Market Value, Market Capitalization and Market-based Approach

Market value is the company’s value in the stock market and indicates the liquidity of the

stocks (Seth, 2021). This approach employs sub-methods such as liquidation value, salvage value,

and comparable transaction method. Market value formula, also known as market capitalization, “is

calculated by multiplying a company’s outstanding shares by its current market price, that is:

Market Cap = Price Per Share × Shares Outstanding” (Seth, 2021, p.1)

1. It is praised among the appraisers for the reason that “the market approach is

probably the most fundamental approach in a fair market value appraisal. Because

fair market value is supposed to come from the market, it seems natural that this

approach should be greatly emphasized” (Trugman, 2012, p.285);

2. However, finding a similar/comparable company and/or transaction is a challenging

task as the factors that determine similarity greatly varies from company to company.

Such factors include past growth of sales and earnings, rate of return on invested

capital, stability of past earnings, dividend rate and record, quality of management,

nature and prospect of the industry” (Trugman, 2012, p.287) and so on.

Future Value and Revenue/Income-based Approach

In contrast with the present value, future value expresses the prospective value of a business

at an foreseeable future date based on the assumed rate of growth (Chan, 2021). This value approach

has high practical importance for “the amount of growth generated by holding a given amount in

cash will likely be different than if that same amount were invested in stocks; therefore, the future

value equation is used to compare multiple options” (Chan, 2021, p.4). This approach bases its

projections on future expectations and employs discounted cash flow and

1. It relies on “the cash flows the firm will be able to generate in the future” (Fazzini,

2018, p. 77) in order to compute the value of the business. Such expected cash flows
 projection is critical to the application of this method and exists in the centre of this

approach.

2. Even though “the ability to generate cash from past operations is often an important

indication of whether the enterprise will be able to pay for recurring operating costs”

(Dauderis, Annand, & Jensen, 2021, p.404), the future projections are always limited

to uncertainties.

Exhibit. Summary of Applicability of Business Valuation Approaches (Mellen & Evans,

2018, p.219)

Other additional methods: Cost of Capital Approach and Liquidity Approach

Cost of Capital approach estimates the value of an enterprise based on the free cash flow

from operations. “In this approach the costs and benefits of debt are considered directly in the cost of
capital used as a discounted rate of the future expected free cash flow from operations” (Luca, 2018,

p.368). This approach is also helpful to calculate the tax benefits of debt financing used for capital.

Liquidity approach is another approach that determines the value of an enterprise by the

lower end of valuation range and it is usually considered as alternative and static method. It is also

criticized for being negligent on business growth potential and leads to volatile prices for the assets

(Schmidlin, 2014).

Comparison of Business Valuation Methods

Methods/ BV-Asset- MV-Market- FV-Income- Cost of Liquidity

Criteria based based approach based capital approach
approach approach approach
Basis of Book/histori Market/comparabl Future Capital Acid
method c value e transaction value estimate costs serves test/liquidity
serves as the serves as the basis. serves as the as the basis. value serves
basis. basis. as the basis.
Required Data from Comparable data Financial Interest Fast-sale
input data financial from multiple plans, rate, transaction
statements* databases* discount repayment data, salvage
factor, schedule value
industry and other information
risks * capital
financing
costs
Need for Only Required for a Special Special Required for
experts required in moderate extent* expertise expertise a moderate
certain required* required* extent*
cases*
Advantages Basic data Simple and quick Anticipated Explores Provides
can be easily to carry out* performance tax alternative
retrieved*; is taken into implication exit or
Realistic account* s of debt capitalizatio
(Mercer, costs n strategy
2008)
Disadvantage Asset value Assessing Both time- Provides Negligent of
s can be comparative data consuming limited company’s
influenced is costly* and costly* perspective growth
by on the value potential
measurement
methods*
 Limitations If asset is Limitations apply Future Cost of Liquidation
valued at in terms of business capital prices are
market price, accessibility or plans are provides difficult to
expert availability of based on limited determine
involvement comparative data* assumptions perspective (Schmidlin,
is required* * 2014)

Note: The above criteria for business valuation methods were adopted from Szabolcs Szeles,

a senior partner at Hungarian business consulting firm WTS Client and parts with * symbol is in-text

citation from the named source (WTS Client. n.d., p.1).

To conclude, every valuation methods have their own pros and cons depending on where to

use them and at what costs. Managers should make themselves fully aware of the peculiarities of

these approaches and to combine them for the specific purpose of the needed action, whether it is for

any merger and acquisition, litigation and other purposes.

 References:

Accounting Tools. (2021, April 13). Book value definition.

Accountingtools. https://www.accountingtools.com/articles/what-is-book-value.html

Chan, J. (2021, August, 13). Future Value (FV). Investopedia.

https://www.investopedia.com/terms/f/futurevalue.asp

Dauderis, H., Annand, D., & Jensen, T. (2021). Introduction to financial Accounting. Lyryx

Learning Inc. https://lyryx.com/introduction-financial-accounting/

Fazzini, M. (2018). Business Valuation: Theory and Practice. Palgrave Macmillan. Available at:

https://doi.org/10.1007/978-3-319-89494-2

Luca, P. (2018). Analytical Corporate Valuation: Fundamental Analysis, Asset Pricing, and

Company Valuation. Springer. https://doi.org/10.1007/978-3-319-93551-5

Mellen, C., & Evans, F. (2018). Valuation for M&A: Building and Measuring Private Company

Value. Third Edition. John Wiley and Sons, Inc. New Jersey: Hoboken.

Mercer, Z. (2008). Business Valuation: An Integrated Theory. Second Edition. John Wiley &

Sons, Inc. New Jersey: Hoboken.

Seth, S (2021, January, 17). Book value vs. market value: What's the

difference? Investopedia. https://www.investopedia.com/articles/investing/110613/market

-value-versus-book-value.asp

Schmidlin, N. (2014). The Art of Company Valuation and Financial Statement Analysis: A Value

Investor’s Guide with  Real-life Case Studies. John Wiley & Sons, Inc. UK.

Trugman, G. (2012). Understanding Business Valuation: A Practical Guide to Valuing Small to

Medium Sized Businesses. Fourth Edition. Wiley. NY: New York.

UoPeople. (n.d.). BUS 5111-01 Learning Guide Unit 5 – Introduction. Retrieved from:
https://my.uopeople.edu/mod/book/view.php?id=307412&chapterid=358904