Introduction to Business Valuation Questions and Answers

Introduction to Business Valuation Questions and Answers Why perform a valuation? - selling a business - acquiring a business - raising money - investment recommendations - internal business decision making - impairment testing - valuing employee options and compensation - bankruptcy estate planning - litigation Factors to consider for a valuation - company management -industry & competition -threats and challenges -microeconomic environment -macroeconomic environment Valuation techniques - Asset Approach (FMV of net assets) -Intrinsic value (Income Approach) -Relative Value (Market Approach) Intrinsic value - DCF - forecasting future performance -calculating future cash flows -discounting back to present Relative Value - Public Company Comparables - Using multiples to find the worth of the company trying to value Relative value - Precedent Transactions - Past mergers & acquisitions Enterprise Value Enterprise Value = market cap + deb - cash Enterprise Value Vs Equity Value (Advantages) Enterprise Value - More useful when comparing companies with different capital structures -minimizes accounting policies relative to net income in Earnings/Share Equity Value -more relevant to equity valuation -requires less judgment than enterprise value, where there is debate over cash and debt Enterprise Value Vs Equity Value (Disadvantages) Enterprise Value -Other debt and cash like items that are difficult to measure -Less useful for analyzing stocks Equity Value -multiples rely on accrual accounting, which can be manipulated -different capital structures impact earnings, even if businesses are otherwise identical NPV UFCF Cash flow before paying debts and obligations LFCF Cash flow after it has met its debt obligations UFCF/WACC Numerator and denominator consistency 2 Parts of a DCF Discrete cashflows and terminal value projections Calculating UFCF (EBIT Method) Calculating UFCF (Net Income & EBITDA Method) Cost of Debt Yield*(1-tax rate) Cost of Equity Risk free rate + (Beta*(Equity risk premium)) Risk Free Rate Yield on a long term government bond. Free from default risk. Beta The output of a statistical regression that measures change in a stock return vs the overall market. Beta of 1.25 indicates that its riskier than the market. Equity Risk Premium Return of the stock market over and above the risk-free-rate (usually 4-8%) Factors that impact Cost of Equity -Beta - market risk -Alpha - firm specific risk Industry Beta (If Low R^2, calculate industry beta) -un-lever beta -take average or median -re-lever beta Terminal Value (Perpetuity Growth Method) Terminal Value (Terminal Multiple Method) Use estimated EV based on EBTDA multiple EV/EBITDA = exit multiple NPV Function Assumptions -end of period discounting -discounts all cash flows Adjusted NPV Function -Mid period discounting -remember to add one final period of discounting -discounts all cash flows