 70% Class Standing + 30% Major Examination. Final Grade will be the average of the two periodical grades. Midterm Grading Class Standing 70% ∙ Quizzes ∙ Activities Midterm Examination 30% 100% Final Grading Class Standing 70% ∙ Quizzes ∙ Activities Final Examination 30% 100% Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 FINAL GRADE = Midterm Grade + Final Grade 2 RUBRICS Criteria Assignment/ Activity Exemplary Satisfactory Developing Beginning Non-compliance 1.00 - 1.25 1.50 – 1.75 2.00 - 2.50 2.75 - 3.50 4.00 - 5.00 The submitted output manifests qualities which go beyond the requirements The submitted output manifests the required qualities The submitted output partially manifests the required qualities. Certain aspects are incomplete. The submitted output does not manifest any of the requirements or certain aspects are incorrect No submitted output COURSE GUIDE v SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Regular class (18 weeks, 3hrs/week, 54hrs) WEE K NO. TOPIC LEARNING OUTCOMES METHODLO GIE S RESOURCE S/ ASSES SM ENT REFERENC ES 1 Class Management ∙ Introduction to the course ∙ Discussion of the syllabus ∙ Classroom policies The learner will be to: ∙ Have an appreciation of the coverage of the course ∙ Establish order in the class ∙ Lecture and discussion ∙ Manage expectation by sharing insights of the instructor and the students ∙ Copy of the syllabus ∙ Student handbook Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) ∙ Summary of student reflection and expectatio n ∙ Elect class officers, prepare seat plan. lOMoARcPSD|5768396 1-4 Fundamentals Principles of Valuation ∙ Foundations of value ∙ Frameworks for valuation ∙ Definition of valuation ∙ Concepts of valuation ∙ Objectives/uses of valuation ∙ Importance/Rationale of valuation ∙ Fundamental principles of value creation ∙ Valuation process After the session the student is expected to: ∙ Discuss the history of valuation ∙ Describe the use and importance of valuation ∙ Illustrate Porter’s Five Forces ∙ Enumerate the principles and processes in creating value 5-6 Types of business valuation methods a. Going Concern Asset Based Valuation 1. DCF analysis 2. Comparable company Analysis 3. Earning Accretion and Dilution 4. Economic value added After the session, the learner must: 7-9 9 10-13 Types of business valuation methods b. Going Concern Asset Based Valuation Tools 1. Inflation analysis 2. Weighted Cost of Capital (WACC) 3. Capital Asset Pricing Model (CAPM) 4. Sensitivity analysis ∙ Differentiate the valuation methods ∙ Describe the going concern and liquidation concern asset based approach ∙ Illustrate the capitalizing and discounted future earnings After the session, the student is expected to: ∙ Identify the factors that will affect the discount rate using CAPM ∙ Describe and calculate the impact of tax regulation on discount rate calculation ∙ Calculate Other discount rates using arbitrage pricing and Gordon growth model ∙ Lecture ∙ Case study o Lecture o Case Study o Problem Solving o Lecture o Problem Solving o Case Study Basics of Corporate Valuation and Financial Modelling. Lascano Baron and Cachero. ∙ Recitation ∙ Presentati on ∙ Quiz Basics of Corporate Valuation and Financial Modelling. Lascano Baron and Cachero. ∙ Recitation ∙ Reaction Papers ∙ Quizzes or Long Exams Basics of Corporate Valuation and Financial Modelling. Lascano Baron and Cachero. ∙ Recitation ∙ Quizzes or Long Exams Basics of Corporate ∙ Recitation MIDTERM DEPARTMENTAL EXAMINATION Liquidation Based Valuation After the session, the o Lecture vi SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 14-17 ∙ Situations to consider liquidation value ∙ Uses of liquidation value in Investment Analysis ∙ Calculating Liquidation Value leaner is expected to: ∙ Identify situations that would require liquidation value ∙ Determine the liquidation value to be used in investment analysis Earnings and Market Approach Valuation ∙ Earnings Approaches ∙ Discounting Future Approaches ∙ Market Valuation Approaches After the session, the student is expected to: ∙ Enumerate the different earning approaches ∙ Compute for the discounted future earnings ∙ Define the market approach ∙ Enumerate the advantages and disadvantages of market approach 18 o Case Study o P roblem Solving o Lecture o Problem Solving o Case Study ∙ Quizzes or Long Exams ∙ Practice Set Valuation and Financial Modelling. Lascano Baron and Cachero. Basics of Corporate Valuation and Financial Modelling. Lascano and Cachero. ∙ Recitation ∙ Quizzes or Long Exams FINAL EXAMINATION vii SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA TABLE OF CONTENTS Topic Page Introduction Lesson 1 Overview of Valuation Concepts and Methods 1 Unit 1: Valuation Concept and Processes 1 Lesson 2 Going Concern Asset Based Valuation 5 Unit 1: Discounted Cash Flow Analysis 5 Unit 2: Company Comparable Analysis 9 Lesson 3 Going Concern Asset Based Valuation Tool 12 Unit 1: Financial Models 12 Lesson 4 Liquidity Based Valuation 15 Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Unit 1: Liquidation Value 15 Unit 2: Uses and Calculation of Liquidation Value 18 Lesson 5 Earnings and Market Valuation Approach 20 Unit 1: Earnings Approach 20 Unit 2: Market Approach 22 References viii SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA ACCO 40013 VALUATION CONCEPTS AND METHODS Lesson 1 – OVERVIEW OF VALUATION CONCEPTS AND METHODS Unit 1 – Foundation and Concepts of Valuation Overview: The fundamental point behind success investments is understanding what is the prevailing value and the key drivers that influence this value. In this lesson, the valuation and the processes in valuation will be discussed. Learning Objectives: After successful completion of this lesson, you should be able to: 1. Describe the use and importance of valuation 2. Illustrate Porter’s Five Forces 3. Enumerate the principles and processes in creating value Course Materials: Valuation It is the estimation of an asset’s value based on variables perceived to be related to future investment returns, on comparison with similar assets, or when relevant, on estimates of Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 immediate liquidation proceeds, says CFA Institute. OBJECTIVE OF THE VALUATION EXERCISE 1. Intrinsic Value – refers to the value of any asset based on the assumption assuming there is a hypothetically complete understanding of its investment characteristics. It is the value that an investor considers, on the basis of an evaluation or available facts, to be the “true” or “real” value that will become the market value when other investors reach the same conclusion. 