Asset-Based Valuation

• Asset-based valuation is employed to determine the worth of a company by evaluating the value of its assets.

Understanding Assets

• Assets are transactions expected to provide future economic advantages through past transactions.
• The value of investment options relies significantly on what the asset generates now and in the future.
• The valuation needs to remain confidential to allow for negotiating better acquisition deals.
• Valuation should calculate the cash flows created until the asset is disposed of.
• Asset valuation challenges arise with green field investments.
• Green field investments begin from scratch, while brown field investments operate partially or fully.
• Brown field investments are ongoing businesses with future growth potential.
• Going concern business opportunities (GCBOs) have long-term to infinite operational periods.
• GCBOs provide historical data, enabling risk indicator quantification.

Risk Management

• The Committee of Sponsoring Organizations of the Treadway Commission (COSO) states risk management standards are vital in running and valuing businesses.
• Enterprise-wide Risk Management enables the company to:
  • Increase opportunities.
  • Identify risk factors.
  • Identify cost-efficient opportunities.
  • Manage performance variability.
  • Improve resource management and distribution.
  • Enhance business resilience to changes.

Key Considerations for Asset-Based Valuation

• A business's assets determine its value, allowing analysts to confirm firm value through asset valuation.
• Asset-based valuation focuses on current and historical asset values, potentially overlooking future value generation.
• Knowledge of GAAP is vital for analysts.
• Information required for asset-based valuation includes total asset value, financing structure, total liabilities, total equity, equity classes, and funding sources.
• Asset-based valuation is suitable when the value basis is accurate and complete.

Asset Valuation Methods

• Various methods are used to determine value using assets which include:
  • Book value method.
  • Replacement value method.
  • Reproduction value method.
  • Liquidation value method.

Book Value Method

• Book value is the value recorded in a company's accounting records.
• The enterprise's value is determined by subtracting non-equity claims from the assets' book value.
• The formula for calculating this:
• Net Book Value of Assets per Share = (Total Assets - Total Liabilities) / Number of Outstanding Shares
• For example:
  • If Grape and Vines Corp. reports $500,000,000 in current assets, $1,000,000,000 in non-current assets, $200,000,000 in current liabilities, $700,000,000 in non-current liabilities, and 1,000,000 outstanding shares,
  • The net book value of assets is calculated as follows:
  • Total Assets = $500,000,000 (current) + $1,000,000,000 (non-current) = $1,500,000,000
  • Total Liabilities = $200,000,000 (current) + $700,000,000 (non-current) = $900,000,000
  • Net Book Value of Assets = $1,500,000,000 - $900,000,000 = $600,000,000
  • Net Book Value per Share = $600,000,000 / 1,000,000 shares = $600
• The advantage of using the book value strategy is that firm value is more visible and verifiable due to financial statement figures.
• Book value reflects past values and might not accurately represent the business's current value.

Replacement Value Method

• The individual assets' value is adjusted to reflect the relative or cost equivalent to replace the assets.
• Replacement value is impacted by:
  • The age of the asset.
  • The size of assets.
  • Competitive advantage.
• The formula:
  • Replacement Value per share = Net Book Value +(-) replacement adjustment / Outstanding Shares.
• Example calculation:
  • If 50% of the non-current assets have a replacement value of 150% of their recorded net book value, and the remaining half has an estimated replacement value of 75% of their recorded net book value:
  • 50% of Non-current Assets at 150%:
    • Non-Current Assets: $1,000,000,000; 50% of affected item: $500,000,000.
    • Premium on Replacement: 150%; Adjusted Non-current Assets (A): $750,000,000.
  • 50% of Non-current Assets at 75%:
    • Non-current Assets: $1,000,000,000; 50% of affected item: $500,000,000.
    • Discount on Replacement: 75%; Adjusted Non-current Assets (B): $375,000,000.
  • Total Adjusted Non-current Assets = $750,000,000 + $375,000,000 = $1,125,000,000.
  • With current assets of $500,000,000, the total adjusted assets is $1,625,000,000.
  • Using the formula:
    • Total Assets- Replacement Value= $1,625,000,000 - $900,000,000
    • Replacement Value = $ 725,000,000 / 1,000,000 Shares
    • Replacement Value is $725 per share

