CHAPTER 1 TO CHAPTER 4

01 – FUNDAMENTALS PRINCIPLES OF ▪ It is assumed that the entity will realize

VALUATION assets and pay obligations in the normal
▪ Value – pertains to the worth of an object in course of business.
another person’s point of view. 3. Liquidation Value
▪ Valuation – estimation of an asset’s value ▪ Net amount that would be realized if the
based on variables perceived to be related to business is terminated and the assets are
future investment returns, on comparisons with sold on a piecemeal basis.
similar assets, or, when relevant, on estimates ▪ Value is computed on the assumption that
of immediate liquidation proceeds. the entity will be dissolved.
o Includes the use of forecasts to come up with 4. Fair Market Value
reasonable estimate of value of an entity’s ▪ The price at which property would change
assets or equity. hands between a hypothetical willing and
Factors in the Value of a Business able buyer and a hypothetical willing and
1. Current Operations – how is the operating able seller, acting at arm’s length in an open
performance of the firm been in recent and unrestricted market, when neither is
years? under compulsion to buy or sell and when
2. Future prospects – what is the long-term, both have reasonable knowledge of the
strategic direction of the company? relevant facts.
3. Embedded Risk – what are the business ▪ assumes that both parties are informed of all
risks involved in running the business? material characteristics of the investment
Definitions of Value 1. Intrinsic Value that might influence their decision
▪ Refers to the value of any asset based on the Roles of Valuation in Business
assumption that there is a hypothetical Portfolio Management - Largely depends on the
complete understanding of its investment investment objectives of the investors or financial
characteristics managers managing the investment portfolio
▪ the value that an investor considers, on the 1. Fundamental Analysts
basis of an evaluation of available facts, to be ▪ Persons who are interested in
the "true" or "real" value that will become the understanding and measuring the intrinsic
market value when other investors reach the value of the firm.
same conclusion ▪ For them, the true value of a firm can be
Grossman – Stiglitz Paradox estimated by looking at its financial
▪ If the market prices, which can be obtained characteristics, its growth prospects, cash
freely, perfectly reflect the intrinsic value of an flows, and risk profile.
asset, then a rational investor will not spend to ▪ Principles:
gather data to validate the value of a stock. o Relationship between value and
▪ Investors will not analyze information about underlying factors can be reliably
stocks anymore. measured
▪ Investors will not rationally spend to gather o Above relationship is stable over an
more information about an asset unless they extended period
expect that there is reward in exchange of the o Any deviations from the above
effort. relationship can be corrected within a
2. Going Concern Value reasonable time
▪ Believes that the entity will continue to do its ▪ Value investors o tend to be mostly
business activities into the foreseeable interested in purchasing shares that are
future. existing and priced at less than their true
value
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▪ Growth investors o Lean towards growth Business deal 1. Acquisition

assets and purchase these at a discount. ▪ An acquisition usually has two parties the
2. Activists Investors buying firm and the selling firm.
▪ tend to look for companies with good ▪ The buying firm - needs to determine the fair
growth prospects that have poor value of the target company prior to offering a
management. bid price.
▪ Takeovers - they use their equity holdings ▪ the selling firm (or sometimes, the target
to push old management out of the company) - should have a sense of its firm
company and change the way the value to gauge the reasonableness of bid
company offers.
is run 2. Merger - General term which describes the
3. Chartists transaction wherein two companies had their
▪ relies on the concept that stock prices are assets combined to form a wholly new entity.
significantly influenced by how investors 3. Spin-off - Separating a segment or component
think and act business and transforming this into a separate
▪ assume that stock prices change and legal entity.
follow predictable patterns since investors 4. Leveraged buyout
make decisions based on their emotions ▪ acquisition of another business by using
rather than on rational analysis significant debt which uses the acquired
4. Information Traders business as collateral.
▪ Traders that react based on new ▪ Synergy and Control
information about firms that are revealed to o Synergy - potential increase in firm value
the stock market that can be generated once two firms merge
▪ Valuation is important to information with each other.
traders since they buy or sell shares based o Control - change in people managing the
on their assessment of how new organization brought about by the
information will affect stock price acquisition
Activities in portfolio management that are Corporate Finance
performed through valuation: ▪ involves managing the firm’s capital structure,
1. Stock selection - Is a particular asset fairly including funding sources and strategies that
priced, overpriced, or underpriced in relation to the business should pursue to maximize firm
its prevailing computed intrinsic value and value.
prices of comparable assets? Legal and Tax Purposes
2. Deducing market expectations - Which ▪ The value of a business is used in determining
estimates of a firm's future performance are in statutory obligations (in some taxes or
line with the prevailing market price of its business distribution requirements)
stocks? Are there assumptions about Other Purposes
fundamentals that will justify the prevailing ▪ Issuance of a fairness opinion for valuations
price? provided by a third party (e.g. investment
Analysis of Business Transactions / Deals bank)
▪ Potential acquirers use relevant valuation ▪ Basis for assessment of potential lending
techniques (whichever is applicable} to activities by financial institutions
estimate the value of target firms they are ▪ Share-based payment/compensation
planning to purchase and understand the Valuation Process Steps:
synergies they can take advantage of the 1. Understanding of the business
purchase 2. Forecasting financial performance

