01 – FUNDAMENTALS PRINCIPLES OF ▪ It is assumed that the entity will realize assets

VALUATION and pay obligations in the normal course of

business.
▪ Value – pertains to the worth of an object in 3. Liquidation Value
another person’s point of view. ▪ Net amount that would be realized if the
▪ Valuation – estimation of an asset’s value business is terminated and the assets are
based on variables perceived to be related to sold on a piecemeal basis.
future investment returns, on comparisons with ▪ Value is computed on the assumption that
similar assets, or, when relevant, on estimates the entity will be dissolved.
of immediate liquidation proceeds. 4. Fair Market Value
o Includes the use of forecasts to come up with ▪ The price at which property would change
reasonable estimate of value of an entity’s hands between a hypothetical willing and
assets or equity. able buyer and a hypothetical willing and able
seller, acting at arm’s length in an open and
Factors in Value of a Business unrestricted market, when neither is under
1. Current Operations – how is the operating compulsion to buy or sell and when both
performance of the firm in recent year? have reasonable knowledge of the relevant
2. Future prospects – what is the long-term, facts.
strategic direction of the company? ▪ assumes that both parties are informed of all
3. Embedded Risk – what are the business material characteristics about the investment
risks involved in running the business? that might influence their decision
Definitions of Value
1. Intrinsic Value Roles of Valuation in Business
▪ Refers to the value of any asset based on the Portfolio Management - Largely depends on the
assumption that there is a hypothetical investment objectives of the investors or financial
complete understanding of its investment managers managing the investment portfolio
characteristics
▪ the value that an investor considers, on the 1. Fundamental Analysts
basis of an evaluation of available facts, to be ▪ Persons who are interested in
the "true" or "real" value that will become the understanding and measuring the intrinsic
market value when other investors reach the value of the firm.
same conclusion ▪ For them, the true value of a firm can be
Grossman – Stiglitz Paradox estimated by looking at its financial
▪ If the market prices, which can be obtained characteristics, its growth prospects, cash
freely, perfectly reflect the intrinsic value of an flows, and risk profile.
asset, then a rational investor will not spend to ▪ Principles:
gather data to validate the value of a stock. o Relationship between value and
▪ Investors will not analyze information about underlying factors can be reliably
stocks anymore. measured
▪ Investors will not rationally spend to gather o Above relationship is stable over an
more information about an asset unless they extended period
expect that there is reward in exchange of the o Any deviations from the above
effort. relationship can be corrected within a
2. Going Concern Value reasonable time
▪ Believes that the entity will continue to do its ▪ Value investors
business activities into the foreseeable o tend to be mostly interested in
future. purchasing shares that are existing and
priced at less than their true value
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 ▪ Growth investors Business deal
o Lean towards growth assets and 1. Acquisition
purchasing these at a discount. ▪ An acquisition usually has two parties the
2. Activists Investors buying firm and the selling firm.
▪ tend to look for companies with good ▪ The buying firm - needs to determine the fair
growth prospects that have poor value of the target company prior to offering a
management. bid price.
▪ Takeovers - they use their equity holdings ▪ the selling firm (or sometimes, the target
to push old management out of the company) - should have a sense of its firm
company and change the way the company value to gauge reasonableness of bid offers.
is run 2. Merger - General term which describes the
3. Chartists transaction wherein two companies had their
▪ relies on the concept that stock prices are assets combined to form a wholly new entity.
significantly influenced by how investors 3. Spin-off - Separating a segment or component
think and act business and transforming this into a separate
▪ assume that stock price change and follow legal entity.
predictable patterns since investors make 4. Leveraged buyout
decisions based on their emotions than by ▪ acquisition of another business by using
rational analysis significant debt which uses the acquired
4. Information Traders business as a collateral.
▪ Traders that react based on new ▪ Synergy and Control
information about firms that are revealed to o Synergy - potential increase in firm value
the stock market that can be generated once two firms
▪ Valuation is important to information traders merge with each other.
since they buy or sell shares based on their o Control - change in people managing the
assessment on how new information will organization brought about by the
affect stock price acquisition
Corporate Finance
Activities in portfolio management that are ▪ involves managing the firm’s capital structure,
performed through valuation: including funding sources and strategies that
1. Stock selection - Is a particular asset fairly the business should pursue to maximize firm
priced, overpriced, or underpriced in relation to value.
its prevailing computed intrinsic value and Legal and Tax Purposes
prices of comparable assets? ▪ The value of a business is used in determining
2. Deducing market expectations - Which statutory obligations (in some taxes or
estimates of a firm s future performance are in business distribution requirements)
line with the prevailing market price of its Other Purposes
stocks? Are there assumptions about ▪ Issuance of a fairness opinion for valuations
fundamentals that will justify the prevailing provided by third party (e.g. investment bank)
price? ▪ Basis for assessment of potential lending
activities by financial institutions
Analysis of Business Transactions / Deals ▪ Share based payment/compensation
▪ Potential acquirers use relevant valuation
techniques (whichever is applicable} to Valuation Process
estimate value of target firms they are Steps:
planning to purchase and understand the 1. Understanding of the business
synergies they can take advantage from the 2. Forecasting financial performance
purchase 3. Selecting the right valuation model
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 4. Preparing valuation model based on forecasts Forecasting Approaches:
5. Applying Valuation conclusions and providing 1. Top-down forecasting approach - Forecast
recommendation starts from international or national
macroeconomic projections with utmost
consideration to industry specific forecasts.
2. 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

