CH1. Fundamental
Principles of Valuation
Value- worth of an object in another person's point of view.
VALUATION- 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
maximize shareholder value- most fundamental principle
for all investments and business
Profesional Judgement- valuation places great emphasis
on it that are associated in the process.
INTREPRETING DIFFERENT CONCEPTS OF VALUE
ROLES OF VALUATION IN BUSINESS
A. PORTFOLIO MANAGEMENT
A company creates value if and only if the return on capital
invested exceeed the cost of acquiring capital -Alfred
Marshall
3 MAJOR FACTORS WHERE THE VALUE OF A BUSINESS
CAN BE BASICALLY LINKED IN:
1. Current Operations- how is the operating performance of
the firm in recent year?
2. Future prospects- what is the long-term, strategic
direction of the company?
3. Embedded risk- what are the business risks involved in
running the business?
Types of Investors
Fundamental Analyst- persons
interested in understanding and
measuring the intrisic value of a
firm.
FUNDAMENTALS- characteristics of an
entity related to financial strength,
profitability or risk appetite.
4 DIFFERENT VALUES THAT CAN MEASURE THE
WORTH OF AN ASSET:
Intrinsic Value- refers to the value of any asset based on
the assumption assuming there is a hypothetically
complete understanding of its investment characteristics.
Liquidation Value- net amount that would be realized if
the business is terminated and the assets are sold
piecemeal, particularly relevant for companies who are
experiencing severe financial distress.
Going concern value- value is determined under the going
concern assumption.
Fair market value- The price, expressed in terms of cash,
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.
the relevance of valuation here
largely depends on the investment
objectives of the investors or
financial managers managing the
investement portfolio.
Activist Investors- tend to look
for companies with good growth
prospects that have poor
management.
Chartists- they believe that
these metrics imply investor
psychology and will predict
future movements in stock
prices.
Information Traders- they are
more adept in guessing or
getting new info about firms and
they can make predict how the
market will react based on this.
Activities that can be performed (in
portfolio management):
Stock Selection
Deducing Market Expectation
C. CORPORATE FINANCE
VALUATION PROCESS (5 steps)
Forecasting financial
performance
1
Understanding
the Business
Preparing Valuation
Model Based on Forecasts
2
4
5
3
Selecting the right
valuation Model
Applying conclusion and
providing recommendations
1. Understanding the Business
industry and competitive analysis, analysis of publicly available
financial information and corporate disclosures.
-WHY?: give analysts and investors the idea about the following
factors: economic conditions, industry peculiarities, company strategy
and company's historical performance. (thru framework)
B. ANALYSIS OF BUSINESS
TRANSACTION/DEALS
- to estimate value of target firms they
are planning to purchase
-understand the synergies they can
take advantage from the purchase
Business deals include the
following:
Spin-off- separating a segment
or component business and
transforming this into a separate
legal entity whose ownership will
be transferred to shareholders.
Divestiture-sale of a major
component or segment of a
business (e.g. brand or product
line) to another company.
Merger-general term which
describes the transaction
wherein two companies had
their assets combined to form a
wholly new entity.
Acquisition-has two parties: the
buying firm and the selling firm.
> buying firm-needs to determine the fair
value of the target company prior to
offering a bid price.
>selling firm (or sometimes, the target
company) should have a sense of its firm
value to gauge reasonableness of bid
offers.
Leveraged buy-out- acquisition
of another business by using
significant debt which uses the
acquired business as
COLLATERAL.
-managing the firm's capital structure,
including funding sources and
strategies that the business should
pursue to maximize firm value.
2 important unique factors:
-Control- change in people
managing the organization brought
about by the acquisition.
-deals with prioritizing and distributing
financial resources to activities that
increases firm value.
-Synergy- assumes that the
combined value of 2 firms will be
greater than the sum of separate
firms (1+1=3)
D. LEGAL TAX PURPOSES
-estate tax
-partnership
-
E. OTHER PURPOSES
Issuance of a fairness opinion for valuations provided by third party (e.g.
investment bank)
Basis for assessment of potential lending activities by financial institutions
Share-based payment/compensation
PORTER’S FIVE FORCES
1. Industry Rival-the nature and intensity of rivalry between
market players in the industry.
2. New Entrants- the barriers to entry to industry by new market
players.
3. Substitute and Complements- the relationships between
interrelated products and services in the industry.
4. Supplier Power- how suppliers can negotiate better terms in
their favor.
5. Buyer Power- how customers can negotiate better terms in
their favor for the products/services they purchase.