APRIL JOY DARADAR BSA 4B VALUATION CONCEPT & METHODOLOGIES

CHAPTER 1 TO CHAPTER 4

3. Selecting the right valuation model 1. Top-down forecasting approach - Forecast

4. Preparing valuation model based on forecasts starts from international or national
5. Applying Valuation conclusions and providing macroeconomic projections with utmost
recommendation. consideration to industry specific forecasts.
2. 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
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.
Preparing the Valuation model based on
forecasts
▪ Once the valuation model is decided, the
forecasts should now be inputted and
converted to the chosen valuation model.
Corporate Strategies to Achieve Competitive
Advantage: Aspects to consider:
1. Cost Leadership - Relates to the incurrence of 1. Sensitivity Analysis - A common methodology
the lowest cost among market players with in valuation exercises wherein multiple analyses
quality that is comparable to competitors are done to understand how changes in an
allowing the firm to price products around the input or variable will affect the outcome.
industry average. 2. Situational adjustments or scenario
2. Differentiation - Firms tend to offer modeling - Firm-specific issues that affect firm
value that should be adjusted by analysts.
differentiated or unique product or service
Applying valuation conclusions and
characteristics that customers are willing to pay
providing recommendation
for an additional premium
▪ Once the value is calculated based on all
3. Focus - Firms are identifying a specific
assumptions considered, the analysts and
demographic segment or category segment to
investors use the results to provide
focus on using either of the two strategies (cost
recommendations or make decisions that
leadership or differentiation).
suit their investment objective.
Business model
Key Principles in Valuation
▪ pertains to the method of how the company
1. The Value of a Business is Defined Only at a
makes money — what are the products or
specific point in time
services they offer, how they deliver and
2. Value varies based on the ability of business to
provide these to customers and their target
generate future cash flows
customers
3. Market dictates the appropriate rate of return
▪ The results of the execution of the
for investors
aforementioned strategies will ultimately be
4. Firm Value can be impacted by underlying net
reflected in the company performance results
tangible assets
contained in the financial statements. Analysts
5. Value is influenced by the transferability of
look at the historical financial statements to
future cash flows
get a sense of how the company performed.
6. Value is impacted by liquidity
Forecasting Approaches:
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Risks in Valuation The importance of identifying risks is to enable

▪ Uncertainty - The possible range of values investors to quantify the risk and/or the cost of
where the real firm value lies. managing these risks.
1. Some valuation methods use future estimates Among the popular methods used to determine the
which bear the risk that what will actually value using assets as its bases are:
happen may be significantly different from the (1) book value method;
estimate. (2) replacement value method,
2. Analysts use their judgments to ascertain (3) reproduction value method; and
assumptions based on current available facts (4) liquidation value method.
3. Depending on the industry, businesses can be Book Value Method
very sensitive to changes in macroeconomic ▪ Book value can be defined as the value
climate (investment goods, luxury products) or recorded in the accounting records of a
not at all (food and pharmaceutical) company.
4. Innovations and entry of new businesses may ▪ Current assets are those expected to be
also bring uncertainty to established and realized within the company's normal
traditional companies. operating cycle, expected to be realized within
12 months after these transactions were
02 – ASSET-BASED VALUATION reported, or held primarily for the purpose of
▪ Asset - has been defined by the industry as trading.
transactions that would yield future economic ▪ Cash and cash equivalents may also be
benefits as a result of past transactions. included only if it is not restricted.
▪ The value should also include all cash flows ▪ On the other hand, assets wherein benefits
that will be generated until the disposal of the can be realized in more than 12 months are
asset. known as non-current assets.
Kinds of Investment ▪ On the other hand, liabilities are also
▪ Green field investments - investments that categorized as current and non-current.
started from scratch Current liabilities are expected to be settled
▪ Brown field investments - those within the entity's normal operating cycle, due
opportunities that can be either partially or to be settled within 12 months, held for the
fully operational. Brown field investments are purpose of trading, or if the company does not
those already in the going concern state, as have the ability to settle beyond 12 months.
most businesses are in the optimistic ▪ Non-current liabilities are liabilities that are
perspective that they will grow in the future due to be settled longer than 12 months. In
▪ Going concern business opportunities the book value method, the value of the
(GCBO) are those businesses that have a enterprise is based on the book value of the
long-term to infinite operational period assets less all non-equity claims against it.
The benefits of having a sound Enterprise-wide ▪ Hence, the formula is:
Risk Management allows the company to: Net Book Value of Assets = Total Assets –
1. Increase the opportunities; Total Liabilities / Number of Outstanding
2. facilitate management and identification of Shares
the risk factors that affect the business; BV = Total Assets – Total Liabilities
3. identify or create cost-efficient opportunities BV per Share = BV / Outstanding Shares
4. manage performance variability:
5. improve management and distribution of The advantage of using book value method is that
resources across the enterprise; and it provides a more transparent view on firm value
6. make the business more resilient to abrupt and is more verifiable since this is based in the
changes. figures reflected in the financial statements.

