Business valuation

1. Business Valuation

6.  Introduction
 Key Drivers of Valuation
 Concepts of Value
 Golden Rules of Valuation
 Valuation Methods
 Valuation of Shares
 Goodwill / Brand Valuation
Contents

7. Introduction
Liberalization of economy, emphasis on core competence,
and relaxation of tax laws led to spurt of mergers, takeover,
acquisitions, de-mergers etc.
Aligning business activities in line with the prime objective
of creating & maximizing shareholders’ wealth, has
propelled large organizations into such strategic decisions.
In all these strategic decisions, one common thing that
assumes very critical proposition is “Business Valuations”.
‘Value’ means economic value, an amount expressed in
monetary terms, to be paid in exchange for an asset or right
to receive future benefits from use of the asset.

8. Introduction
Business
Valuation
• Total economic environment
• Potential use of the asset
• Timing of the value estimate
• Location of the asset
• Relative scarcity
• Availability of substitutes
• Extent of ownership involved
• Liquidity of the asset
• Physical condition of asset
Valuation dynamics
Value is not a static or homogenous concept
Value is different from
price or cost.
Price is the amount
spent to acquire an
asset, while Value is
what lies in the eyes of
the payer

9. Key Drivers of Valuation
Purpose of Valuation
• Buyer vs. Seller
• Acquisition vs. Investment
• Legal vs. Commercial
Industry and Sector
• Economy – Boom vs. Gloom
• Emerging vs. Dying Sector
• Manufacturing vs. Service
• Structured vs. Traditional
Macro factors
• Economic scenario
• Investment patterns in sector
• Government role
• Fin. Inst, Banks role
Micro factors
• Nature of product / service
• Business life cycles
• Seasonal nature
• Growing vs. Maturity
Regulations
• SEBI Takeover Regulations
• Banking mergers – RBI role
• Stock Exchange guidelines
• Companies Act

10. Concepts of Value
 Fair Market Value – the amount (arms’ length price) at which an
asset would exchange between a willing seller and a willing buyer
(having reasonable knowledge).
 Investment Value – the value of future benefits of ownership of an
asset to a particular buyer. Similar to Opportunity Cost.
 Book Value – it means the value of a business, as reflected in the
audited financial statements of an enterprise.
 Intrinsic Value – it is the total value of business after considering all
hidden and latent facts. Also defined as the present value of future
earnings stream discounted at the current market rate of return.
 Going Concern Value – the value under the assumption that the
business will never die. Value is based on future maintainable
income as a going concern, capitalized by a suitable rate of return.

11. Concepts of Value
 Replacement Value – replacement value is the cost of acquiring a
new asset of equal utility.
 Goodwill / Brand Value – the value of intangible assets. Difference
between price paid for acquiring a business and the fair market
value of all assets acquired, net of liabilities.
 Liquidation Value – it is the net amount that can be realized if a
business is terminated, its assets sold and liabilities satisfied.
 Benchmark Value – based on comparative company valuation,
used for justifying valuation of companies via several adjustments.
 Salvage Value – the amount realisable upon sale or other
disposition of an asset after it is no longer useful to the current
owner and is to be taken out of service. Different from scrap value,
where the asset is not useful for anyone for any purpose.

12. Golden Rules of Valuation
Valuation is an art, more than science
Valuation is more of subjective nature than objective
Valuation depends upon perceptions and skills of valuer
Valuation has a reference to time, even a single person
can have different values at different times
Price is paid for the deal, Value is in the eyes of the payer
Valuation is an critical tool for strategic decision making
Valuation is an application of theory and practice

13. Business Valuation Methods
 Historical Cost
 Current Cost
 Economic Valuation
 Asset Valuation
 Market Valuation

14. Business Valuation Methods
Historical Cost Valuation – Also known as the Book Value
Method. All assets are taken at their respective historical
costs. Value of goodwill is ascertained and added to such
historical cost of assets.
Current Cost Valuation – Current cost of assets are taken
for valuation purposes, instead of historical costs.
• Tangible assets – current replacement price is taken
• Investment – valued at current market prices, unquoted
investments are taken at cost, unless MP determined
• Inventory – current market prices
• Debtors – net collection / realizable amount
• Intangibles – current acquisition prices (Patents, TM, CP)

15. Business Valuation Methods
Economic Valuation (Income based) – Fundamental logic
behind the concept is that values of business are determined
by its profitability (present and future) and cash generation
ability. There are three techniques:
 Capitalization method – past profits (3-4 yrs) are capitalized at
a proper rate of return, as applicable to the company and the
industry. Adjustments are made for extraordinary items,
abnormal losses, taxation, appropriate weights to profits etc.
 Profit Earning Capacity Value – similar to capitalization
method, except that future maintainable profits are considered
for capitalization.
 Discounted Cash Flow – value of business is the present value
of all future cash flows. Better method, since it considers time
value of money. WACC be used as the discount factor. Future
cash flows calculation based on taxes, depreciation etc.

16. Business Valuation Methods
Asset based Valuation – this method is used in combination
with profitability and market value methods.
• While valuing assets under this approach, total assets are
divided into operating and non-operating assets.
• Non-operating assets are valued at realizable value, while
operating assets are valued at their book values.
Market Valuation – applicable for listed companies, where
share price is determined by market forces. Average price is
selected for valuation purposes
Comparative companies – certain parameters of comparative
companies are used for valuation. This method is more used
for negotiation, rather than valuation.