COMPETITIVE POSITION
refers to how the products, services and the company itself is set apart from
other competing market players
Generic corporate strategies to achieve competitive advantage: (accdg to
Porter):
Cost Leadership- relates to the incurrence of the lowest cost among
market players with quality that is comparable to competitors allow the
firm to price products around the industry average.
Differentiation- firms tend to offer differentiated or unique product or
service characteristics that customers are willing to pay for an additional
premium.
Focus- Firms are identifying specific demographic segment or category
segment to focus on by using cost leadership strategy (cost focus) or
differentiation strategy (differentiation focus).
BUSINESS MODEL
the method how the company makes money - what are the products or
services they offer, how they deliver and provide these to customers and their
target customers.
QUALITY OF EARNINGS ANALYSIS
detailed review of financial statements and accompanying notes to assess sustainability
of company performance and validate accuracy of financial information versus
economic reality.
2. Forecasting Financial Performance
it is the next step after understanding how the business operates and analyzing historical
financial statements.
2 lenses where forecasting financial performance can be looked at:
Macro perspective- viewing the economic environment and industry
where the firm operates in.
Micro perspective- focusing in the firm's financial and operating
characteristics
2 approaches in forecasting:
Top-down forecasting approach- Forecast starts from international or
national macroeconomic projections with utmost consideration to
industry specific forecasts.
Bottom-up forecasting approach- Forecast starts from the lower levels
of the firm and is completed as it captures what will happen to the
company based on the inputs of its segments / units.
3. Selecting the right valuation Model
The appropriate valuation model will depend on the context of the
valuation and the inherent characteristics of the company being
valued
4. Preparing Valuation Model Based on Forecasts
Once the valuation model is decided, the forecasts should now be
inputted and converted to the chosen valuation model.
not only about manually encoding the forecast to the model to
estimate the value (which is the job of Microsoft Excel).
analysts should consider whether the resulting value from this
process makes sense based on their knowledge about the business.
To do this, two aspects should be considered:
Sensitivity Analysis- a common methodology in valuation
exercises wherein multiple analyses are done to understand
how changes in an input or variable will affect the outcome (i.e.
firm value).
Situational Adjustment or Scenario Modelling - For firmspecific issues that affect firm value that should be adjusted by
analysts. In some instances, there are factors that do not affect
value per se when analysts only look at core business operations
but will still influence value regardless.
5. Applying Valuation conclusions and Providing recommendations
Once the value is calculated based on all assumptions considered,
the analysts and investors use the results to provide
recommendations or make decisions that suits their investment
objective.
RISKS IN VALUATION
In all valuation exercises, uncertainty will be consistently present. s.
When performing any valuation method, analysts will never be sure
if they have accounted and included all potential risks that may
affect price of assets. Some valuation methods also use future
estimates which bear the risk that what will actually happen may be
significantly different from the estimate. Value consequently may be
different based on new circumstances.
Uncertainty is captured in valuation models through cost of capital
or discount rate.
UNCERTAINTY- refers to the possible range of values where the real
firm value lies
ASSESSMENT
TRUE OR FALSE:
1.Value pertains to how much a particular object is worth to a
particular set of eyes.
2.Methods to value for real estate can may be different on how to
value an entire business.
3.Businesses treat capital as a scarce resource that they should
compete to obtain and efficiently manage.
4. According to the CFA Institute, 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.
5. Valuation includes the use of forecasts to come up with reasonable
estimate of value of an entity's assets or its equity.
6.Valuation techniques may differ across different assets, but all
follows similar fundamental principles that drives the core of these
approaches
7. As valuation mostly deals with projections about future events,
analysts should hone their ability to balance and evaluation different
assumptions used in each phase of the valuation exercise, assess
validity of available empirical evidence and come up with rational
choices that aligns with the ultimate objective of the valuation
activity.
8. In the corporate setting, the fundamental equation of value is
grounded on the principle that Alfred Marshall popularized a company
creates value if and only if the return on capital invested exceed the
cost of acquiring capital.
9. Value, in the point of view of corporate shareholders, relates to the
difference between cash inflows generated by an investment and the
cost associated with the capital invested which captures both time
value of money and risk premium.
10. Intrinsic value refers to the value of any asset based on the
assumption assuming there is a hypothetically complete
understanding of its investment characteristics.
KEY PRINCIPLES IN VALUATION
1.The Value of a Business is Defined Only at a specific point
in time
Business value tend to change every day as transactions happen that can affect
earnings, cash position, working capital and market conditions.