APRIL JOY DARADAR BSA 4B VALUATION CONCEPT & METHODOLOGIES

CHAPTER 1 TO CHAPTER 4

However, the book value only reflects historical Reproduction Value Method Reproduction
value and might not reflect the real value of the ▪ value is an estimate of the cost of reproducing,
business. creating, developing, or manufacturing a similar
Replacement Value Method asset.
▪ The National Association of Valuators and ▪ The reproduction value method requires
Analysts has defined the replacement cost reproduction cost analysis which is internally
as the cost of similar assets that have the done by companies especially if the assets are
nearest equivalent value as of the valuation internally developed.
date. ▪ The challenge of using the reproduction value
▪ Under the replacement value method, the method is the ability to validate the
value of the individual assets shall be reasonableness of the value calculated since
adjusted to reflect the relative value or cost there are only limited sources of comparators
equivalent to replace that asset. and benchmark information that can be used.
▪ Insurance companies use the replacement ▪ Formula same with replacement value:
value in determining the appropriate Steps in determining the equity value using
insurance premium to be charged to their the reproduction value method are as
clients. follows:
Replacement Value = NCA x % of NCA 1. Conduct reproduction costs analysis on all
Replacement Cost assets.
Replacement Value of Company = (RV of NCA + 2. Adjust the book values to reproduction costs
CA) – Total Liabilities values (similar to replacement values)
Replacement Value per Share = RV of Company 3. Apply the replacement value formula using the
/ Outstanding Shares figures calculated in the preceding step
The following are the factors that can affect the Liquidation Value Method
replacement Value of an asset: ▪ considers the salvage value as the value of
1. Age of the asset - It is important to know how the asset.
old the asset is. This will enable the valuator to ▪ This assumes that the reasonable value for
determine the costs related in order to upkeep the company to be purchased is the amount
a similarly aged asset and whether assets with which the investors will realize in the end of
similar engineering design are still available in its life or the value of the when it is
the market. terminated.
2. Size of the assets - This is important for fixed ▪ The future value is not fully incorporated in
assets particularly real property where assets the calculated equity value.
of the similar size will be compared. Some ▪
analysts find that the assets can produce the 03 - LIQUIDATION BASED VALUATION
same volume for the assets of the same size.
Formulas to remember.
3. 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.
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• Going concern value > Liquidation value o Assets are sold as quickly as possible;
Liquidation value o Used when there are doubts o Creditors have sued or bankruptcy is
about going concern ability; filed.
o Value of a company if it were dissolved and Calculating liquidation value
assets sold individually (CFA Institute); o Present value of sums that can be
o Net amount to be gathered upon business obtained through disposal of assets net
shutdown and disposal of assets; of closure costs, debt repayment,
o Base price or floor price liability settlement, tax charges and
liquidation costs.
Present Value of Sale of Asset xx o Liquidation value per share should be
Less: Present Value of Cost for (xx) considered with other quantitative and
Termination and statement of liabilities qualitative metrics to justify business
Less: Present Value of Tax Chargers (xx) decisions (e.g. current share price,
For the Transactions and Other going concern discounted cash flows).
Liquidation Costs o Discount rate should reflect the risk
Liquidation Value xx involved back to the date of original
Situations to Consider Liquidation valuation.
Value o Special considerations should be
o Business failures; emphasized for unsaleable intangible
o Corporate or project end of life; and assets (offset against shareholders’
o Depletion of scarce resources. equity).
General principles on liquidation value
o If liquidation value (LV) exceeds income 04 - INCOME-BASED VALUATION
approach valuation and liquidation is • Value of returns it yields or income it
considered, liquidation value should be used; generates = best estimate of company
o If the business has a limited lifetime, the value
terminal value should be based on liquidation • Income = amount of money the company or
(considering the costs necessary to close the assets will generate over time (to be
operations); reduced
o Non-operating assets should be valued by by costs to operate)
liquidation method; Two opposing theories
o Liquidation valuation must be used if • Dividend irrelevance – stock prices are not
business continuity is dependent on affected by dividends/returns; it’s affected
management that will not stay; by the ability and sustainability of the
o LV can also be used as a benchmark in company’s assets.
making investment decisions (e.g. sell or • Bird in hand (aka dividend relevance) –
keep); dividends/capital gains have an impact on
o When LV>MV, corporate investors can profit the stock prices.
from buying at MV and selling at LV. Upon establishment of the valuation of assets, the
following factors are also considered:
Types of liquidation
• Earning accretion or dilution - additional
ORDERLY LIQUIDATION value (accretion) to account for potential
o Assets are sold strategically to generate growth, increase in prices, operating
most money for the assets. efficiencies, or reduced value (dilution) if
FORCED LIQUIDATION otherwise.

