A NARRATIVE REPORT IN CONCEPTS OF VALUE,

PRINCIPLES AND TECHNIQUES OF VALUATION

Submitted by:

Alicante, Daisy Lou

Masayon, Jhem Carylle

Quita, Elaizah Lyn

Romero, Arnie

Taladro, Moschino

Vargas, Frencis Erika

September 2024
BRIEF OUTLINE:

I. Foundations of Value
II. Definition of Valuation
III. The Value of Business can be basically linked into three major factors:

Current Operations

Future Prospects

Embedded Risks

IV. Concepts of Valuation:

Intrinsic Value

Going Concern Value

Book Value

Liquidation Value

Fair Market Value

V. Roles of Valuation (Aisy and Jhem)

Portfolio Management

Analysis of Business Transactions/Deals

Corporate Finance

Legal and Tax Purposes

Other Purposes

VI. Valuation Process

Step 1: Understanding of the business

Step 2: Forecasting financial performance

Step 3: Selecting the right valuation model

Step 4: Preparing valuation model based on forecasts

Step 5: Applying valuation conclusions and providing recommendation

VII. Key principles in Valuation

• The value of a business is defined only at a specific point in time

• Value primarily varies in accordance with the capacity of a business to generate
future cash flow

• The market commands what the proper rate of return for investors

• The value of a business may be impacted by underlying net tangible assets

• Value is influenced by transferability of future cash flows

• Value is impacted by liquidity

VIII. Valuation Methods/Techniques

Market Approach

Income Approach

Asset/Cost Approach

IX. Risk In Valuation

CONTENT
DISCUSSION

This chapter will talk about:

- Concepts of Values
- Principles and Techniques of Valuation

To be discussed by:

Alicante, Daisy Lou

Masayon, Jhem Carylle

Quita, Elaizah Lyn

Romero, Arnie

Taladro, Moschino

Vargas, Frencis Erika

CONTENT DISCUSSION:

I. Foundations of Value

In today's economy, "value" is what determines how much something is worth, whether it's an
estimate or a specific number. When people invest, they expect the value of their investment to
grow enough to make up for the risk or effort they put in, taking into account the time it takes.
Everything we do involves some kind of sacrifice, and that sacrifice has value. It means giving up
something important, hoping to get something in return, like a profit or reward, that feels worth
the trade-off. Therefore, knowing how to measure value or how to create value is an essential tool
for everybody to be able to make wise decisions.

II. What is Valuation?

Valuation 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.

III. The Value of Business can be basically linked into three major factors:

Accordingly, the fundamental equation of value is based on the principle popularized by

Alfred Marshall that a company creates value if and only if the return on capital invested exceed
the cost of acquiring capital. This means a value can be created from the difference of the capital
invested to the cash inflows generated through the capital investment wherein this point of view
of the shareholders of a certain company includes the periodicity of the money gained and risks
premium from the challenged taken by the shareholders on their investment as every business
have their respective risk associated. The value of a business can be basically linked to three
major factors whereas valuation from the definition above is estimated to identify the value of the
asset through the variables related to the future investment return which is these three factors
mainly affect the possible return of investment of an entity or shareholder.

These factors are:

• Current operations
• Future prospects
• Embedded risk.

Current operations mainly focus on the day-to-day activities of the business which correspond to
the operating performance of the firm in the recent year measured using the key metrics of
revenue, profitability, market share and operational efficiency. With the business on its growing
stage, it creates a path for identifying what expectation in terms of its growth can be expected and
its potential opportunities that can be capitalize or invested by the business, this second factor
emphasize on the long-term and strategic direction the business can grab and grow their business
into such as expanding the business in terms of its location and operation matters. The third factor
on the other hand emphasize that the possible value of a business is embedded with risks,
meaning doing business or operating a business an individual should expect risk including
possible challenges and uncertainties that can affect one’s business operation. This includes
market volatility, competition, regulatory changes, and operational risks.

These factors are the major variables that can affect the valuation of a business but as new
innovations and globalization occur new technologies being utilized also changed in order to keep
up and stay competitive as this increased competition, making a complex supply chain,
Additionally, due to globalization it led consumers to have diverse expectations towards the
products or services consumed and incurred by the consumers.

IV. DIFFERENT CONCEPTS OF VALUE

Valuation is based on economic factors, industry variables, and the analysis of financial
statements and the entire outlook of the firm. The valuation process will determine the long-run
fundamental economic value of its common stock or preferred stock. Different concepts of
valuation are based on the following:

• Intrinsic Value – a concept based on an asset's theoretical 'true worth' and is determined
by its record and potential earning power.