Valuation made a year ago may not hold true and not reflect the prevailing firm
value today. As a result, it is important to give perspective to users of the
information that firm value is based on a specific date.
2. Value varies based on the ability of business to generate
future cash flows
General concepts for most valuation techniques put emphasis on future cash
flows except for some circumstances where value can be better derived from
asset liquidation.
Cash flows will depend on the estimates of future performance of the business
and strategies in place to support this growth. Historical information can
provide be a good starting point when projecting future cash flows.
3. Market dictates the appropriate rate of return for
investors
Market forces are constantly changing, and they normally provide guidance of
what rate of return should investors expect from different investment vehicles
in the market. Interaction of market forces may differ based on type of industry
and general economic conditions. Understanding the rate of return dictated by
the market is important for investors so they can capture the right discount rate
to be used in valuation. This can influence their decision to buy or sell
investments.
4. Firm Value can be impacted by underlying net tangible
assets
Business valuation principles look at the relationship between operational
value of an entity and net tangible of its assets. Theoretically, firms with higher
underlying net tangible asset value are more stable and results in higher going
concern value. This is the result of presence of more assets that can be used as
security during financing acquisitions or even liquidation proceedings in case
bankruptcy occurs. Presence of sufficient net tangible assets can also support
the forecasts on future operating plans of the business.
5. Value is influenced by transferability of future cash flows
Transferability of future cash flows is also important especially to potential
acquirers. Business with good value can operate even without owner
intervention. If a firm's survival depends on owner's influence (e.g. owner
maintains customer relationship or provides certain services), this value might
not be transferred to the buyer, hence, this will reduce firm value. In such cases,
value will only be limited to net tangible assets that can be transferred to the
buyer.
6. Value is impacted by liquidity
This principle is mainly dictated by the theory of demand and supply. If there
are many potential buyers with less acquisition targets, value of the target firms
may rise since the buyers will express more interest to buy the business. Sellers
should be able to attract and negotiate potential purchases to maximize value
they can realize from the transaction.
11. Going Concern firm value is determined under the going concern
assumption. The going concern assumption believes that the entity will
continue to do its business activities into the foreseeable future.
12. Liquidation Value is the net amount that would be realized if the business is
terminated and the assets are sold piecemeal.
13. Fair Market Value is 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.
14. Fundamental analysts are persons who are interested in understanding and
measuring the intrinsic value of a firm.
15. Fundamentals refer to the characteristics of an entity related to its financial
strength, profitability or risk appetite.
16. Activities 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.
17. Chartists relies on the concept that stock prices are significantly influenced
by how investors think and act. Chartists rely on available trading KPIs such as
price movements, trading volume, short sales - when making their investment
decisions.
18. Information Traders are Traders that 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.
19. An acquisition usually has two parties: the buying firm and the selling firm.
The buying firm needs to determine the fair value of the target company prior
to offering a bid price.
20. Merger is the general term which describes the transaction two companies
have their assets combined to form a wholly new entity.
TRUE OR FALSE: (continuation)
21. Divestiture is the sale of a major component or segment of a business (e.g.
brand or product line) to another company.
22. Spin-off is separating a segment or component business and transforming
this into a separate legal entity whose ownership will be transferred to
shareholders.
23. Leveraged buyout is the acquisition of another business by using significant
debt which uses the acquired business as a collateral.
24. Synergy can be attributable to more efficient operations, cost reductions,
increased revenues, combined products/markets or cross-disciplinary talents
of the combined organization.
25. Corporate finance mainly involves managing the firm's capital structure,
including funding sources and strategies that the business should pursue to
maximize firm value.
26. Valuation is also important to businesses because of legal and tax
purposes.
27. Top-down forecasting approach - Forecast starts from international or
national macroeconomic projections with utmost consideration to industry
specific forecasts.
28. 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.
29. Sensitivity analysis is the common methodology in valuation exercises
wherein multiple other analyses are done to understand how changes in an
input or variable will affect the outcome (i.e. firm value).
31. Uncertainty is captured in valuation models cost of capital or discount rate.
32. 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.
33. Definition of value may vary depending on the context. Different definitions
of value include intrinsic value, going concern value, liquidation value and fair
market value.
34 . Valuation plays significant role in the business world with respect to
portfolio management, business transactions or deals, corporate finance, legal
and tax purposes.
35. Generally, valuation process involves these five steps: understanding of the
business, forecasting financial performance, selecting right valuation model,
preparing valuation model based on forecasts and applying conclusions and
providing recommendations.