APRIL JOY DARADAR BSA 4B VALUATION CONCEPT & METHODOLOGIES

 CHAPTER 1 TO CHAPTER 4

• Equity control premium – amount that a Economic Value Added (EVA)

buyer is willing to add to firm value to gain o Conventional way to determine the value of
control of it. an asset.
• Precedent transactions – previous deals o EVA quickly measures the firm’s ability to
or experiences similar to the support its cost of capital using its earnings.
investment being evaluated (risks that affect
Elements to be considered in EVA
realizability of projected earnings)
calculation are:
Key driver is the cost of capital or required return
o Reasonableness of earnings or returns;
which can either be computed through:
o Appropriate cost of capital
• Weighted average cost of capital (WACC);
and/or Computation of EVA
• Capital asset pricing model (CAPM) o EVA = Earnings – Cost of Capital
o Cost of Capital = Investment Value x Rate
Weighted Average Cost of Capital of Cost Capital
o WACC formula can be used in determining
the minimum required return. It can be used
Capitalization of Earnings Method
to determine the appropriate cost of capital o Value of an asset is determined using
by weighing the portion of the asset funded anticipated earnings of the company divided
through equity and debt by capitalization rate (i.e. cost of capital). o
o WACC = (Ke x We) + (Kd x Wd) Equity Value = Future Earnings
o Ke – Cost of Equity Required Return
o We – weigh of the equity financing oEarnings are typically interpreted as
o Kd – cost of debt after tax resulting cash flows from operations but
net income may be used if cash flow is
o Wd – weight of debt financing
not available.
o WACC may also include other sources of
o It is generally assumed that all assets are
financing like Preferred stock and Retained
income generating.
Earnings. Including other financing will have
o In case of idle assets, it should be added
to require redistributing the weight based on
the contribution of asset. to the calculated capitalized earnings.
The following are the limitations in using this
Capital Asset Pricing Model
method:
o The cost of equity may be also derived
o It may not fully account for the future
using CAPM. The formula is as to follows:
Ke = Rf + 𝜷 (Rm – Rf)
earnings or cash flows (resulting to over
o
Rf – risk free rate o 𝛽- Beta, is a stock’s
or undervaluation);
o o Inability to incorporate contingencies;
sensitivity to market risk o Rm – market o Assumptions determining cash flows may
return not hold true since projections are based
Cost of Debt on limited time horizon.
Discounted Cash Flows Method
o Most popular method of determining value.
o Kd = Rf + DM
o Generally used by investors, valuators, and
o Rf – Risk free rate analyst since this is the most sophisticated
o DM – Debt Margin approach.
o It is more verifiable since it is a more
detailed approach in valuation.
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o DCF model calculates the equity value by expenses depreciation amortization interest
determining the present value of the taxes and dividends to preferred
projected net cash flows. shareholders.
o Net cash flows may also assume a terminal • Non-cash charges (net)- pertains to non-
value for cash flows beyond projection. cash items that are included in the
computation of net income.
DISCOUNTED CASH FLOW METHOD
• Depreciation and amortization - it is a
• Valuation method used to estimate the value of
noncash expenses and two methods of
an investment based on its expected future
calculating the value for business assets
cash flows.
over time.
• DCF Analysis can be done by determining the
• Restructuring charges - refers to the
present value of the net cash flows of the
change in the organizational structure or
investment opportunity.
business model of a company adapt to
Net Cash Flows changing economic climate or business
• Refer to the amount of cash available for needs.
distribution to both debt and equity claims of
• Provision for doubtful accounts - these
the business or asset.
are estimated amounts to be incurred for
• Preferred basis of valuation if any of the the customer's inability to pay on time which
following conditions are presented: o Company is cumulatively accounted under the
does not pay dividends statement of financial position reported
o The company pays dividends but the against the accounts receivable.
amount paid out significantly differs • After-tax interest expense (net of any tax
from its capacity to pay dividends savings) - it is a cash flow intended for the
o Net Cash Flows and profits are aligned debt providers.
within a reasonable forecast period. • Working capital adjustments - also known
o Investor has a control perspective. If as working capital it represents the net
an investor can exert control over a investment in current assets such as
company, dividends can be adjusted receivables inventory reduced by current
based on the decision of the controlling liabilities like payable.
investor. • Investment in fixed capital - pertains to
Net Cash Flows to Firm cash outflows made to purchase or pay for
• Refers to the cash flow available to the parties capital expenditures that are required to
who supplied capital (lenders and
shareholders) after paying all operating
expenses including taxes and investing in
capital expenditures and working capital support existing and future operating needs.
required by business needs. B. Based from Statement of Cash Flows
A. Based on Net Income (Indirect Approach) • Cash flows from operating activities
- represents how much cash the
company
generated from its operation
• Cash flow from investing activities
represents how much cash is distributed
• Net Income Available to Common Share (received) from investment (sale of) long
Holders - the amount left for the common term assets like property, plant, equipment
shareholders after deducting all costs