2. Going Concern Value – the going concern assumption believes that the entity will continue to do its business activities into the foreseeable future. 3. Liquidation Value – the net amount that would be realized if the business is terminated and the assets are sold piecemeal. It is particularly relevant for companies who are experiencing severe financial distress. 4. Fair Market Value – the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. ROLES OF VALUATION IN BUSINESS Portfolio Management o Fundamental Analyst – these are persons who are interested in understanding and measuring the intrinsic value of a firm. Fundamentals refer to the characteristics of an entity related to its financial strength, profitability or risk appetite. o Activist Investors – activist investors tend to look for companies with good growth prospects that have poor management. Activist investors usually do “takeovers” – they use their equity holdings to push old management out of the company and change the way the company is being run. 1 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA o Chartists – they rely on the concept that stock prices are significantly influenced by how investors think and act and on available trading KPIs such as price movements, trading volume, short sales – when making their investment decisions. o Information Traders – they react based on new information about firms that are revealed to the stock market. The underlying belief is that information traders are more adept in guessing or getting new information about firms and they can make predict how the market will react based on this. Valuation Techniques in Portfolio Management ∙ Stock selection ∙ Deducing market expectations Business Deals for Analysis ∙ Acquisition – an acquisition usually has two parties: the buying firm that needs to determine the fair value of the target company prior to offering a bid price and the selling firm who gauge reasonableness of bid offers. ∙ Merger – transaction of two companies’ combined to form a wholly new entity. ∙ Divestiture – sale of a major component or segment of a business to another company. ∙ Spin-off – separating a segment or component business and transforming this into a Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 separate legal entity whose ownership will be transferred to shareholders. ∙ Leverage buyout – acquisition of another business by using significant debt which uses the acquired business as a collateral. VALUATION PROCESS 1. Understanding the business – it includes performing industry and competitive analysis and analysis of publicly available financial information and corporate disclosures. An investor should be able to encapsulate the industry structure. One of the most common tools used in encapsulating industry is Porter’s Five Forces: 2 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Generic Corporate Strategies to achieve Competitive Advantage - Cost leadership – incurring the lowest cost among market players with quality that is comparable to competitors allow the firm to be price products around the industry average. - Differentiation – offering differentiated or unique product or service characteristics that customers are willing to pay for an additional premium. - Focus – identifying specific demographic segment or category segment to focus on by using cost leadership strategy or differentiation strategy. 2. Forecasting financial performance – can be looked at two perspectives: on a macro perspective viewing the economic environment and industry where the firm operates in and micro perspective focusing in the firm’s financial and operating characteristics. Two Approaches of Forecast Financial Performance o Top down forecasting approach – international or national macroeconomic projections with utmost consideration to industry specific forecasts. o Bottom-up forecasting approach – forecast starts from the lower levels of the firm and builds the forecast as it captures what will happen to the company. 3. Selecting the right valuation model – it depends on the context of the valuation and the inherent characteristics of the company being valued. 4. Preparing valuation model based on forecasts – there are two aspects to be considered: - Sensitivity analysis – common methodology in valuation exercises wherein multiple other analyses are done to understand how changes in an input or variable will affect the outcome. 3 Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA - Situational adjustments – firm specific issues that affects firm value that should be adjusted by analysts since these are events that are not quantified if analysts only look at core business operations. 5. Applying valuation conclusions and providing recommendation KEY PRINCIPLES IN VALUATION o The value of a business is defined only at a specific point in time. o Value varies based on the ability of business to generate future cash flows. o Market dictates the appropriate rate of return for investors. o Firm value can be impacted by underlying net tangible assets. o Value is influenced by transferability of future cash flows. o Value is impacted by liquidity. Activities/Assessments: True or False. State TR when the statement is correct and FA if the statement is incorrect. ________1. Businesses treat capital as a scarce resource that they should compete to obtain and efficiently manage. ________2. Methods to value for real estate can may be different on how to value an entire business. ________3. Valuation includes the use of forecasts to come up with reasonable estimate of value of an entity’s assets or its equity. ________4. Intrinsic value refers to the value of any asset based on the assumption assuming there is a hypothetically complete understanding of its investment characteristics. ________5. Spin-off is separating a segment or component business and transforming this into a separate legal entity whose ownership will be transferred to shareholders. ________6. Fundamental analysts are persons who are interested in understanding and measuring the intrinsic value of a firm. ________7. Chartist relies on the concept that stock prices are significantly influenced by how investors think and act. ________8. Merger is the general term which describes the transaction two companies’ combined to form a wholly new entity. ________9. Valuation is the estimation of an asset’s value based on variables perceived to be related to future investment returns, on comparisons with similar assets or when relevant on estimates of immediate liquidation proceeds. ________10. Value is impact by liquidity. References: - Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 4 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Lesson 2 – GOING CONCERN ASSET BASED VALUATION Unit 1 – Discounted Cash Flow Analysis Overview: This lesson will discuss how investors will determine how much they are willing to acquire it. Since asset has been identified by the industry as transactions that would yield future economic benefits as a result of past transactions. Therefore, the value of investment opportunities is highly dependent on the value that the asset will generate from now until the future. Learning Objectives: After successful completion of this lesson, you should be able to: 1. Differentiate the valuation methods. 