36. Value is defined at a specific point in time
37. Value varies based on ability of business to generate future cash flows
38. Market dictates appropriate rate of return for investors
39. Value is influenced by transferability of future cash flows
40. Value is impact by liquidity
30. Uncertainty is captured in valuation models through cost of capital or
discount rate. Uncertainty is captured in valuation models through cost of
capital or discount rate.
MULTIPLE CHOICE:
1.Pertains to how much a particular object is worth to a particular set of
eyes.
a. Price b. Value c. Cost d. Fundamentals
2. According to the CFA Institute, it 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.
a. Valuation b. Price Estimation c. Fundamentals d. Appraisal
3. Valuation places great emphasis on the_______ that are associated in
the exercise.
a. Professional judgment b. Human reasoning c. Professional Skepticism
d. Due diligence
4. The value of a businesses can be basically linked to three major
factors, except
a. Current Operations b. Future Prospects c. Embedded Risks d. All of the
above
5. One major factor linked to the value of business that shows how is the
operating performance of the firm in the recent year.
a. Current Operations b. Future Prospects c. Embedded Risks d. All of the
above
ENUMERATION:
3 MAJOR FACTORS WHERE THE VALUE OF A BUSINESS CAN BE
BASICALLY LINKED IN (CLUE: CEF)
4 DIFFERENT VALUES THAT CAN MEASURE THE WORTH OF AN ASSET
(CLUE: GLIF)
ROLES OF VALUATION IN BUSINESS (CLUE: PACLO)
TYPES OF INVESTORS (CLUE: FACI)
BUSINESS DEALS (CLUE: MALDS)
STEPS IN VALUATION PROCESS (CLUE: UFSPA)
PORTER’S FIVE FORCES (CLUE: INSSB)
lenses where forecasting financial performance can be looked at
2 approaches in forecasting
Key principles in valuation
6. One major factor linked to the value of business that reflects what is
the long-term and strategic decision of the company.
a. Current Operations b. Future Prospects c. Embedded Risks d. All of the
above
7. One major factor linked to the value of business that shows what are
the business risks involved in running the business.
a. Current Operations b. Future Prospects c. Embedded Risks d. All of the
above refers to the value of any asset based on the
8.. refers to the value of any asset based on the assumption assuming
there is a hypothetically complete understanding of its investment
characteristics.
a. Going concern value b. Liquidation Value c. Intrinsic Value d. Fair
Market Value
9.. particularly relevant for companies who are experiencing severe
financial distress.
a. Going concern value b. Liquidation Value c. Intrinsic Value d. Fair
Market Value
10. Value is determined under the going concern assumption.
a. Going concern value b. Liquidation Value c. Intrinsic Value d. Fair
Market Value
11. 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.
a. Going concern value b. Liquidation Value c . Intrinsic Value d. Fair
Market Value
12. The relevance of valuation in the investment objectives of the
investors or financial managers managing the investment portfolio.
largely depends on
a. Portfolio Management b. Fundamental Management c.Financial
Management d. Investment Management
13. These are persons who are interested in understanding and measuring
the intrinsic value of a firm.
a. Fundamental Analysts b. Activist Investors c. Chartists d. Information
Traders
14. refer to the characteristics of an entity related to its financial strength,
profitability or risk appetite. a. Intrinsic Value b. Fundamentals c. Technical
Characteristics d. Financial Value
15. tend to look for companies with good growth prospects that have poor
management.
a. Fundamental Analysts b. Activist Investors c. Chartists d. Information
Traders
16. They believe that these metrics imply investor psychology and will
predict future movements in stock prices.
a. Fundamental Analysts b. Activist Investors c. Chartists d. Information Traders
17. The underlying belief is that______ are more adept in guessing or getting
new information about firms and they can make predict how the market will
react based on this. Hence, correlate value and how information will affect
this value.
a. Fundamental Analysts b. Activist Investors c. Chartists d. Information Traders
18. Under portfolio management, the following activities can be performed
through the use of valuation techniques, except
a. Stock Selection b. Deducing Market Expectation c. Both can be performed d.
None of the above
19. Separating a segment or component business and transforming this into
a separate legal entity whose ownership will be transferred to shareholders.
a. Mergers b. Acquisitions c. Divestiture d. Spin-off
20. Sale of a major component or segment of a business (e.g. brand or
product line) to another company a. Mergers b. Acquisitions c. Divestiture d.