APRIL JOY DARADAR BSA 4B VALUATION CONCEPT & METHODOLOGIES

 CHAPTER 1 TO CHAPTER 4

and strategic investments in other o Proceeds from Issuance of

companies. Preferred Shares – factored in
• Cash flow from financing activities - calculation of net cash flows
represents how much cash was raised or available to equity.
repaid to finance the company. o Dividends on Preferred Shares –
C. From Earnings Before Interest, payments made to preferential
Taxes, Depreciation and shareholders in the form of
Amortization (EBITDA) dividends are outflows.

• EBITDA – pertains to income before

deducting interest, taxes, depreciation, and
amortization expenses, net of taxes.
A. Based on Net Income (Indirect Approach)
• Tax Savings on Non-cash chargers –
several non-cash charges such as
depreciation and amortization are tax-
deductible.
Net Cash Flow to Equity (NCFE)
• Cash available for common equity
participants or shareholders only after
paying operating expenses, satisfying
operating and fixed capital requirements,
and settling cash flow transactions
involving debt providers and preferred B. From Statement of Cash Flows
shareholders.

• NCFE signifies the level of available cash C. From EBITDA

that a business can freely declare as
dividends to its common shareholders.
o Proceeds from Borrowing – cash
received by the company because
of borrowing long-term debt.
o Debt Service – used to service the
loans or debt financing. Amount of
loan repayment and the interest
expense, net of income tax benefit.
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Terminal Value • Reasonable appropriated cost of capital

• Represents the value of the company in or required rate of return.
perpetuity or in going concern • New quantifiable information.
environment.
Liquidation Value
• Some analysts find the terminal value be
based on the estimated salvage value of
the assets.
Estimated Perpetual Value
• to determine the terminal value is by using
the farthest cash flows you can estimate
divided by the cost of capital less the
growth rate.

Constant Growth
• challenges for some valuators are to
determine the amount of required return
for a specific type of asset or investment.
In lieu of the required return they used
the growth rate as the proxy especially if
the growth is constant and significant.
Scientific Estimates
• Other valuators especially those with vast
experience already in some types of
investments using other bases for them to
determine the reasonable terminal value.
Using guess estimates is not prevented
because in the end equity values will still
be based on negotiation.

DCF analysis is most applicable to use when the

following are available:
• Validated operational and
financial information.

APRIL JOY DARADAR BSA 4B VALUATION CONCEPT & METHODOLOGIES