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Chapter1 - Fundamental Principles of Valuation

This document discusses key principles and concepts in valuation including: 1) Valuation involves estimating an asset's value based on factors related to future investment returns, comparisons to similar assets, or estimates of liquidation proceeds. 2) A company creates value if the return on invested capital exceeds the cost of acquiring that capital. 3) Valuation considers current operations, future prospects, and embedded risk. 4) Valuation methods include intrinsic value, going concern value, liquidation value, and fair market value.

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1K views

Chapter1 - Fundamental Principles of Valuation

This document discusses key principles and concepts in valuation including: 1) Valuation involves estimating an asset's value based on factors related to future investment returns, comparisons to similar assets, or estimates of liquidation proceeds. 2) A company creates value if the return on invested capital exceeds the cost of acquiring that capital. 3) Valuation considers current operations, future prospects, and embedded risk. 4) Valuation methods include intrinsic value, going concern value, liquidation value, and fair market value.

Uploaded by

だみ
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Fundamental Principles

of Valuation
Chapter 1
VALUATION
The estimation of an asset’s value based on variables perceived to
be related to future investment returns; on comparisons with
similar assets, or, when relevant, on estimates of immediate
liquidation proceeds
– CFA Institute
“A company creates value if and
only if the return on capital invested
exceed the cost of acquiring
capital.”
—Alfred Marshall
01
CURRENT 03
OPERATION EMBEDDED
S RISK
3 Major
Factors 02 FUTURE
PROSPECT
S
DEFINITION OF VALUE

01 02
Intrinsic Value Going Concern Value
Value of any asset based on the assumption Value is determined under the going concern
that there is a hypothetical complete assumption
understanding of its investment characteristics

03 04
Liquidation Value Fair Market Value

Net amount that would be realized if the Price at which property would be sold at arm’s
business is terminated and the assets are sold length transaction
piecemeal
Roles of
Valuation
in Business
Portfolio Management

• Fundamental Analysts – interested in understanding and measuring


intrinsic value
• Activist Investors – tend to look for companies with good growth
prospects that have poor management
• Chartists – relies on the concept that stock prices are significantly
influenced by how investors think and act
• Information Traders – react based on new information about firms that
are revealed to the stock market
Activities performed under portfolio management:
• Stock selection
• Deducing market expectations
Analysis of Business Transactions /
Deals
Business deals include the ff. corporate events:
• Acquisition
• Merger
• Divestiture
• Spin-off
• Leveraged buyout
Valuation in deals analysis considers the ff. factors:
• Synergy – potential increase in firm value when two firms merge
• Control – change in people managing the organization
Corporate Finance

 Managing the firm’s capital structure, including funding sources and


strategies that the business should pursue to maximize firm value
Legal and Tax Purposes

• Corporate Tax
• Liquidation
• Dissolution
• Estate Tax
Other Purposes

• Issuance of a fairness opinion for valuations provided by third party


• Basis for assessment of potential lending activities by financial
institutions
• Share-based payment/compensation
Valuation
Process
A. Understanding of the business

 Enables analysts to come up with appropriate assumptions


which reasonably capture the business realities affecting
the firm and its value
• Industry and competitive analysis
Generic corporate strategies to achieve competitive
advantage:
• Cost leadership
• Differentiation
• Focus
B. Forecasting financial performance

 Summarizes the future-looking view which results from the assessment


of industry and competitive landscape, business strategy and historical
financials
2 approaches in forecasting:
• Top-down forecasting approach
• Bottom-up forecasting approach
C. Selecting the right valuation model

 Will depend on the context of the valuation and the inherent


characteristics of the company
D. Preparing valuation model based on forecasts

 Forecasts should be inputted and converted to the chose valuation


model
• Sensitivity Analysis – to understand how changes in an input or
variable will affect the outcome
• Situational adjustments or Scenario Modeling – for firm-specific
issues that affect the firm value that should be adjusted by analysts
E. Applying valuation conclusions and providing recommendation

 Use the results to provide recommendations or make decisions that


suits their investment objectives
Key
Principles
in Valuation
Key Principles in Valuation

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


II.Value varies based on the ability of business to generate future cash
flows
III.Market dictates the appropriate rate of return for investors
IV.Firm value cam be impacted by underlying net tangible assets
V.Value is influenced by transferability of future cash flows
VI.Value is impacted by liquidity
Risks in
Valuation
Risks in Valuation

In all valuation exercises, uncertainty will be consistently present.


• Some valuation methods use future estimates.
• Value consequently may be different based on new circumstances.
• Performance of each industry can be characterized by varying degrees
of predictability.

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