2. Describe the going concern and liquidation concern asset based approach. 3. Illustrate the capitalizing and discounted future earnings. Course Materials: Green field investments - those investments that started from scratch. Brown field investments – those opportunities that are either partially or fully operational. These are investments that are already in the going concern state, as most businesses are in the optimistic perspective that they will grow in the future. Going Concern Business Opportunities (GCBOs) These are the businesses that has a long term into infinite operational period. The risk indicators of GCBOs are identified easily as it provides reference for the performance of similar nature of business or from historical performances. Sound Enterprise-wide Risk Management allows the company to: 1. Increase the opportunities; 2. Facilitates the management and identification of the risk factors that affect the business; 3. Identify or create cost-efficient opportunities; 4. Manages the performance variability; 5. Improve management and distribution of resources across the enterprise; 6. Make the business more resilient to abrupt changes. Discounted Cash Flows Analysis This can be done by determining the Net Present Value of the Net Cash Flows of the investment opportunity. Net Cash Flows are the amounts of cash available for distribution to Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 both debt and equity claim from the business or asset. This is calculated from the net cash generated from operations and for investment over time. Therefore, free cash flows can be computed as: Free Cash Flows = Revenue – Operating Expenditures – Taxes – Capital Expenditures Two Levels of Net Cash Flows 1. Net Cash Flows to the Firm – represents the amount of cash made available to both debt and equity claims against the company. 5 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA 2. Net Cash Flows to Equity – represents the amount of cash flows made available to the equity stockholders after deducting the net debt or the outstanding liabilities to the creditors less available cash balance of the company. Terminal Value – represents the value of the company in perpetuity or in a going concern environment. This can be computed as: TV = CFn G TV = Terminal Value CFn = Farthest net cash flows g = Growth rate g= NCF0 = net cash flows at the beginning NCFn = latest net cash flows n = latest time To illustrate, suppose that a company assumes net cash flows as follows: Year Net Cash Flows (in million Php) 1 5.00 2 5.50 3 6.05 4 6.66 5 7.32 Assuming this is a GCBO, and it is expected that the net cash flows will behave on a normal trend. The growth rate is computed as: g= Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 g = 1.10 – 1 g = 0.10 TV = 7.32/0.10 TV = 73.20 DCF Analaysis is most applicable to use whn the following are available: 1. Validated operational and financial information 2. Reasonable appropriated cost of capital or required rate of return 3. New quantifiable information Supposed Bagets Corporation projected to generate the following for the next five years, in million pesos: Year Revenue Operating Expense* Taxes 1 92.88 65.01 8.36 2 102.17 71.52 9.19 3 112.38 78.67 10.11 6 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA 4 123.62 86.53 11.13 5 135.98 95.19 12.24 *Operating Expenses exclude depreciaiton and amortization The capital expenditures that was purchased and invested in the company amounted to Php100Million. The terminal value was assumed to be computed using 10% growth rate. It was noted further that there is an outstanding loan of Php50 Million. If you are going to purchase 50% of Bagets Corporation, assuming a 7% required return, how much would you be willing to pay? In million pesos Year 0 1 2 3 4 5 Revenue 92.8 8 102.1 7 112.3 8 123.62 135.98 Less: Operating Expenses (excluding Depreciation) 65.0 1 71.52 78.67 86.5 3 95.1 9 Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Less: Income Taxes Paid Less: Capital Expenditures Purchased Net Cash Flow 8.13 9.19 10.11 11.1 3 12.2 4 19.5 1 21.46 23.60 25.9 6 28.5 5 100.0 0 -100.00 Add: Terminal Value 285.50 Free Cash Flows -100.00 19.5 0 21.46 23.60 25.9 6 314.05 Multiply: Discount Factor (7%) 1.00 0.93 0.87 0.82 0.76 0.71 Discounted Free Cash Flows -100.00 18.1 4 18.67 19.35 19.7 3 222.98 Free Cash Flows – Firm 100.0 0 Less: Outstanding Loans 50.00 Free Cash Flows - Equity 50.00 Based on the foregoing information, the value of Bagets Corporation equity is Php50 Million. If th amount at stake is only 50% then the amount to be paid is Php25 Million. Activities/Assessments: TYL Inc. has projected that their performance for the next five years will result to the following: Year Revenue Operating Expense Taxes 1 50.00 30.00 6.00 2 55.00 33.00 6.60 3 60.50 36.30 7.26 4 66.55 39.93 7.99 5 73.21 43.92 8.78 A property was purchased for Php150 Million. The terminal value was assumed based on the growth rate of the cash flows. The outstanding loans is Php16.62 Million. The required rate of return for this business is 12%. Given the information above, answer the following: 1. How much is the Terminal Value? 2. How much is the Discounted Net Cash Flows to the Firm? 3. How much is the Net Cash Flow to the Equity? Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 7 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA 4. Assuming there are no outstanding loans, how much is the Discounted Net Cash Flows to the Equity? 