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.

Preparing the Valuation model based on

Corporate Strategies to achieve competitive forecasts
advantage: ▪ Once the valuation model is decided, the
1. Cost Leadership - Relates to the incurrence of forecasts should now be inputted and
the lowest cost among market players with converted to the chosen valuation model.
quality that is comparable to competitors allow Aspects to consider:
the firm to price products around the industry 1. Sensitivity Analysis - A common methodology
average. in valuation exercises wherein multiple analysis
2. Differentiation - Firms tend to offer are done to understand how changes in an input
differentiated or unique product or service or variable will affect the outcome.
characteristics that customers are willing to pay 2. Situational adjustments or scenario
for an additional premium modelling - Firm-specific issues that affect firm
3. Focus - Firms are identifying specific value that should be adjusted by analysts.
demographic segment or category segment to Applying valuation conclusions and providing
focus on using either of the two strategies (cost recommendation
leadership or differentiation). ▪ Once the value is calculated based on all
assumptions considered, the analysts and
Business model investors use the results to provide
▪ pertains to the method how the company recommendations or make decisions that
makes money — what are the products or suits their investment objective.
services they offer, how they deliver and Key Principles in Valuation
provide these to customers and their target 1. The Value of a Business is Defined Only at a
customers specific point in time
▪ The results of execution of aforementioned 2. Value varies based on the ability of business to
strategies will ultimately be reflected in the generate future cash flows
company performance results contained in the 3. Market dictates the appropriate rate of return for
financial statements. Analysts look at the investors
historical financial statements to get a sense of 4. Firm Value can be impacted by underlying net
how the company performed. tangible assets
5. Value is influenced by transferability of future
cash flows
6. Value is impacted by liquidity
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Risks in Valuation The importance of identifying risks is to enable
▪ Uncertainty - The possible range of values investors to quantify the of the risk and/or the cost of
where the real firm value lies. managing these risks.
1. Some valuation methods use future estimates Among the popular methods used to determine the
which bear the risk that what will actually value using assets as its bases are:
happen may be significantly different from the (1) book value method;
estimate. (2) replacement value method,
2. Analysts use their judgments to ascertain (3) reproduction value method; and
assumptions based on current available facts (4) liquidation value method.
3. Depending on the industry, businesses can be
very sensitive to changes in macroeconomic Book Value Method
climate (investment goods, luxury products) or ▪ Book value can be defined as the value
not at all (food and pharmaceutical) recorded in the accounting records of a
4. Innovations and entry of new businesses may company.
also bring uncertainty to established and ▪ Current assets are those expected to be
traditional companies. realized within the company's normal
operating cycle, expected to be realized within
02 – ASSET-BASED VALUATION 12 months after these transactions were
▪ Asset - has been defined by the industry as reported, or held primarily for the purpose of
transactions that would yield future economic trading.
benefits as a result of past transactions. ▪ Cash and cash equivalents may also be
▪ The value should also include all cash flows included only if it is not restricted.
that will be generated until the disposal of the ▪ On the other hand, assets wherein benefits
asset. can be realized in more than 12 months are
Kinds of Investment known as non-current assets.
▪ Green field investments - investments that ▪ On the other hand, liabilities is also
started from scratch categorized as current and non-current.
▪ Brown field investments - those Current liabilities are expected to be settled
opportunities that can be either partially or fully within the entity's normal operating cycle, due
operational. Brown field investments are those to be settled within 12 months, held for the
