CHAPTER 1: FUNDAMENTAL PRINCIPLES OF - Future Prospects = long term plan

VALUATION - Embedded Risk = business risk involved

Intrinsic Value

Assets, individually or collectively, has value. Generally, - Refers to the value of any asset based on the
value pertains to the worth of an object in another assumption that there is a hypothetical
person’s point of view. Any kind of asset can be valued, complete understanding of its investment
though the degree of effort needed may vary on a case characteristics.
to case basis. - Market value
- Available facts/info
Example: Methods to value real estate may be different
- Value based on what business competitive
on how to value the entire business
position
Business treat capital as a scarce resource that they
Going Concern Value
should compete to obtain and efficiently manage. Since
capital is scarce, capital provider requires users to - Firm value is determined under the going
ensure that they will able to maximize shareholders concern assumption that entity will continue to
return to justify providing capital to them. do its business activities in the foreseeable
future.
The fundamental point behind success in investment is
- Value of the business based on their capability
understanding what is the prevailing value and the key
to generate profit
drivers that influence this value.
Liquidation Value
Increase in value may imply that shareholder capital is
maximize, hence, fulfilling the promise to capital - The amount that would realized if the business
providers. is terminated and the assets are sold
piecemeal.
According to the CFA Institute, Valuation is the
- Computed based on the assumption that entity
estimation of an asset’s value based on variables
will be dissolved, and its asset will be sold
perceived to be related to future investment returns, on
individually.
comparison with similar assets or when relevant, on
estimates of immediate liquidation proceeds. Valuation Fair Market Value
includes the use of forecast to come up with a
- The price, expressed in terms of cash, at which
reasonable estimate of value of an entity’s assets or
property would change hand between a willing
equity. Valuation may differ across different assets but
hypothetical willing and able buyer.
all follow similar fundamental principles that drive the
- Both parties agreed
core of these approaches.

ANALYSIS OF BUSINESS TRANSACTIONS/ DEALS

INTERPRETING DIFFERENT CONCEPTS OF VALUE
Valuation plays a very big role when analyzing potential
In the corporate setting, the fundamental equation of
deals. It is used in the negotiation process to set the
value is grounded on the principle that Alfred Marshall
deal price.
popularized – a company creates value if the return on
capital invested exceed the cost of acquiring capital. Business deals include the following corporate events:

Acquisition
The value of a business can be basically linked in three - An acquisition usually has two parties: the
major factors: buying firm and the selling firm.
- The buying firm determines the fair value of the
- Current Operation = operating performance of
target company prior to offering the bid price.
the firm in the recent year
 - On the other hand, selling firm should have - Understanding the business includes
sense of its firm value to gauge reasonableness performing industry and competitive analysis of
of bid offer. publicly available financial information and
corporate disclosures.
Merger
- Understanding present, past, future prospects
- General term which describes the transaction of the business
where in two companies had their assets
Industry structure
combined to form a wholly new entity.
- A + B = C or A + B = A/B - Refers to the inherent technical and economic
characteristic of an industry and the trends
Divestiture
that may affect this structure.
- Sale of a major component or segment of
Porter’s Five Forces
business ( ex. Product line) to another company
- Most common tool to encapsulate industry
Spin-off
structure.
- Separating a segment or component business
and transforming this into a separate entity 1. Industry Rivalry
- Refers to the nature and intensity of rivalry
Leverage buyout between market players in the industry
- Acquisition of another business by using 2. New Entrants
significant debt which uses the acquired - Refers to the barrier to entry to industry by new
business as collateral. market players.
- Ex. Company A wants to buy Company B but - High entry cost, low number of new entrants
Company A doesn’t have money. With that, which improves profitability
Company A borrowed money to buy Company 3. Substitutes and Complements
B. And, if Company A can’t pay the loan - This refers to the relationships between
Company B will serve as collateral. interrelated products and services in the
industry.
Valuation in deals analysis consider two important, 4. Supplier Power
unique factors; synergy and control - Refers to how suppliers can negotiate better
Synergy terms in their favor.
- Strong supplier power can reduce industry
- Potential increase in firm value that can be profit
generated once two firms merge with each 5. Buyer Power
other. - Pertains to how customer can negotiate better
terms in their favor for products/services they
Control
purchase.
- Change in people managing the organization
brought about by the acquisition. Any impact to
Competitive Position
firm value resulting from change in
management and restructuring of the target - Refers to how the products, services and the
company should be included in the valuation. company itself is set apart from other
competing market players.
Valuation Process
Cost Leadership
Generally, the valuation process considers these five
steps; - It relates to the occurrence of the lowest cost
among market player with quality that is
comparable to competitors allow the firm to
1. UNDERSTANDING OF THE BUSINESS price products around the industry average.
 - Assessing how changes in key variables or
assumptions impact financial outcomes