5. Assuming that the required rate of return is 10%, how much is the Discounted Net Cash Flows to the Equity? References: - Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 8 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Lesson 2 – GOING CONCERN ASSET BASED VALUATION Unit 2 – Comparable Company Analysis Overview: In this lesson, different financial ratios as a tool will be discussed and illustrate to help Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 students assess the relationship of each drivers and show the how these tools could actually simplify the decision making of investors. Learning Objectives: After successful completion of this lesson, you should be able to: 1. Define the financial ratios to compare company performance. 2. Describe the use of financial ratios in estimating entity value and investments. 3. Apply the financial ratios in decision making. Course Materials: Comparable company analysis is a technique that uses relevant drivers for growth and performance that can be used as a proxy to set a reasonable estimate for the value of an asset or investment prospective. It uses tools to enable the comparison between companies given the difference in 3s – Strategy, Structure, and Size. Its objective is to enable the analyst or management accountant to determine the value of the company based on the behavior of similar businesses in the industry which captures the risks factors and other micro and macro economic considerations. The following factors are considered in determining the value in comparable company analysis: ∙ Comparators must be at least with the similar operation or industry. ∙ Total and absolute value should not be compared. ∙ Variables used in determining the ratios must be the same. ∙ Period of observation must be comparable. ∙ Non-quantitative factors must also be considered. Financial Ratios: Price-Earnings ratio – known as Price Multiples or P/E Multiples, represents the relationship of the market value per share and the earnings per share. It shows how much the market perceives the value of the company as compared to what it actually earns. This can be computed as follows: Value Per Share P/E = Market Earnings Per share To illustrate, Payaman Co. is a listed company with the market value per share of Php12.00 and reported earnings per share of Php4.00. Using the equation above, the P/E ratio is Php3.00 which means that Payaman can create 3x the value of what it earns. Book-to-Market ratio – determines the appreciation of the market to the value of the company as oppose to the value it reported under its Statement of Financial Position. Though it has 9 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA limitation for some values incorporated in this ratio does not represent the true value of the company. It can be computed as: Book Value Per Share Book to Market = Net Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Market Value Per Share To illustrate, Payaman Co. reported a book value per share of Php35.00 and with a market value per share of Php12.50. the book-to-market ratio is 2.80. Dividend-Yield ratio – describes the relationship between the dividends received per share and the appreciation of the market on the price of the company. It is also known as dividend multiple. This theory assumes that the value of the firm is affected by the dividends the company pays. Per Share DYR = Dividend Market Value Per Share To illustrate, Starlight Inc. declared and paid dividends of Php1.50 per share and their market value per share is Php12.50. Based on the foregoing, the dividend yield ratio is 0.12 which means that for every Php1.50 dividends they pay, it will translate into 12% of the market value of the equity and this can be computed as follows: DYR = 1.5 12.5 EBITDA Multiple – it is Earnings Before Interest, Taxes, Depreciation and Amortization which represents for the net amount of revenue after deducting operating expenses and before deducting financial fixed costs, taxes and non-cash expenses. Value Per Share EBITDA Multiple = Market EBITDA Per Share EBITDA per share is derived by dividing EBITDA into outstanding share for common equity or ordinary share. To illustrate, Starlight Inc. reported EBITDA per share of Php6.00 and the market value per share being Php12.00. Given the equation the EBITDA Multiple is 2 (2=Php12.0/Php6.0). Economic Value Added (EVA) – it is the most conventional way to determine the value of the asset is through its economic value added. It is the convenient for this is assessing the ability of the firm to support its cost of capital with its earnings. It is the excess of the earning after deducting the cost of capital. The assumption is that the excess shall be accumulated for the firm the higher the excess the better. Elements that must be considered in using EVA are: ∙ Reasonableness of earnings or returns ∙ Appropriate cost of capital EVA = Earnings – Cost of Capital Cost of Capital – Investment Value x Rate of Capital Cost To illustrate, Starlight Inc. projected earnings to be Php350 Million per year. The board of directors decided to sell the company for Php1,500 Million with a cost of capital appropriate for this type of business is 10%. With the given data, the EVA is Php200 Million (Php350 Million – (Php1,500 Million x 10%)). This result means that the value offered by the company is 10 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA reasonable for the level of earnings it realized on an average and sufficient to cover for the cost for raising the capital. Activities/Assessments: Answer the following problems: 1. Compute for the price earnings ratio if the earnings per share is Php5.50. Year Market Value per Share 1 27.500 2 30.250 3 22.000 4 17.875 5 28.875 P/E ratio 2. CIA INC. reported earnings for the year amounting to Php25 Million with outstanding shares of 1Million. The market value per share of CIA INC. is Php122. The reported CIA Inc. is Php10. If the investor is aware of the CIA INC.’s performance, how much should the investor value CIA INC.? 3. Lovesky Co. declared dividends of Php2.00 per share for their performance last year after the declaration of dividends the market value per share increased to Php45.00 per share. What is the dividend yield ration of Lovesky Co.? 4. Enlightened Company’s statement of financial position as of December 31, 2019 reported the following: Asset – Php400 Million; Liabilities – Php100 Million; Equity – Php300 Million with outstanding shares of 10 Million. The Enlightened’s stock is already selling at Php37 per share. a. How much is the Book-to-Market ratio? b. Assuming Enlightened has not available market information, but the industry Book-to-Market ratio is 1.2, what is the market value of Enlightened? 