Reproduction Value Method

• Reproduction value is employed when replacement cost data is limited for highly specialized assets.
• Reproduction value estimates the cost of replicating an asset.
• For instance, a firm estimates Php 1.3 Million to develop another asset with the ability to generate 500 tons of inventory.
• Reproduction requires reproduction cost analysis which is internally done by the companies if the assets are internally developed.
• It's useful for new or start-up businesses and heavily dependent on intangible assets.
• Evaluating the reasonableness of the calculated value is challenging.
• Steps to determine equity value:
  • Conduct reproduction costs analysis on all assets.
  • Adjust the book values to reproduction costs values.
  • Apply the replacement value formula using the figures calculated in the preceding step.
• Example:
  • In Grapes and Vines Corp, 80% of total non-current assets cost 90% less to reproduce, and 20% comprise accurately valued goodwill:
    • Conduct reproduction cost analysis on assets:
      • 80% of Total Noncurrent Assets, if reproduced, cost 90% of their value.
      • For the Php 1,000,000,000 non-current assets, only 80% require review = Php 800,000,000.
      • The remaining 20% = Php 200,000,000 is goodwill and already at its proper value.
    • Adjust the book value of reproduction costs:
      • Review: Non-current assets = Php 800,000,000
      • Reproduction cost estimate 90%
      • Reproduction cost Php 720,000,000
      • Total adjustment = Php 920,000,000
    • Add current assets of 500,000,000

Liquidation Value Method

• Considers the salvage value as the value of the asset.
• It assumes that the fair value for the company purchased is the amount that investors will achieve when the company ends.
• Future value is not incorporated in the calculated equity value.
• According to the CFA Institute.
  • Liquidation refers to the value of a company if it were dissolved and its assets sold individually.
  • it represents net amount if shut down and assets sold piece meal.
  • It is also known as net asset value ( hotel - beds, chairs, furniture, and kitchen equipment)
• Liquidation values may erode based on the timeframe (perishable goods).
• Used to value dying or losing companies where liquidation is to take place.
• Cannot be used to value profitable or growing companies.
• Can be used to check whether profits can be realized if profits can still be made after the sale of the assets.
• Liquidation can be difficult to obtain because they are not readily available.

Situations to Consider with Liquidation Value

• The most common reason why businesses must either cluse or liquidate is Business failure such as
  • Low or negative returns might indicate potential business failure.
  • Insolvency may occur when a company asset is more than liabilities but they are unable to pay due to lack of cashflow.
  • Bankruptcy is the most serious failure because the liabilities are more than asset balance.
• External factors for business failure are
  • Economic downturn.
  • Changing customer preferences.
  • Government action or regulation.
  • Natural disaster or calamities or a pandemic.
  • Depletion of scarce resources and corporate or project end of life
• Formula:
• Liquidation Value = Present Value of Asset Sales - Present Value of Termination / Settlement Liabilities - Present Value of Tax Charges and Liquidation Costs

Liquidation Example

• Pavement Company has 250,000 shares, with assets and their values at which they could be sold.
• Cash is valued at 100%
• A/r is valued for what the debts would be sold at 85%
• Inventories are sold for 60%
• Prepaid expenses are sold at 25%
• PP&E is sold at 60%
• Liabilities:
• Notes Payable: $1,200,000
• Other Liabilities: $800,000

Illustrative Example #2

• Golda Company ends its corporate life in 3 years.
• It intends to extract a joint venture of gold.
• Net Cash Flow is $3,000,000
• Cost for Closure of mining and other liquidation prices is $10,000,000
• Cost of Capital = 10%
• Remaining assets at the end of the year will be sold for $ 30,000,000
• Debt = $4,000,000
• Total value of Golda Comapany (P7,460,556 + P12,2021037) P19,481,593

Illustrative Example #3

• Droid total assets: $3,000,000 Total Liabilities: $1,000,000
• $100,000 of outstanding ordinary shares.
• They can be sold for $1,800,000 upon checking with buyers
• Liquidation costs = $300,000

Summary of Asset-Based Valuation

• It Is used by analysts because assets represent what the company has, minus non-equity claims.
• Asset-based valuation options:
• Book, replacement, reproduction, and liquidation value methods.
• The satement of financial postitions, less liabilities, uses the book value.
• Assets are presented through financial statements when using replacement value.
• When using reproduction value, the assets are judged while rebuilding.
• The liquidation of the assets and their salvage when valuing.