- Also called fundamental value

- It is the true value of an asset

- Actual value of a company or an asset instead of its market value. It includes

variables such as brand name, patents, copyrights, business model, and personal value
contacts which are difficult to value in the open market properly. Therefore, intrinsic value
is a more subjective term than fair market value as different investors use different
techniques to calculate intrinsic value.

- In general, is defined as a fair or inherent value of any asset (whether real or

financial) company, its stock, derivatives, options, etc. This term is the most prominent in
defining the value of a company's stock.

• Going Concern Value – the value of an asset to the enterprise as a going concern or the
value of an asset 'in use". Most business valuations will be prepared based on a going
concern. - The value of the firm as an operating business.

• Book Value – the amount at which an asset or liability is recorded on the entity's books of
accounts; also called carrying value or carrying amount.
 - The accounting value of a firm or an asset

• Liquidation Value- This refers to the net amount that would be gained if a business is
terminated and its assets are sold off piece by piece. The value of the company is
calculated under the assumption that it will shut down, and its assets will be sold
separately through a liquidation process.

• Fair Market Value- This refers to the price at which a property would be exchanged
between a hypothetical buyer and seller, both willing and able, in an open and unrestricted
market. The transaction occurs at arm’s length, meaning both parties are independent and
acting in their own best interest. Neither the buyer nor the seller is under any pressure or
compulsion to make the deal, and both have a reasonable level of knowledge about the
relevant details and facts surrounding the property and the market conditions.

V. ROLES OF VALUATION
• Portfolio Management

Portfolio management in valuation refers to the process of making informed investment

decisions based on the valuation of assets within a portfolio. It involves selecting, overseeing, and
adjusting a collection of investments to achieve specific financial objectives while managing risk.

Fundamental Analysts- These are persons who are interested in understanding and measuring
intrinsic value of a firm.

Activists Investors- Activist investors tend to look for companies with good growth prospects
that have poor management.

Chartists- Chartists rely on the concept that stock prices are significantly influenced by how
investors think and act.

Information Traders- Traders that react based on new information about firms that are revealed
to the stock market

• Analysis of Business Transactions/Deals

Valuation plays a very big role when analyzing potential deals. Potential acquirers typically use
relevant valuation techniques (whichever is applicable) to estimate value of target firms they are
planning to purchase and understand the synergies they can take advantage from the purchase.
They also use valuation techniques in the negotiation process to set the deal price.

Business deals include the following corporate events:

Acquisition - usually has two parties: the buying firm and the selling firm. The buying firm needs
to determine the fair value of the target company prior to offering a bid price. On the other hand,
the selling firm (or sometimes, the target company) should have a sense of its firm value, as well
to gauge reasonableness of bid offers. Selling firms also use this information to guide which bid
offers to accept or reject. On the downside, bias may be a significant concern in acquisition
analyses. Target firms may show very optimistic projections to push the price higher or pressure
to make resulting valuation analysis favorable if the target firm is certain to be purchased as a
result of strategic decision.

Merger - transaction two companies’ combined to form a wholly new entity. An example is the
merger of Divestiture Sale of a major component of segment of a business (e.g. brand or product
line) to another company

Spin-off - Separating a segment or component business and transforming this into a separate
légal entity whose ownership will be transferred to shareholders.

Leveraged buyout - Acquisition of another business by using significant debt which uses the
acquired business as a collateral.

Valuation in deals analysis also considers two important, unique factors:

synergy and control.

Synergy - potential increase in firm value that can be generated once two firms merge with each
other. Synergy assumes that the combined value of two firms will be greater than the sum of
separate firms. Synergy can be attributable to more efficient operations, cost reductions,
increased revenues, combined products/markets or cross-disciplinary talents of the combined
organization.
Control - change in people managing the organization brought about by the acquisition. Any
impact to firm value resulting from the change in management and restructuring of the target
company should be included in the valuation exercise. This is usually an important matter for
hostile takeovers

• Corporate Finance

Corporate finance mainly involves managing the firm's capital structure, including funding sources
and strategies that the business should pursue to maximize firm value. Corporate finance deals
with prioritizing and distributing financial resources to activities that increase firm value. The
ultimate goal of corporate finance is to maximize the firm value by appropriate planning and
implementation of resources, while balancing profitability and risk appetite.

Small private businesses that need additional money to expand, use valuation concepts when
approaching private equity investors and ventures. capital providers to show the promise of the
business. The ownership stake that these capital providers will ask from the business in exchange
of the money that they will put in will be based on their estimated value of the small private
business.

Larger companies who wish to obtain additional funds by offering their shares to the public also
need valuation to estimate the price they are going to be offered in the stock market. Afterwards,
decisions regarding which projects to invest in, amount to be borrowed and dividend declarations
to shareholders are influenced by company valuation.