5. Conservative Inc. is exploring an investment that will required Php750 Million that would yield and annual earnings of Php185 Million. If the company required rate of return for the company is 12%, how much is the Economic Value Added (EVA)? References: - Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 11 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Lesson 3 – GOING CONCERN ASSET BASED VALUATION TOOLS Unit 1 – Financial Models Overview: Valuation process requires incorporation of a lot of factors that can be used to facilitate the calculation. These help investors to enable to execute the formula and fundamentals that are necessary to determine the value and at the same time to determine the share from the company. And one of the tools that can also be used by investors is financial model. This lesson will show how financial model is being prepared. Learning Objectives: After successful completion of this lesson, you should be able to: 1. Define the financial models. 2. Describe the steps in developing a financial model. 3. Enumerate the components of financial model. Course Materials: Financial models are mathematical models designed to aid in coming up with a recommended decision and at the same time can be used to validate the assumptions made. It is similar to financial plan or quantification of strategies and operating plans of the enterprise that is used to facilitate the following: - Determination of asset value or enterprise value and equity value. - Identification of risk. - Development of scenarios and sensitivities. Steps in developing a financial model: 1. Gather historical and material information - historical information may come from audited financial statements where past performance of the company is reported, from corporate disclosures which provide more context for the future plans and strategies of the company, from contracts which shows the covenants and existing agreements of the firm with other parties and peer information that provides other researches and support Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 to identified risks from industry experts and other consultants. 2. Establish driver for growth and assumptions – drivers are data that have been validated by government or experts. Growth drivers are based on population as most of the products are consumer goods so the growth indicators may be inflation, population growth, GNP or GDP growth. The bases may come from different sources such as Philippine Statistics Authority (PSA), Bangko Sentral ng Pilipinas (BSP), National Economic and Development Authority (NEDA) and other government agencies. n- 1 x 100% CPIo Inflation = CPI To illustrate, in year 2019, the CPI is 151 so the cost of the basket is PHP151. In year 2020, the CPI published is Php155. Since there is an increase of 4 from 2019 to 2020 CPI, there is an inflation of 2.64% using the equation above. 12 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Financial ratios may be used as tools to determine the growth drivers and assumptions. Trend analysis will also help you establish the trajectory of growth pattern. The financial modeler must assess whether the company can sustain the pattern otherwise, it is conservative to assume a less aggressive growth. Normally, the weighted growth pattern will be considered in the long term financial perspective. It must be assessed whether the average year on year growth will be sustained or may be surpassed. To illustrate, PIP Company’s historical production grows 10% per year. It is expected that in the next five years, the probability are as follows: Scenari o Rat e Probability A 5% 10% B 10% 40% C 15% 50% Given the data above, the weighted average growth rate to be used is 11.55% computed as follows: Scenari o Rat e Probability Weighted A 5% 10% 0.5% B 10% 40% 4.0% C 15% 50% 7.5% Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Total 11.55% 3. Determine the reasonable cost of capital – financial modeler must be able to determine the appropriate cost of capital by weighing the portion of the asset that is funded of equity and of debt. To do this, the weighted average cost of capital (WACC). WACC = (Ke x We) + (Kd x Wd) Ke – cost of equity We – weight of the equity financing Kd – cost of debt after tax Wd – weight of the debt financing Ke = Rf + B (Rm – Rf) Rf – risk free rate B – beta Rm – market return Kd = Rf + DM Rf – risk free rate DM – debt margin 13 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA To illustrate, the risk free rate is 5% and the prevailing interest rate is 6%. The cost of debt is then 11%. Based on the current share of financing, equity is 30% and debt is 70% while tax rate is 30%. Using the formula above, the WACC is 10%. 4. Execute the formula to compute for the value – financial modeler usually use DCF or Discounted Cash Flow in applying the capital budget techniques such as Internal Rate of Return (IRR) or Net Present Value (NPV) for an instance. Below example shows the computation and formula of NPV and IRR in excel/spreadsheet. In million pesos 1 2 3 4 5 Revenue 92.88 102.17 112.38 123.62 135.98 Less: Operating Expenses (excluding Depreciation) 65.01 71.52 78.67 86.53 95.19 Less: Income Taxes Paid 8.13 9.19 10.11 11.13 12.24 Less: Capital Expenditures Purchased 100 21.46 23.6 25.96 28.55 Net Cash Flow -80.26 Add: Terminal Value Free Cash Flows 285.5 -80.26 21.46 23.6 Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) 25.96 314.05 lOMoARcPSD|5768396 Multiply: Discount Factor (7%) Discounted Free Cash Flows 0.93 -74.6418 Free Cash Flows – Firm 206.09 Less: Outstanding Loans 50.00 0.87 0.82 0.76 0.71 18.6702 19.352 19.7296 222.976 Free Cash Flows - Equity 156.09 Net Present Value ₱206.72 =NPV(7% 58% =IRR(B9 9 Internal Rate of Return On the other hand, NPV and IRR may be computed manually using the below formula: NPV = PV * (1/(1+i)n PV – present value I – interest N – number of years or period 5. Make scenarios and sensitivity analysis based on the result – a financial model could easily be adjusted based on the perceived or desired result or information on a given situation. Hence, the “what if analysis” can be done using the financial model. For an instance, the 7% cost of capital may be 10% or 12% and with the use of financial model, the results like the equity value can easily be computed even when the sudden changes happen. The scenarios may be presented in financial model based on the possible occurrences like level of operating expense, mode of operations, capital expenditure development. This is