17. Valuation of Shares
Computation of the share value of a firm, using various
techniques. It involves arriving at the proper share value,
i.e. value which ‘ought to be’.
Considerations governing share valuation are intricate,
varied and numerous. They are quantifiable as well as
non-quantifiable, objective as well as subjective.
Valuer’s approach is influenced by purpose of valuation.
E.g. a valuer may use liberal ways in compensation cases,
while a strict view for taxation. (basic principles being same)
Valuation requires judicious assessment of the interests,
advantages, expectations, hazards of parties involved

18. Valuation of Shares – Purpose
 Purchase of a block of shares, which may or may not give
the holder – a controlling stake in the company
 Formulation of scheme of amalgamation, absorption,
merger and acquisition etc.
 Acquisition of interest of dissenting shareholders under a
scheme of reconstruction
 Compensating shareholders by the Govt. under scheme
of nationalization
 Advancing a loan on the security of shares
 Assessment under Wealth Tax Act
 Conversion purposes (Deb., Pref. into equity shares)

19. Valuation of Shares
 In case of shares quoted on recognized stock exchanges,
these prices are normally taken as the basis for valuation.
 However, stock exchange quotations are not acceptable –
o Stock exchange prices are driven by demand-supply cycles
o Prices are more sentiment based, rather than fact based
e.g. Tata Motors price fell on acquisition of Jaguar, Rover
o Many factors other than company performance affect the
prices such as inflation, crude oil rate, political turmoil etc.
o Reign of speculation, intelligence, guess-work, fear etc.
Two factors stand-out to be basically important for share
valuation viz. assets employed and earning capacity. For a
going concern, earning power plays a major role, while
assets are considered only to indicate safety margin.

20. Share Valuation Methods
 Net Assets Basis
# Net assets available to Equity share holders
Number of equity shares
# Tangible fixed assets (plant, bldg. etc.) and intangibles
(patents, copyrights etc) should be taken at their current
market costs. Separate valuation for goodwill is necessary.
# Investment at market prices / book value (availability basis)
# Stock of FG @ market price, but RM, WIP, stores may be
taken at cost. (using a conservative approach)
# Receivables be taken based on quality, with provisions.
# Fictitious assets, P&L debit balance, preliminary expenses
should be excluded.

21. Share Valuation Methods
 Net Assets Basis
# All short-term and long-term liabilities should be deducted
from total assets. (incl. accrued interest and expenses)
# Preference capital, including dividend arrears be deducted.
# If ex-dividend equity share value is reqd., proposed equity
dividend should also be deducted.
# Adequate provisions for taxation and liabilities not provided
in the books of accounts.

22. Share Valuation Methods
 Yield Basis
∂ Yield based valuation is earnings and rate of return centric.
∂ If a block of shares (controlling interest) is to be taken, rate
of earnings should be the basis.
∂ For a small block of shares, rate of dividend is the basis.
∂ Steps in valuation include determination of the future
maintainable profits and establishing desired rate of return.
Suitable adjustments be made in calculation of profits such
as abnormal items, taxation, depreciation, govt. policy etc.
∂ Capitalize the earnings by the rate of return to arrive at the
total value. Divide the total value with the number of shares
to get the value per share.

23. Valuation of Goodwill / Brand
 Goodwill is an intangible asset and contributes to
the profit earning capacity of a business.
 Goodwill is the difference between the value of a
business as a whole and the aggregate of the fair
values of its separable net assets. (UK A/c Std.)
 Peculiarities of goodwill –
 No direct / predictable relation with any costs incurred
 Distinct factors adding brand value cannot be valued
 Value of goodwill fluctuates widely, over short periods
 Assessment of brand / goodwill is highly subjective
 Types of goodwill – ‘Dog’, ‘Cat’ and ‘Rat’

24. Goodwill / Brand Creation
‫גּ‬ Steady, growing profitability
‫גּ‬ Minimal risk exposure
‫גּ‬ Superior management
‫גּ‬ High quality products
‫גּ‬ Exceptional sales section
‫גּ‬ Secret / patent processes
‫גּ‬ Effective advertising
‫גּ‬ Outstanding credit ratings
‫גּ‬ Cost savings
‫גּ‬ Technology advantage
‫גּ‬ Strong capital base
‫גּ‬ Better liquidity position
‫גּ‬ Good public image
‫גּ‬ Strategic location
‫גּ‬ Favourable govt. policies
‫גּ‬ Good labour relations
‫גּ‬ Social commitments
‫גּ‬ Weak competitors
‫גּ‬ Market dominance
‫גּ‬ Economies of scale

25. Goodwill / Brand Valuation
Simple Profit Method – In this method, goodwill is valued
on the basis of certain number of years purchase of average
profits of the past few years.
Average profits = Capital employed * normal rate of return
Goodwill = Average profits * no. of years purchase
Super Profit Method – Excess of future maintainable profit
over normally expected profit is known as super profits.
Under this method, goodwill is taken as the number of years
purchase of super profits expected to be maintained.
Super Profit = future profits – (capital employ * normal rate)
Goodwill = Super profits * no. of years maintained

26. Goodwill / Brand Valuation
Capitalization Method – Future maintainable profits are
capitalized, by using a normal rate of return to arrive at the
normal capital employed. Goodwill is the excess of normal
capital employed over actual capital employed.
Normal Capital Employed = Future maintainable profit
Normal rate of return
Goodwill = Normal capital employ (-) Actual Capital employ