Spin-off
MULTIPLE CHOICE: (continuation)
27 Which key principles in valuation refers to Business value tend to change
21. General term which describes the transaction two companies combined to every day as transaction happens? a. The value of a business is defined only at a
form a wholly new entity a. Mergers b. Acquisitions c. Divestiture d. Spin-off
specific point in time b. Value varies based on the ability of business to generate
future cash flows c. Firm value can be impacted by underlying net tangible assets
22. usually has two parties: the buying firm and the selling firm. The buying
d. Market dictates the appropriate rate of return for investors
firm needs to determine the fair value of the target company prior to offering a
bid price. On the other hand, the selling firm (or sometimes, the target
28. refers to the possible range of values where the real firm value lies.
company) should have a sense of its firm value as well to gauge
a. risk of the unknown b. volatility c. uncertainty d. None of the above
reasonableness of bid offers. a. Mergers b. Acquisitions c. Divestiture d. Spin-off
29. Which key principles in valuation refers to Market forces are constantly
23. Acquisition of another business by using significant debt which uses the
changing, and they normally provide guidance of what rate of return should
acquired business as a collateral. a. Mergers b. Acquisitions c. Divestiture d.
investors expect from different investment vehicles in the market? in a. The
Leveraged buy-out
value of a business is defined only at a specific point time b. Value varies based
on the ability of business to generate future cash flows assets c. Firm value can
24.. assumes that the combined value of two firms will be greater than the sum be impacted by underlying net tangible assets d. Marlet dictates theappropriate
of separate firms. can be attributable to more efficient operations, cost
rate of return for investors
reductions, increased revenues, combined products/markets or crossdisciplinary talents of the combined organization. a. Synergy b. Control c.
30. The key principles in valuation refers to general concepts for c. Firm value
Synergy and Control d. None of the above
can be impacted by underlying net tangible d. Market dictates the appropriate
rate of return for investors most valuation techniques put emphasis on future
25. deals with prioritizing and distributing financial resources to activities that cash flows except for some circumstances where value can be better derived
increases firm value. The ultimate goal is to maximize the firm value by
from asset liquidation is a. The value of a business is defined only at a specific
appropriate planning and implementation of resources, while balancing
point in time b. Value varies based on the ability of business to generate future
profitability and risk appetite. a. Financial Management b. Corporate Finance c. cash flows c. Firm value can be impacted by underlying net tangible assets d.
Risk Management d. Portfolio Management
Market dictates the appropriate rate of return for investors
26. Generally, the valuation process considers these steps, except
a. Understanding the Business b. Forecasting Financial Performance d.
Preparing Valuation model based on forecasts d. All of the above
CH2. Asset Based
Valuation
ASSET- a present economic resource controlled by the entity
as a result of past events.
-a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity
ECONOMIC RESOURCE- a right that has the potential to
produce economic benefits.
INTRO
Asset has been defined by the industry as transactions that
would yield future economic benefits as a result of past
transactions.
Green field investments- investments that started from
scratch.
-value should be based on pure estimates
Brown field investments- are those opportunities that can be
either partially or fully operational.
-those already in the going concern state, as most businesses
are in the optimistic perspective that they will grow in the
future.
GCBOs(Going concern business opportunities)
those businesses that has a long term to infinite operational
period.
Benefits of having a sound Enterprise-wide Risk
Management (ERM) allows the company to:
increase the opportunities;
facilitate management and identification of the risk
factors that affect the business;
identify or create cost-efficient opportunities
manage performance variability;
improve management and distribution of resources
across the enterprise; and
make the business more resilient to abrupt changes
Replacement Value Method
Replacement Cost- the cost of SIMILAR assets that have the
nearest equivalent value as of the valuation date.
Under the replacement value method, the value of the individual
assets shall be adjusted to reflect the relative value or cost
equivalent to replace that asset.
.
Factors that can affect the replacement value of an asset:
Age of the asset - It is important to know how old the asset is. This will
enable the valuator to determine the costs related in order to upkeep a
similarly aged asset and whether assets with similar engineering
design are still available in the market.
Size of the assets - This is important for fixed assets particularly real
property where assets of the similar size will be compared. Some
analysts find that the assets can produce the same volume for the
assets of the same size.
Competitive advantage of the asset - Assets which have distinct
characteristics are hard to replace. However, the characteristics and
capabilities of the distinct asset might be found in similar, separate
assets. Some valuators combine the value of the similar, separate
assets that can perform the function of the distinct asset being valued.
There is a specific discipline in determining the replacement value.
Appraisers have their own technique to determine the replacement value.