Corporate finance ensures that financial outcomes and corporate strategy drives
maximization of firm value: Current business conditions push business leaders to focus on
value enhancement by looking at the business holistically and focus on key levers affecting value
in order to provide some level of return to shareholders.

Firms that are focused on maximizing shareholder value use valuation concepts to assess
impact of various strategies to company value. Valuation methodologies also enable
communication about significant corporate matters between management, shareholders,
consultants and investment analysts.
 • Legal and Tax Purposes

Valuation is important for businesses for legal and tax reasons as well. For instance, when
a new partner joins a partnership or an existing partner retires, the entire partnership needs to be
valued to determine the appropriate buy-in or sell-out amount. This is similarly true for businesses
that are dissolved or liquidated at the owners' discretion. Additionally, firms are valued for estate
tax purposes in the event of the owner's death.

• Other Purposes
- Issuance of a fairness opinion for valuation provided by third party.
- Basis for assessment of potential lending activities by financial institutions.
- Share-based payment/compensation.

VI. THE VALUATION PROCESS

Step 1: Understanding of the business

It includes performing industry and competitive analysis and analysis of publicly available
financial information and corporate disclosures. it is important as these give analysts and
investors the idea about the following factors that affect the business:

Industry Structure - the inherent technical and economic characteristics of an industry and the
trends that may affect this structure

Industry Characteristics - these are true to most, if not all, market players participating in that
industry.

Poster’s Five Forces is the most common tool used to encapsulate industry structure.
Competitive position

- refers how the products, services and the company itself is set apart from the other
competing market players.
- typically gauged using the prevailing market share level that the company enjoys.

Generally, a firm’s value is higher if it can consistently sustain its competitive advantage against
its competitors.

According to Michael Porter, there are 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 price products around the industry average.

• Differentiation - firms tend to offer differentiated or unique product or service

characteristics that customers are willing to pay for an additional premium
 • Focus - firms are identifying demographic segment or category segment to focus on by
using cost leadership strategy or differentiation strategy.

In analyzing historical financial information, focus is afforded in looking at quality of earnings.

Quality of earnings analysis pertain to the detailed review of financial statements and
accompanying notes to assess sustainability of company performance and validate accuracy of
financial information versus economic reality. During analysis transactions that are nonrecurring
such as financial impact of litigation settlements, temporary tax reliefs or gains/losses on sales of
non-operating assets might need to be adjusted to arrive at the performance of the firm's core
business.

Quality of earnings analysis also compares net income against operating cash flow to make sure
reported earnings are actually realizable to cash and are not padded through significant accrual
entries. Typical observations that analysts can derive from financial statements are listed below:
Based on AICPA guidance, other red flags that may indicate aggressive accounting include
the following:

• Poor quality of accounting disclosures, such as segment information, acquisitions,

accounting policies and assumptions, and a lack of discussion of negative factors.
• Existence of related-party transactions or excessive officer, employee, or director loans.
• Reported (through regulatory filings) disputes with and/or changes in auditors.
• Material non-audit services performed by audit firm.
• Management and/or directors' compensation tied to profitability or stock price (through
ownership or compensation plans)
• Economic, industry, or company-specific pressures on profitability, such as loss of market
share or declining margins.
• High management or director turnover.
• Excessive pressure on company personnel to make revenue or earnings targets,
particularly when management team is aggressive
• Management pressure to meet debt covenants or earnings expectations.
• A history of securities law violations, reporting violations, or persistent late filings.
Step 2: Forecasting financial performance

Forecasting financial performance After understanding how the business operates and
analysing historical financial statements, forecasting financial performance is the next step.
Forecasting financial performance can be looked at two lenses: (a) on a macro perspective
viewing the economic environment and industry where the firm operates in and (b) on a micro
perspective focusing in the firm's financial and operating characteristics. Forecasting summarises
the future-looking view which results from the assessment of industry and competitive landscape,
business strategy and historical financials. This can be summarized in two approaches:

Top-down forecasting approach - Forecast starts from international or national macroeconomic

projections with utmost consideration to industry-specific forecasts. From here, analysts select
which are relevant to the firm and then applies this to the firm and asset forecast. In top-down
forecasting approach, the most common variables include GDP forecast, consumption forecasts,
inflation projections, foreign exchange currency rates, industry sales and market share. A result
of top-down forecasting approach is the forecasted sales volume of the company. Revenue
forecast will be built from this combined with the company-set sales prices.

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. For example, store expansions and increase in product availability is collated and
revenues resulting from these are calculated. Inputs from various segments are consolidated until
company-level revenues is calculated.

Step 3: 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. Details of these valuation models and the
circumstances when they should be used will be discussed in succeeding chapters.

