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Lecture Note on Business Valuation (1)

Business valuation determines the economic worth of a company and is essential for various purposes such as mergers, acquisitions, and legal disputes. Different valuation methods include the Asset-Based Approach, Income Approach, and Market Approach, each suited for specific circumstances. Understanding these methods is crucial for making informed decisions regarding business transactions and financial reporting.

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5 views

Lecture Note on Business Valuation (1)

Business valuation determines the economic worth of a company and is essential for various purposes such as mergers, acquisitions, and legal disputes. Different valuation methods include the Asset-Based Approach, Income Approach, and Market Approach, each suited for specific circumstances. Understanding these methods is crucial for making informed decisions regarding business transactions and financial reporting.

Uploaded by

Ana Vida
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Lecture Note on Valuation of Business and Shares (module 3)

Chapter 1:
1.1 Introduction
Business valuation is the process of determining the economic value of a
business or company. It’s the process of determining the current worth of a
business using objective measures. It evaluates all aspects of the business.
Business valuation is typically conducted when a company is looking to sell all
or a portion of its operations. It also serves multiple purposes including
mergers and acquisitions, shareholder disputes, financial reporting, taxation
and even as a part of divorce proceedings.
Importance of Business Valuation
Informs potential investors or buyers about the worth of a business.
Helps in strategic decision-making for mergers, acquisitions, or liquidations.
Essential for legal purposes, including divorce, bankruptcy, or litigation.

The Nature and Purpose of Business Valuations


whenever a company is bought what the new owners have a right to depends
on the stake they hold and valuations are required:
Majority holders: have access to their share of earnings and, because they can
opt for a winding up, their share of net assets of the company.
Minority holders: have access to the dividends the majority decide to pay and a
share of the net assets if the majority decides to wind the company up.
A share valuation will be necessary for the following purposes
(a) Mergers, acquisitions, sales and taxation (estate planning, gift tax
purposes)
(a) For quoted companies, when there is a takeover bid and the offer price is an
estimated fair value in excess of the current market price of the shares.
(b) For unquoted companies, when: (i) the company wishes to go public and
must fix an issue price for its shares. (ii) there is a scheme of merger. (iii)
shares are sold. (iv) shares need to be valued for the purposes of taxation. (v)
shares are pledged as collateral for a loan.
(c) For subsidiary companies, when the group’s holding company is negotiating
the sale of the subsidiary to a management buyout or to an external buyer.
(d) For any company, where a shareholder wishes to dispose of his or her
holding.
(e) For any company, when the company is being broken up in a liquidation
situation or the company needs to obtain finance, or re-finance current debt.
(f) Financial reporting (impairment testing, purchase price allocation)
(g) Legal disputes (divorce settlements, partner disputes)
(h) Strategic planning (business restructuring, equity financing)
How to choose the share valuation method
There are various reasons for adopting a particular method for share valuation;
it generally depends upon the purpose of valuation. Sometimes, even publicly
traded shares have to be valued because the market quotation may not show
the true picture or large blocks of shares are under transfer etc. Using a
combination of methods generally provides a more reliable valuation.
1. Assets Approach If a company is a capital-intensive company and invested a
large amount in capital assets or if the company has a large volume of capital
work in progress then asset-based approach can be used. This method is also
applicable for valuing the shares during amalgamation, absorption or
liquidation of companies.
2. Income Approach This approach has two different methods namely
Discounted Cash Flow (DCF) or Price Earning (P/E) method. DCF method uses
the projection of future cash flows to determine the fair value and if this data is
reasonably available, DCF method can be used. P/E method uses historical
earnings.
3. Market Approach Under this approach, the market value of the shares is
considered for valuation. However, this approach is feasible only for listed
companies whose share prices can be obtained in the open market. If there are
set of peer companies which are listed and engaged in the similar business,
then such company’s share public prices can also be used.
1.2 Valuation Methods
There are various methods for valuing businesses and shares,
Therefore, these methods are categorized into three main approaches:
1. Asset-Based Approach: Values a business based on its assets and
liabilities (including intangible assets and contingent liabilities) the approach
may be very useful to manufacturers, distributors etc where a huge volume of
capital assets is used. This approach is also used as a reasonableness check to
confirm the conclusions derived under the income or market approaches
Following are some of the important points to be considered while valuing of
shares under to this method:
 All the asset base of the company including current assets and liabilities such
as receivables, payables, provisions should be considered.
 Fixed assets have to be considered at their realizable value.
 Valuation of goodwill as a part of intangible assets is important
 Even unrecorded assets and liabilities to be considered
 The fictitious assets such as preliminary expenses, discount on issue of shares
and debentures, accumulated losses etc. should be eliminated.
a) Book Value Method: Based on the balance sheet, subtracting liabilities from
assets. For determination of the net value of assets, deduct all the external
liabilities from the total asset value of the company. The net value of assets so
determined has to be divided by the number of equity shares for finding out
the value of the share. The formula used is as follows:
Net Asset – Preference
Share
value per share = No of ordinary Shares

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