Insurance companies use the replacement value in determining the
appropriate insurance premium to be charged to their clients.
FORMULA
Replacement Value per share= NBV (+-) replacement adjustment
No. of outstanding shares
illustration:
JPIA Corp., suppose that 50% of the non-current assets has an estimated
replacement value of 150% of its recorded net book value while the remaining
half has estimated replacement value of 75% of their recorded net book value.
With the given information, what is the replacement value per share:
Solution:
50% of NCA - 150% of the NBV
1M x 50% = 500,000
500,000 x 150%= 750,000
Adjusted NCA= 750,000 (A)
50% of NCA - 75% of the NBV
1M x 50% = 500,000
500,000 x 75%= 375,000
Adjusted NCA= 375,000 (b)
Adjusted NCA (A) + Adjusted NCA (B)
Total Adjusted NCA + CA
1,125,000 + 500,000
=1,625,000
750,000 + 375,000
=1, 125,000
Rep. val= 1.625M- 900K / 1M shares
725,000/1M
=P725 per share
ASSET-BASED VALUATION METHODS
Book Value
Method
Replacement
Value Method
Reproduction
Value Method
Liquidation
Value Method
Book Value Method
Book Value- the value recorded in the accounting records of a
company.
- dependent on the value of the assets as declared in the
audited financial statements, particularly the balance sheet or
the statement of financial position.
-IAS No.1 requires that the statement of financial position to
summarize the total value of its assets, liabilities and equity of
a firm.
-assets are required to be categorized into current and noncurrent assets
CURRENT ASSETS
expected to be realized within the
company's normal operating cycle
expected to be realized within 12
months after these transactions
were reported,
held primarily for the purpose of
trading
NON CURRENT ASSETS
- benefits can be realized in more
than 12 months
CURRENT AND NON
CURRENT LIABILITIES
- same treatment with the asset
-Cash and cash equivalents may
also be included only if it is not
restricted.
FORMULA
In the book value method, the value of the enterprise is based on
the book value of the assets less all non-equity claims against it.
Hence, the formula is as follows
Net Book Value of Assets = Total Assets – Total Liabilities
No. of outstanding shares
illustration:
JPIA Corp in the year 2022 presented their statement of financial
position with the following balances:
Current Asset_500,000,000
Non Current Asset_1,000,000,000
Current Liabilities_200,000,000
Non-Current Liabilities_700,000,000
Outstanding Shares_1 Million
What is the book value per share of the assets?
Solution:
NBVA= TA-TL/# of shares
=1.5M - 900K/1M
=600K/1M
=PHP 600 per share
Advantage: Provides more transparent view on firm value and
and is more verifiable since this is based in the figures reflected in
the FS.
Limitation: : It only reflects historical value (based only on
what‘s recorded in the acctg books) and might not reflect the
REAL VALUE of a business.
Liquidation Value Method
Reproduction Value Method
In some instances, no external information is available that can
serve as basis for replacement cost of assets that are highly
specialized in nature. In this case, reproduction value is used
instead.
Reproduction value- an estimate of cost of reproducing, creating,
developing or manufacturing a similar asset.
While this is a convenient approach, the challenge of using
reproduction value method is the ability to validate the
reasonableness of the value calculated since there are only limited
sources of comparators and benchmark information that can be
used.
an equity valuation approach that considers the salvage value
as the value of the asset.
This assumes that the reasonable value for the company to be
purchased is the amount which the investors will realize in the end
of its life or the value of the when it is terminated.
While the value it provides is the most conservative, the limitation
of this approach is that the future value is not fully incorporated in
the calculated equity value
WILL BE FURTHER DISCUSS IN THE NEXT CHAPTER
Steps in determining the equity value using the reproduction
value method are as follows:
1. Conduct reproduction costs analysis on all assets
2. Adjust the book values to reproduction costs values (similar as
replacement value)
3. Apply the replacement value formula using the figures
calculated in the preceding step.
FORMULA
Reproduction Value per share= NBV (+-) replacement adjustment
No. of outstanding shares
(same as replacement)
illustration:
JPIA Corp., supposed that it was noted that the 80% of the total noncurrent
assets are cheaper by 90% of the book value when reproduced. 20% of the total
noncurrent assets are comprised of goodwill which upon testing was proven to
be valued correctly. What is the reproduction value per share?
Solution:
NCA 1,000,000 x 80%affected item
=800, 000
Since the remaining 20% or Php 200
Million is goodwill and already in its
proper value, it will not be adjusted.