Step 4: Preparing valuation model based on forecasts

Once the valuation model is decided, the forecasts should now be inputted and converted
to the chosen valuation model. This step is not only about manually encoding the forecast to the
model to estimate the value (which is the job of Microsoft Excel).
 To do this, two aspects should be considered:

• Sensitivity analysis

• Situational adjustment

Step 5: Applying valuation conclusions and providing recommendation

Once the value is calculated based on all assumptions considered, the analysts and
investors use the results to provide recommendations or make decisions that suits their
investment objective.

VII. KEY PRINCIPLES IN VALUATION

• The value of a business is defined only at a specific point in time

- As large number of transactions occurred in the operation of the business the

recording of this transactions affect the earnings being recognized, cash position,
working capital and market conditions of the business wherein this also affect the
valuation or value of the business at present year wherein what was recorded a
year ago might or might not justify or reflect the current value of the business in
the present time that is why the information given to the users of the information is
the present up-to-date valuation of the business on a specific date.

• Value primarily varies in accordance with the capacity of a business to generate

future cash flow

- A company's valuation is essentially a function of its future cash flows except in

unusual situations where net asset liquidation may lead to a higher value.

- The consideration here is the term future. It implies that historical results of the
company's earnings before the date of valuation are useful in predicting the future
results of the business under certain conditions. Another consideration is the term
cash flow. It is because cash flow, which takes into account capital investments,
working capital changes, and taxes, is the true determinant of business value.
Business owners should aim at building a comprehensive estimate of future cash
 flows for their companies. Even though making estimates is a subjective
undertaking, it is vital that the value of the business is validated. Reliable historical
information will help in supporting the assumptions that the forecasts will use.

• The market commands what the proper rate of return for investors

- The market determines the appropriate rate of return that investors should expect.
Market forces are constantly in flux and generally guide what returns can be
anticipated from various investment options. These forces can vary depending on
the industry type and prevailing economic conditions. For investors, understanding
the rate of return set by the market is crucial, as it allows them to identify the correct
discount rate for valuation purposes. This understanding can significantly impact
their decisions regarding buying or selling investments.

• The value of a business may be impacted by underlying net tangible assets

- Business valuation measures of the relationship between the operational value of

a company and its net tangible value. Theoretically, a company with a higher
underlying net tangible asset value has higher going concern value. It is because
of the availability of more security to finance the acquisition and lower risk of
investment since there are more assets to be liquidated in case of bankruptcy.
Business owners need to build an asset base. For industries that are not capital
intensive, the owners need to find means to support the valuation of their goodwill.

• Value is influenced by transferability of future cash flows

- This is one of the measurement tools since future cash flows are transferred by
the ability by which the value of a business is highly determined. This is because
some degrees of client relationship are based on the current owner or some
specific skills that put dependence on the current owner; the perceived risk is high
and thus reduces the business value to the potential buyers significantly. On the
other understanding, more customer loyalty, better and stronger systems and
management evaluation resulting from the separation of the business from its
owner lead to more transportable cash flows hence the increase in the value of the
business. Hence, it is the responsibility of the business owner to ensure that there
is an effective operational environment to put in place towards realizing the ideal
situation of transferring cash and generically valuing.

• Value is impacted by liquidity

 - This principle is primarily guided by the theory of demand and supply. When there
are many potential buyers but fewer acquisition targets available, the value of the
target firms may increase because the heightened interest among buyers creates
competitive pressure to acquire the business. In general, greater liquidity and
interest in a business can led to a higher perceived value. Therefore, sellers need
to effectively attract and negotiate with potential buyers to maximize the value they
can achieve from the transaction.

VIII. VALUATION METHODS/TECHNIQUES

Market Approach

-The market approach utilizes prices and other relevant data generated by market transactions
involving identical or similar assets and liabilities this means that a company can determine its
assets, investment or business through comparing its market price to the other company that also
have the same nature and feature of its assets, investment and business. The techniques that
can be used were market multiples derived for certain variables and matrix pricing.

Income Approach

-The income approach converts future amounts (such as cash flows or income and expenses)
into a singular discounted amount, taking into account various factors, including risk and
uncertainty (IFRS 13.B15-B17). This approach is intrinsic meaning the value of the business is
derive from the ability of the business to generate future cash flows. Techniques that are aligned
to the income approach are the present value techniques, option pricing models, and the multi-
period excess earnings method (IFRS 13.B10-B11)

Asset/Cost Approach

-Often referred to as the current replacement cost, the cost approach aims to represent the sum
that would presently be required to replace the service capacity of an asset, adjusted for
obsolescence (for example, physical deterioration, technological or economic obsolescence). The
techniques used in this approach were Book Value Method and Adjusted Book Value Method.

IX. RISK IN VALUATION

- It is the uncertainty about the difference between the fair value reported for a
financial instrument at the valuation date and the price that could be obtained on
that same date if the instrument were effectively traded.