FUNDAMENTALS PRINCIPLES OF

VALUATION
 Value
- pertains to the worth of an object in
another person's POV
1 • Business treat capital as a scarce
resource that they should compete
to obtain and efficiently manage.
• The most fundamental principle
for all investments and business is
to maxima shareholder value.
• Placing scarce resources provides
in their most productive use best
serves the interest of different
stakeholders in the country.
 • Increase in value may imply that
2 shareholder capital is maximized, hence,
fulfilling the promise to capital providers.
This is where valuation steps in.
• According to the CFA Institute,
valuation is the estimation of an asset's
Vue 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.
• Valuation places great emphasis on the
professional judgment
 INTERPRETING DIFFERENT
3
C O N C E P T S O F VA L U E

In the corporate setting, the

fundamental equation of value
is grounded on the principle that
Alfred Marshall popularized
- a company creates value if and
only if the return on capital
invested exceed the cost of
acquiring capital.
 The value of a business can
4
be basically linked to three
major factors:

• Current operations
• Future prospects
• Embedded risk
 • As firms continue to quickly
5
evolve and adapt to new
technologies, valuation of
current operations becomes
more difficult as compared to
the past.
• New risks and competition
also surface which makes
determining uncertainties
critical.
 The definition of value may
6 also vary depending on the
context and objective of the
valuation exercise.

• Intrinsic Value
- value of any asset based on the assumption
that there is no hypothetical complete
understanding of its investment characteristics.

• Going Concern Value

- believes that the entity continue to do its
business activities into the foreseeable future.
 • Liquidation Value
7 - The net amount that would be realized if
the business is terminated and the assets
are sold piecemeal.

• Fair Value
- The price, expressed in terms of cash, at
which property would change hands between
a hypothetical willing and able buyer and a
hypothetical willing and able a seller, acting
at arm's length in an open and unrestricted
market, when neither is under compulsion to
buy or sell and when both have reasonable
knowledge of the relevant facts.
VALUATION
PROCESS
8 F i v e S t e p s o f Va l u a t i o n
Process:
1.Industry Rivalry - Refers to the nature
and intensity of rivalry between market
players in the industry.
2. New Entrants - Refers to the barriers
to entry to industry by new market
players .
3. Substitutes and Complements -
This refers the relationships between
inter related products and services in
the industry.
9 F i v e S t e p s o f Va l u a t i o n
Process:
4. Supplier Power - refers to
how suppliers can negotiate
better terms in their favor.
5. Buyer Power - pertains to
how customers can negotiate
better terms in their favor for
the products/services they
purchase.
10

Competitive position refers to

how the products, services
and the company itself is set
apart from other competing
market players.
11 According to Micheal
Porter, There are generic
corporate strategies to
achieve competitive
advantage:

a. Cost Leadership
b. Differentiation
c. Focus
12

Business Model pertains to the

method how the company
makes money - what are the
products or services they offer,
how they deliver and provide
these to customers and their
target customers.
13
14
 B a s e d o n A I C PA , g u i d a n c e o t h e r
15 red flags that may indicate
aggressive accounting include the
following:
•Poor quality of accounting disclosures
•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.
 •Economic, industry or company - specific
16
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
target, particularly when management
team is aggressive.
•Management pressure to meet debt
covenants or earnings expectations.
•A history of security law violations,
reporting violations or persistent late
filings.
17 Forecasting financial
performance

- Understanding how the

business operates and
analyzing historical financial
statements, forecasting
financial performance is the
next step.
18 Forecasting financial
performance can be looked at
two lenses:

a. On a macro perspective viewing

the economic environment and
industry where the firms operates
and
b. On a micro perspective focusing
in the firms financial and operating
characteristics.
19 Tw o A p p r o a c h e s :
1. Top Down Forecasting Approach -
forecast start from international or
national micro economic projections
with utmost consideration to industry
specific forecast.
2. Bottom-up forecasting approach -
Forecasts 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.
20 Forecasting Process:
•Selecting the Right Valuation Model
•Preparing valuation model based on
forecasts
1.Sensitive Analysis- it is a common
methodology in valuation exercises
wherein multiple analyses are done to
understand how changes in an input or
variable will affect the outcome.
2. Situational Adjustments or Scenario
Modeling
•Applying Valuation Conclusions and
Providing Recommendation
ROLES OF VALUATION
IN BUSINESS
21 Portfolio Management:
The relevance of valuation in portfolio
management largely depends on the
investment objectives of the investors
or financial managers managing the
investment portfolio. Passive
investors tend to be disinterested in
understanding valuation, but active
investors may want to understand
valuation in order to participate
intelligently in the stock market.
22 • Fundamental analysts -These are persons
who are interested in understanding and
measuring the intrinsic value of a firm.
Typically, fundamental analysts lean
towards long-term investment strategies
which encapsulate the following principles:

>Relationship between value and underlying

factors can be reliably measured
>Above relationship is stable over an
extended period
>Any deviations from the above relationship
can be corrected within a reasonable time.
 Fundamental analysts can be
23 either value or growth
investors.

• Activist investors -Activist investors tend

to look for companies with good growth
prospects that have poor management
• Chartists -Chartists relies 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.
24
Under portfolio management,
the following activities can
be performed through the
use of valuation techniques:

• Stock selection
• Deducing market
expectations
25 Analysis of Business Transactions /
Deals

Valuation plays a very big role when

analyzing potential deals. Potential
acquirers 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
26
following corporate events:
• Acquisition -An acquisition usually has two
parties: the buying firm and the selling firm.
• Merger -General term which describes the
transaction wherein two companies had
their assets combined to form a wholly new
entity.
• Divestiture -Sale of a major component or
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 legal entity.
 • Leveraged buyout Acquisition of
27
another business by using significant
debt which uses the acquired business
as a collateral.
Valuation in deals analysis 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.
• Control -change in people managing
the organization brought about by the
acquisition.
 Corporate Finance
28 Corporate finance 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 increases firm value.

Small private businesses that need

additional money to expand use valuation
concepts when approaching private equity
investors and venture capital providers to
show the promise of the business.
 Larger companies who wish to obtain
29 additional funds by offering their shares to
the public also need valuation to estimate the
price they are going to fetch in the stock
market.
Corporate finance ensures that financial
outcomes and corporate strategy drives
maximization of firm value.
Firms that are focused on maximizing
shareholder value uses 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.
30 Legal and Tax Purposes
Valuation is also important to
businesses because of legal and tax
purposes.

Other Purposes
• Issuance of a fairness opinion for
valuations provided by third party (e.g.
investment bank)
• Basis for assessment of potential
lending activities by financial institutions
• Share-based payment/compensation
VALUATION CONCEPTS
AND METHODOLOGIES
31 PRINCIPLES IN
VA L U AT I O N :
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 can be impacted by
underlying net tangible assets.
V. Value is influenced by transferability
of future cash flows.
VI. Value is impacted by liquidity.
32 R i s k i n Va l u a t i o n :
Valuation risk is the risk of loss
arising from the difference between
the price of an instrument reported
on a bank's balance sheet – as
determined by accounting rules –
and the actual price a bank would
obtain if it sold that instrument (if it
is an asset) or the price a bank
would pay to buy it or transfer it
FUNDAMENTALS PRINCIPLES OF
VALUATION