already in the going concern state, as most purpose of trading or if the company does not
businesses are in the optimistic perspective have ability to settle beyond 12 months.
that they will grow in the future ▪ Non-Current liabilities are liabilities which
▪ Going concern business opportunities (GCBO) are due to be settled longer than 12 months In
are those businesses that has a long term to the book value method, the value of the
infinite operational period enterprise is based on the book value of the
assets less all non-equity claims against it.
The benefits of having a sound Enterprise-wide ▪ Hence, the formula is:
Risk Management allows the company to: Net Book Value of Assets = Total Assets –
1. Increase the opportunities; Total Liabilities / Number of Outstanding
2. facilitate management and identification of the Shares
risk factors that affect the business; BV = Total Assets – Total Liabilities
3. identify or create cost-efficient opportunities BV per Share = BV / Outstanding Shares
4. manage performance variability:
5. improve management and distribution of The advantage of using book value method is that
resources across the enterprise; and it provides a more transparent view on firm value
6. make the business more resilient to abrupt and is more verifiable since this is based in the
changes. figures reflected in the financial statements.
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 However, the book value only reflects historical Reproduction Value Method Reproduction
value and might not reflect the real value of the ▪ value is an estimate of cost of reproducing,
business. creating, developing or manufacturing a similar
Replacement Value Method asset.
▪ The National Association of Valuators and ▪ The reproduction value method requires
Analysts has defined the replacement cost reproduction cost analysis which is internally
as the cost of similar assets that have the done by companies especially if the assets are
nearest equivalent value as of the valuation internally developed.
date. ▪ The challenge of using reproduction value
▪ Under the replacement value method, the method is the ability to validate the
value of the individual assets shall be reasonableness of the value calculated since
adjusted to reflect the relative value or cost there are only limited sources of comparators
equivalent to replace that asset. and benchmark information that can be used.
▪ Insurance companies use the replacement ▪ Formula same with replacement value
value in determining the appropriate Steps in determining the equity value using the
insurance premium to be charged to their reproduction value method are as follows:
clients. 1. Conduct reproduction costs analysis on all
Replacement Value = NCA x % of NCA assets.
Replacement Cost 2. Adjust the book values to reproduction costs
Replacement Value of Company = (RV of NCA + values (similar as replacement values)
CA) – Total Liabilities 3. Apply the replacement value formula using the
Replacement Value per Share = RV of Company figures calculated in the preceding step
/ Outstanding Shares Liquidation Value Method
▪ considers the salvage value as the value of
The following are the factors that can affect the the asset.
replacement Value of an asset: ▪ This assumes that the reasonable value for
1. Age of the asset - It is important to know how the company to be purchased is the amount
old the asset is. This will enable the valuator to which the investors will realize in the end of
determine the costs related in order to upkeep a its life or the value of the when it is
similarly aged asset and whether assets with terminated.
similar engineering design are still available in ▪ The future value is not fully incorporated in
the market. the calculated equity value.
2. Size of the assets - This is important for fixed
assets particularly real property where assets of
the similar size will be compared. Some
analysts find that the assets can produce the
same volume for the assets of the same size.
3. Competitive advantage of the asset - Assets
which have distinct characteristics are hard to
replace. However, the characteristics and
capabilities of the distinct asset might be found
in similar, separate assets. Some valuators
combine the value of the similar, separate
assets that can perform the function of the
distinct asset being valued.

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