where Risk Based Valuation could actually be used as it incorporates climate change, war, economic sabotage and pandemic. While sensitivity analysis is almost similar to scenario modelling. The only difference is that sensitivity analysis will have to 14 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA select a driver or few drivers, ceteris paribus, and check the degree of change it will cause to the results. It is very useful in developing ballpark estimates. Ballpark figures are quantitative drivers or multipliers that allow the investors to quickly make an estimate or offer. COMPONENTS OF FINANCIAL MODEL 1. Title Page 2. Data Key Results 3. Assumption Sheet 4. Pro-forma Financial Statements 5. Supporting Schedules Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Activities/Assessments: Answer the following Problems: Problem 1 Hats and Shoes Corp. is projecting its operating activities for the next five years. The volume of units to be sold on the first year is 60 and to grow by 15% every year. They are selling their merchandise at Php50 on the average. Operating income margin is 25%. 1. Revenue of the company for Year 1,2,3,4, and 5 are ___________________________. 2. Operating Income of the company for Year 1,2,3,4 and 5 are _____________________. 3. Annualized Growth Rate of the company for the 5 years is _______________________. Problem 2 Electricute Inc. has projected its net cash flows at Php45Million on the first year. In order to realize the 10% growth for the succeeding years, Electricute purchased CAPEX amounting to Php250 Million within the year. Half of the CAPEX was funded by liability and no other long term liability was existing before the purchase on the first year. 4. For its 5 year projections, Electricute’s Enterprise value, assuming there is a discount rate of 7.5%, is __________________. 5. For its 5 year projections, Electricute’s Equity Value, assuming there is a discount rate of 7.5%, is ________________________. References: - Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero 15 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Lesson 4 – LIQUIDATION BASED VALUATION Unit 1 – Liquidation Value Overview: An alternative approach to Going Concern Based Valuation when going-concern ability of a business is being question or doubtful is the Liquidation Based Valuation or use of liquidation value. This chapter will discuss the concept of this valuation and describe the situations or scenarios to consider in this valuation. Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Learning Objectives: After successful completion of this lesson, you should be able to: 1. Identify situations that would require liquidation value. 2. Enumerate the principles to apply in liquidation valuation. Course Materials: Liquidation value It is a value of a company if it were dissolved and its assets were sold individually. It represents the net amount that can be gathered if the business is shut down and its assets are sold in piecemeal. This is known as Net Asset Value. Situations to Consider Liquidation Value a. Business Failures – low or negative returns are signs of business failures that is why it is the most common or usual reason why a certain business closes or liquidates. Types of Business Failures i. Insolvency, when a company cannot pay liabilities as they become due. ii. Bankruptcy, when liabilities become greater than an asset balance. Factors causing Business Failures iii. Internal Factors – can come from mismanagement, poor financial evaluation and decisions, failure to execute strategic plans, inadequate cash flow planning or failure to manage working capital. iv. External Factors – are severe economic downturn, occurrence of natural calamities or pandemic, changing customer preferences, and adverse governmental regulations. b. Corporate/Project End of Life – normally, corporations have stated their finite life in their Articles of Incorporation. If there will be no extension on the corporate life, the terminal value may be computed using liquidation value. c. Depletion of Scarce Resources – this is most applicable to mining and oil where availability of scarce resources influences the value of the firm. Liquidation happens in this business when the permits or contracts with the government expire and the operation will no longer be allowed to execute. 16 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA General Principles on Liquidation Value 1. If the liquidation value is above income approach valuation (based on going concern principle) and liquidation comes into consideration, liquidation value should be used. 2. If the nature of the business implies limited lifetime (e.g. quarry, gravel, fixed term company etc.), the terminal value must be based on liquidation. All costs necessary to close the operations (e.g. plant closure costs, disposal costs, Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 rehabilitation costs) should also be factored in and deducted to arrive at the liquidation value. 3. Non-operating assets should be valued by liquidation method as the market value reduced by costs of sales and taxes. Since they are not part of the firm’s operating activities, it might be inappropriate to use the same going concern valuation technique used for business operations. If such result is higher than net present value of cash flows from operating the asset, the liquidation value should be used. 4. Liquidation value must be used if the business continuity is dependent on current management that will not stay. Activities/Assessments: True or False. ________1. Liquidation value represents the net amount that can be gathered if the business is shut down and its assets are sold in piecemeal. ________2. A unique callout for liquidation value is if the firm is operating under a proprietorship or partnership model. ________3. Liquidation value is the base price or the floor price for any firm valuation exercise. ________4. Bankruptcy is the most serious type of business failure as this happens when liabilities become greater than asset balance. ________5. Insolvency happens when a company cannot pay liabilities as they become due. ________6. Business failure is the most common reason why businesses close or liquidate. ________7. External factors such as severe economic down turn, occurrence of natural calamities or pandemic and the likes may contribute to business failure. ________8. For analysts, liquidation value method can also be used as benchmark in making investment decisions. ________9. Share price often reflects growth prospects of the company which is a consideration that liquidation value does not have. ________10. Book value should not be used as liquidation value. References: - Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero 17 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Unit 2 – Uses and Calculation of Liquidation Value Overview: This lesson will discuss the uses of liquidation value especially in investment analysis Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 and illustrate how the liquidation value is calculated. Learning Objectives: After successful completion of this lesson, you should be able to: 1. Determine the liquidation value to be used in investment analysis. 