NCA x repro cost estimate %
=800,000 x 90%
=720,000 repro cost
Repro cost + goodwill
NCA= 720,000 + 200, 000
=920,000+ Current assets
920,000 + 500,000
TA = 1, 420,000
Repro Value per share = 1.420 -900 /1M shares
=520/1M
=Php 520 per share
ASSESSMENT
TRUE OR FALSE:
1. Asset has been defined by the industry as transactions that would
yield future economic benefits as a result of past transactions.
2. Brown field investment is the term used to describe businesses that
are starting from scratch.
3. Enterprise-wide Risk Management allows the company to increase
performance variability.
4. Risk identification is important to allow investors to assess impact
of the risk to their investment.
5. Brown field investments are easier to evaluate as information is
already available from prior years
6. Book value is the term used to describe the value derived from the
amounts reflected in the financial statements.
7. Borrowings that are contracted to be paid after 24 months is
classified as current liabilities.
8. Equipment is classified as non-current assets.
9. To get book value per share, total liabilities is deducted from total
assets and the resulting figure is divided by total authorized shares.
10. Book value method is a transparent approach since value can be
easily verified by looking at the financial statements.
11. Replacement cost is the cost of similar assets that have the nearest
equivalent value as of the valuation date.
12. Replacement value is affected by asset age, size and its
competitive advantage.
13. Insurance companies use replacement value as basis to determine
the appropriate insurance premium to be charged to their clients.
ENUMERATION/IDEN
Asset based valuation methods
Formula for net book value per share
Formula for replacement value per share
Asset turnover formula
Factors that can affect the replacement value of an asset:
14. For real properties, it is more important to look at the age of the
asset than its size.
15. Replacement value method is superior to book value as it gives an
indication of true value of the firm as of the valuation date.
16. Replacement value is an estimate of cost of reproducing, creating,
developing or manufacturing a similar asset
17. If there is no comparable assets found in the market, it is more
appropriate to use reproduction value method.
18. Reproduction value is used for business ventures that are using
highly specialized equipment in their operations.
MC THEORIES
1.This has been defined by the industry as transactions that would yield
future
economic benefits as a result of past transactions.
a. Asset b. Equity c. Net Assets d. Shares of Stocks
2. These are investments which are already in the going concern state, as
most business are in the optimistic perspective that they will grow in the
future because of historical proof
a. Green Field Investments b. Brown Field Investments c. Blue Field Investment
d. Black Field Investments
3. The following describes the benefits of having a sound Enterprise-wide
Risk Management system except a. Facilitates elimination of all business risks
b. Manage performance variability c. Enhance business resilience against
changes d. Improve distribution of resource across the firm
19. Reproduction value is easy to validate despite not having
comparable assets in the industry.
20. Among the approaches, the book value method gives the most
recent approximate of the company value.
MC THEORIES (continuation)
4. One of the advantages of using asset based methods in valuation is
a. Relies on the ability of the firm to generate revenues in the coming years
b. Considers future cash flows that can be derived from the use of assets
c. Incorporates how the market perceives the value of the company
d. Enables stakeholders to validate firm value based on the value of assets it
currently own
5. This refers to the value recorded in the accounting books of a firm as
reflected in the audited financial statements.
a. Exit value b. Book value c. Earnings per share d. Fair market value
6. Receivables that are collectible after 60 days are classified as
a. Current Liabilities b. Non-current Liabilities c. Current Assets d. Non-current
Assets
7. The net book value of assets may also represents
a. Total shareholder's equity b. Total assets c. Total liabilities d. Total longterm debt
8. Book value also reflects the company's
a. Historical value b. Liquidation value c. Intrinsic value d. Fair market value
9. Using the book value has its advantages, the following statements provide
them except
a. Information necessary for computation can be quickly gathered
b. Validated by a third-party expert with knowledge on how much assets are
sold in the open market c. Shows a transparent view on firm value
d. Can easily be validated by reviewing the company's audited
financial statements
10. Cost of similar assets that have the nearest equivalent value as of the
valuation date.
a. Book value b. Replacement cost c. Fair market value d. Reproduction value
14. Book value and replacement values of an asset are theoretically different.
The difference of these two is
a. Book value is based on the historical acquisition costs while replacement
value is based on the net asset value as of balance sheet date.
b. Book value can be computed from the financial statements while
replacement value is gathered by employing services of an appraiser.
c. Book value is computed on a per share basis, but replacement cost is shown
as absolute values.
d. Book value includes cost allowances for gaps against market prices while
replacement cost does not.