Differentiation

- Firm tends to offer differentiated or unique

product or service characteristic that customers Situational Adjustments or Scenario Modelling
are willing to pay for an additional premium.
- For firm-specific issues that affect firm value
Focus that should be adjusted by analysts. In some
instances, there are factors that do not affect
- Firms are identifying specific demographic
value per se when analysts only look at core
segment or category segment to focus on by
business operations but will still influence value
using cost leadership strategy (cost focus) or
regardless.
differentiation strategy (differentiation focus)
- Modifying plans or forecast based on changes in
the business environment or unforeseen
2. FORECASTING FINANCIAL PERFORMANCE
circumstances.
- After understanding how the business operates
and analyzing historical statements, forecasting
5. APPLYING VALUATION CONCLUSIONS AND
financial performance is the next step.
PROVIDING RECOMMENDATION
This can be summarized in two approaches: - Once the value is based on all assumptions
considered, the analyst and investors use the
Top-down forecasting approach results to provide recommendations are make
- Forecast starts from international or national decision that suits their investment objective.
macroeconomic projections with utmost -
consideration to industry specific forecasts. KEY PRINCIPLES IN VALUATION
Bottom-up forecasting approach 1. The Value of a Business is Defined Only at a
- Forecast starts with lower level of the firm and specific point in time
is completed as it captures what will happen to - Business value tend to change every day as
the company based on inputs of its segment. transactions happen. Different circumstances
that occur on a daily basis affect earnings, cash
3. SELECTING THE RIGHT VALUATION MODEL position, and working capital land market
- Appropriate valuation model will depend on conditions.
the context of the valuation and the inherent 2. Value varies based on the ability of business to
characteristics of the company being valued. generate future cash flows
- General concepts for most valuation techniques
4. PREPARING VALUATION MODEL BASED ON put emphasis on future cash flows except for
FORECASTS some circumstances where value can be better
- Once the valuation model is decided, the derived from asset liquidation.
forecast should now be inputted and converted 3. Market dictates the appropriate rate of return for
to the chosen valuation model. investors
- Market forces are constantly changing, and they
Sensitivity Analysis normally provide guidance of what rate of
- It is a common methodology in valuation return should investors expect from different
exercises wherein multiple analyses are done to investment vehicles in the market.
understand how changes in an input or 4. Firm value can be impacted by underlying net
variable will affect the outcome (i.e. firm tangible assets
value). - Business valuation principles look at the
relationship between operational value of an
 entity and net tangible of its assets.
Theoretically, firms with higher underlying net
tangible asset value are more stable and results
in higher going concern value.

5. Value is influenced by transferability of future cash

flows
- Transferability of future cash flows is also
important especially to potential acquirers.
Business with good value can operate even
without owner intervention.
6. Value is impacted by liquidity
- This principle is mainly dictated by the theory of
demand and supply.

Risks in Valuation

In all valuation exercises, uncertainty will be

consistently present. Uncertainty refers to the possible
range of values where the real firm value lies.

Innovations and entry of new businesses may also bring

uncertainty to established and traditional companies. It
does not mean that a business that has operated for
100 years will continue to have stable value.
 BOOK VALUE

- Can be defined as the value recorded in the

accounting records of a company
- Advantage of using book value method is that it
provides a more transparent view on firm
value. However, it only reflects historical value
CHAPTER 2 – ASSET BASED VALUATION and might not reflect the real value of a
business now.

Value of asset will depend on its ability to generate REPLACEMENT VALUE METHOD
economic benefits - While the book value method offers
GREEN FIELD INVESTMENTS convenient determination of the company
value, the limitation of the book value method
- are the investments that started from scratch is that it does not account for the value of the
BROWN FIELD INVESTMENTS net assets now that would result for overage or
understatement of value of the net assets
- are those opportunities that can be either recorded in the book.
partially or fully operational - According to National Association of Valuators
- are those already in going concern state, as and Analysts (NAVA), replacement cost is cost
most business are in the optimistic perspective similar assets that have the nearest equivalent
that they will grow in the future value as of the valuation date.
- considered as Going Concern Business
Opportunities (GCBOs) The value of the individual assets shall be adjusted to
reflect the relative value or cost equivalent to replace
COMMITTEE OF SPONSORING ORGANIZATION OF THE the assets.
TREADWAY COMMISSION (COSO)
Factors that can affect the replacement value of an
- Suggest that risk management principles must asset:
be observed in doing business and determining
its value.  Age of the asset – it is important to know how
old the asset
It was noted in their report that the benefits of having a  Size of the asset – important for fixed assets
sound Enterprise-wide Risk Management allows the particularly real property where assets of the
company to: similar size will be compared
 Competitive advantage of the asset – asset
1. Increase the opportunities
which have distinct characteristic are hard to
2. Facilitate management and identification of the
replace.
risk factors that affect the business;
3. Identify or create business cost-efficient REPORDUCTION VALUE METHOD
opportunities
4. Manage performance variability; - In some instances, no external information is
5. Improve management and distribution of available that can serve as basis for
resources across the enterprise; and replacement cost of the assets that are highly
6. Make the business more resilient to abrupt specialized in nature. In this case, reproduction
changes value is used.

In Asset-based Valuation, familiarity with the generally

accepted accounting principles is a key attribute for an
analyst to enable them to establish the value.

METHOD TO DETERMINE THE VALUE USING ASSETS: