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
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
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.
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.
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
9. High Level of
Leadership and
Organization Skills
technology in financial modelling and
business valuation.
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%
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
∙ ​Summary
of student
reflection
and
expectatio
n
∙ ​Elect
class
officers,
prepare
seat plan.
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
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
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
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 w
​ ho 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
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
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
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
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
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 = ​CF​n
G
TV = Terminal Value
CFn = Farthest net cash flows
g = Growth rate
g=
NCF​0 =
​ net cash flows at the beginning
NCF​n =
​ 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=
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
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?
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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
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
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
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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
​
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
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
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
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% ​
CPI​o
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%
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 =
(K​e x​ W​e​) + (K​d x
​ W​d​)
K​e –
​ cost of equity
W​e –
​ weight of the equity financing
K​d –
​ cost of debt after tax
W​d ​– weight of the debt financing
K​e =
​ R​f +
​ B (R​m –
​ R​f​)
R​f ​– risk free rate
B – beta
R​m –
​ market return
K​d =
​ R​f +
​ DM
R​f –
​ 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
25.96
314.05
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
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.
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,
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
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.
Asset
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
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
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 i​ s 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
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
Earnings
1
50,000.00
2
60,000.00
3
65,000.00
4
75,000.00
5
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
Earnings
1
50,000.00
2
60,000.00
3
65,000.00
4
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),
BIZCOMPS​R​, Pratt’s Stats​TM​, Done Deal​TM​, Mid Market Comps​TM​, Mergerstat​R​.
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.
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
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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.
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
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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
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
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SUBJECT: ACCO 40013 – VALUATION CONCEPTS AND METHODS
PREPARED BY: CIELO AMOR E. DIQUIT, CPA, MBA