15. What method is appropriate in valuing assets which do not have available
external information even after consulting with appraisers?
a. Book value method b. Replacement value method c. Reproduction value
method d. Liquidation value method
16. The use of reproduction value method is appropriate for the following
except
a. When calculating value of new technology or start-up businesses
b. Ventures with highly specialized equipment
c. Companies that are highly reliant with intangible assets
d. Businesses that use equipment supplied by third-party manufacturer
17. Reproduction value is the
a. Estimate of cost of reproducing, creating, developing or manufacturing a
similar asset internally b. Salvage value of the asset c. Net value reflected in the
company's financial statements d. Cost of similar assets that have the nearest
equivalent value as of the valuation date
18. What is the limitation imposed by the use of reproduction value method
a. It considers only the original cost of the assets at the time they are acquired
b. High professional fees of appraisers
c. Difficulty in validating reasonableness of calculated value because of limited
comparators d. Inability to forecast future cash flows accurately because of
uncertainties in the market
11. The factor that affects the replacement value of an asset are the following
except
a. Competitive advantage of the asset b. Size of the asset c. Original acquisition
cost of the asset d. Asset age
19. The following methods shows the most recent value of the firm assets in
the market as of the valuation date, except
a. Replacement value method b. Liquidation value method c. Reproduction
value method d. Book value method
12. The main basis to determine the value of the insurance premium to be
paid to cover the risk for an asset is
a. Original acquisition cost b. Replacement cost c. Book value as of premium
payment date d. Acquisition cost less accumulated depreciation and
impairment losses
20. When computing for book value, which of the following items should be
deducted the asset value?
a. Total liabilities b. Total shareholders equity c. Long-term debt only d.
Ordinary share capital
13. When determining replacement costs of assets, valuators tend to consult
with a. Actuaries b. Board of Directors c. Appraisers d. Equity Analysts
COMpUTATION
1.The following data were gathered from the annual report of Desk Products.
Market price per share - 30.00
Number of common shares - 10,000
Preferred stock, 5% P100 par - 10,000
Common equity - 140,000
The book value per share is
2.As of December31, 2020, Donna Corporation presented the following
accounts in its balance
sheet:
Easy Company
Statement of Financial Position
December 31, 2021
Accounts receivable 450,000
Cash and cash equivalents 800,000
Intangible Inventories 900,000
Long-term investments 950,000
Mortgage payable, due in 5 years 1,500,000
Note payable, short-term debt 200,000
Note payable, long-term debt 500,000
Prepaid expenses 200,000
Property, plant and equipment 4,400,000
Retained earnings 1,350,000
Share capital, P100 par 4,000,000
Share premium 500,000
Trade and other payables 450,0001
amount of Total Current Assets as of December 31, 2021
amount of Total Non-Current Assets as of December 31, 2021
amount of Total Current Liabilities as of December 31, 2021
mount of Total Non-Current Liabilities as of December 31, 2021
Book Value of Easy Company
Book Value per share
3. As of December31, 2020, Donna Corporation presented the following
accounts in its balance
sheet:
Cash 340,000
Receivables 520,000
Inventory 350,000
PPE 3,000,000
Equipment 850,000
Accounts Payable 500,000
Short-term Notes Payable 500,000
14 months Debt 1,000,000
Share Capital, P2 Par 500,000
Donna Corporation contracted with a third-party appraiser to determine how
much is thereplacement cost of its assets. Based on the report of the
appraiser, the property and plant has replacement cost of 150% of its
reported value. On the other hand, the equipment only commands
replacement cost 60%of its value. According to the appraiser, the equipment
was designed using an old technology, thus, the lower replacement cost.
Other assets and liabilities are valued fairly.
Total Non-Current Assets reflected in the books of Donna Corporation as
of December 31, 2020
book value per share of Donna Corporation as of December 31, 2020
replacement value of the non-current assets of Donna Corporation
replacement value per share of Donna Corporation?
4. Mary Company, a new company which developed a dating application for
all single users. Their recent financial statement showed the following data:
Cash 250,000
Inventory 500,000
Accounts Receivable 300,000
Marketable securities 200,000
Cash Surrender Value of Life Insurance 1,500,000
Patent2, 500,000
Accounts Payable 400,000
Accrued Liabilities 450,000
Bond Payable 250,000
Mary Company tried to trace back the costs of developing the patent and
determined that the reproduction cost of that particular patent is at
3,500,000
Book value er share
Reproduction value
Reproduction value per share