2. Calculate the liquidation value. Course Materials: Liquidation value method is also used by analysts as a benchmark in making investment decisions. Most analysts and investors are looking for a profitable companies and as perceived, companies with high profitability have less chances of liquidating, thereby, liquidation value is lower than its prevailing market price per share. On the other hand, when firms are experiencing decline or an industry is consistently declining, liquidation value will be higher than its market share price which often leads to total closure or liquidation of the business. Share price often reflects growth prospects of the company which is a consideration that liquidation value does not have. Investors of the firms usually buy the shares at prevailing market price and sell the company at the higher liquidation value. This results in risk-free arbitrage profit for corporate investors. Calculating Liquidation Value Liquidation value considers the present value of the sums that can be obtained through the disposal of the assets of the firm in the most appropriate way, net of the sums set aside for the closure costs, repayment of the debts and settlement of all liabilities, and net of the tax charges related to the transaction and the costs of the process of liquidation itself. It can also be computed on a per share basis by dividing total liquidation value by outstanding ordinary shares and be considered together with other quantitative and qualitative metrics to justify business decisions to be made. Liquidation Value = PV of Sale of Assets – PV of Closure Costs and Payment for liabilities- Tax Charges for the Transaction and Other Liquidation Costs To illustrate: 18 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA To compute for the adjusted value of the assets, the current book values should be multiplied by the assumed realizable value if they are liquidated. Then the liabilities should be deducted from the asset adjusted value to arrive at the liquidation value or net asset value. Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Adjusted Value Php 5,605,000 Less: Total Liabilities to be settled 2,000,000 Liquidation Value – Pavement Co. Php 3,605,000 Number of Outstanding Shares / 250,000 Liquidation Value per Share Php 14.42 Asset Type of Liquidation 1. Orderly liquidation – assets are sold strategically over an orderly period to attract and generate the most money for the assets. This process will expose assets for sale on the open market, with a reasonable time allowed to find a purchaser, both buyer and seller having knowledge of the users and purposes to which the asset is adapted and for which it is capable of being used, the seller being compelled to sell and the buyer being willing, but not compelled to buy. 2. Forced liquidation – is a liquidation process at which the assets are sold as quickly as possible such as an auction. This happens when creditors have sued the company or bankruptcy is filed, hence liquidation value decreases as it resulted to lower prices because of rush sale. Activities/Assessments: Answer the problem: At year end, Lysle Company balance sheet showed total assets of Php50 Million, total liabilities of Php30 Million and 500,000 ordinary shares outstanding. If Lysle could sell its assets for Php40 Million, Lysle liquidation value per share of ordinary share is? References: - Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero 19 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Lesson 5 – EARNINGS AND MARKET APPROACH Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 VALUATION Unit 1 – Earnings Approach Overview: In this lesson, other business valuation methods will be discussed like Earnings Approach. This will tackle how to value a company based on its earnings or ability to earn or produce revenue. Learning Objectives: After successful completion of this lesson, you should be able to: 1. Discuss the two common methods under earnings approach. 2. Illustrate how capitalizing past earnings and discounting future earnings are calculated. Course Materials: Earnings Approach is another common method of valuation and is based on the concept that the actual value of a business lies in the ability to produce revenue, profit and eventually wealth in the future. Two Common Methods of Earnings Approach 1. Capitalizing Past Earnings Approach – it determines an expected level of cash flow for the company using a company’s record of past earnings, normalizes them for unusual revenue or expenses and multiplies the expected normalized cash flows by a capitalization factor. Capitalization factor is a reflection of what rate of return a reasonable purchaser would expect on the investment, as well as a measure of the risk that the expected earnings will not be achieved. The estimate here is found by taking the future earnings of the company and dividing them by capitalization rate – income valuation approach which shows the value of a company by analyzing the annual rate of return, the current cash flow and the expected value of the business. Illustration. Cecilia Company has earned and had a cash flows of about P500,000 every year. The same cash flow would continue for the forseeable future as a prediction of company’s earnings. The expenses for the business every year is about P100,000 only which leads to P400,000 income every year. To figure out the value of the business, an investor analyses other risk investment that have the same kind of cash flows. The investor now recognizes a P4 Million Treasury Bond that returns about 10% annually or P400,000. Given the information above, the business value is also computed as P4 Million (P400,000/10%). Both investments have the same risks and rewards. 2. Discounting Future Earnings – it uses average of the trend of predicted future earnings and divided by the capitalization factor. Therefore, it is a valuation method that estimate firm’s worth or value based on earnings forecasts. Three Methods for Estimating Terminal Value 20 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA a. Liquidation Value Model b. Discounted Cash Flow Model c. Stable Growth Model Illustration. A firm that expects to generate the following earnings stream over the next five years. The terminal value in Year 5 is based on a multiple of 10 times that year’s earnings. What is the present value of the firm? Year 1 2 3 4 5 Earnings 50,000.00 60,000.00 65,000.00 75,000.00 750,000 Terminal Value Using a discount rate of 10%, the present value of the firm is P657,378.72. Computed as follows: P50,000 x (1/1.10)^1 + P60,000 x (1/1.10)^2 + P65,000 x (1/1.10)^3 + P70,000 x (1/10)^4 + P750,000 x (1/1.10)^5 = P657,378.72 Activities/Assessments: Answer the problem: Ciamara’s expects to generate the following earnings over the next five years. The terminal value is P900,000. Assuming the discount rate is 12%, what is the present value of the firm? Year 1 2 3 Earnings 50,000.00 60,000.00 65,000.00 4 Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 75,000.00 5 900,000 Terminal Value References: - Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero 21 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Unit 2 – Market Approach Overview: The idea behind the market approach is that the value of the business can be determined by reference to reasonably comparable guideline companies for which transaction values are known. Learning Objectives: After successful completion of this lesson, you should be able to: 1. Enumerate the methods under market approach. 2. Illustrate the market value approaches. Course Materials: Market-based valuation methods are routinely used by business owners, buyers, and their professional advisors to determine the business worth. It offers the view of business market value that is both easy to grasp and straightforward to apply. The idea is to compare the business with other similar businesses that have actually been sold. It could provide quick pricing estimate or selling price. Its mechanic involves finding a price multiple of the benchmark such as price to earnings ratio, price to book value and etc. Approaches under Market Value Approach 1. Empirical/Statistical – this involves the following a. Comparative private company sale data – formerly known as comparative transaction method. This involves finding out previous transactions like merger and acquisitions of comparable companies. Transactions should come from the same industry. Some of the sources are Institute of Business Appraisers (IBA), BIZCOMPSR, Pratt’s StatsTM, Done DealTM, Mid Market CompsTM, MergerstatR. b. Guideline Public Company Data – involves identifying a comparable company and obtaining the stock price for the company’s listed securities. The source usually is coming from Securities and Exchange Commission (SEC). c. Prior Transactions Method – involves looking up historical transactions in securities of the business undervaluation such as historical stock quote from a listed stock exchange. Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 2. Heuristic Pricing Model – uses the opinion of experts who are usually the professional practitioners. The best professional group that is doing this is the business intermediaries or brokers. Advantages and Disadvantages of Market Value Approaches 22 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Price should be matched to the appropriate parameted based on providers of capital and the numerator will be paid with the money given in the denominator. For example, in Price/EBIT, price is the market value of invested capital (MVIC), since the earnings before interest payments and taxes will be paid to both the debt and equity holders. In price/net income, price is the market value of equity (MVEq) only, since net income is after interest payment to debt holders and represents amount potentially available to shareholders. MVIC – is usually the numerator paired with Revenues, EBITDA, EBIT, Debt-free net income, Debt-Net Cash Flows, Assets, Tangible book value of invested capital. Market Value of Invested Capital is defined as the amount of money invested or raised by issuing shares to shareholders and bondholders, hence the sources are equity and debt. MVEq – is the numerator paired with Pre-tax Income, Net Income and Net Cash Flow and Book Value of Equity. It is defined as the mount of money invested or raised by issuing securities to shareholders only – hence equity alone. Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Illustration. You are to evaluate Lung Company’s current value and assigned to find out the reasonable minimum price the company can issue for 20% shareholdings. A comparable company has been identified – Heart Company which is very similar with Lung Company and that was priced or valued at P150 Million taken as a whole (MVIC). The following are the relevant financial information of the two companies: In million Php Heart Company Lung Company Gross Revenue 100 80 Net Sales 90 75 Net Cash Flows 15 10 EBITDA 17 14 Gross Profit 60 49 Book Value of Total Assets 100 90 Book Value of Equity 80 60 23 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Net Income 15 10 Compute for the Value or the Price of Lung Company using the following parameters: a. Gross Revenue b. Net Income Activities/Assessments: Answer the problem: You are an analyst of a private company, ABC CO. and has been assigned to do the curren valuation of the company and what is the reasonable minimum price the company can issue for 20% shareholdings. A comparable DEF Co. has been identified as a similar company which have been priced at P30 Million for 20% market value of invested capital (MVIC). The following are the relevant financial information of the two companies: In million Php DEF Co. ABC Co. 88 Gross Revenue 110 99 82.5 Net Sales 16.5 11 Net Cash Flows 18.7 15.4 EBITDA 66 53.9 Gross Profit 110 99 Book Value of Total Assets 88 66 Book Value of Equity 16.5 11 Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com) lOMoARcPSD|5768396 Net Income 1. What is the MVIC and MVEq of ABC Co. using gross revenue as parameter? 2. What is the MVIC and MVEq of ABC Co. using net income as parameter? References: - Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero 24 SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA Downloaded by Princess Pauline Cariño (paulinecarino2000@gmail.com)
