Questions and Answers
Why is it necessary to calculate the value of shares for unlisted companies?
Which valuation method focuses on the relationship between a company's assets and liabilities?
What is a potential disadvantage of using asset-based valuation?
How is the value calculated in asset-based valuation when the total assets and liabilities are known?
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What must a target company follow for asset-based valuation to be meaningful?
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In a scenario where total assets are $107 billion and liabilities are $60 billion, what is the calculated value?
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For which type of business valuation can the study of a firm's working capital be essential?
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What is the total asset value derived from a book value of $50,000 with an added fair market value of $76,000?
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What does ROCE stand for?
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Which formula is used when there is no growth in dividends?
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What are the components of the CAPM formula?
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What does the free cash flow model primarily analyze?
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In computing average return on capital employed, which two values are involved?
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If dividends are expected to grow, which formula is used to calculate share price?
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Why is ROCE more meaningful when expressed in current cost figures?
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What is a critical step in the free cash flow model's three-step procedure?
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What is the total liabilities amount after adding the contingent liabilities of $7,000?
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Which of the following is NOT a characteristic of the earnings-based valuation approach?
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In the PE based valuation, what is the relationship between earnings per share (EPS) and the price-earnings (PE) ratio?
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What factor is likely to make the PE multiple lower for unlisted companies compared to listed companies?
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Which method calculates the value per share using the formula for earning per share and the normal return on investment?
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What is the primary consideration for valuing intangible assets in an earnings-based valuation method?
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What is a potential drawback of using numerous assets when assessing business profitability?
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In calculating the company's value using the ROCE driven model, what must be assigned to arrive at a weighted average?
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Study Notes
Need for Valuing Shares
- Valuation of shares is essential for unlisted companies, where market prices are not readily available.
- Market prices of listed companies may not accurately represent the fair value.
- Potential manipulation or rigging of market prices necessitates independent valuation.
Methods of Valuation
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Asset Based Valuation
- Relies on the balance sheet's owner's equity, calculated as total assets minus total liabilities.
- Useful when companies have undergone regular depreciation and revaluation.
- Starting point for comparisons with other valuation methods.
- Key figures:
- Total assets = $107 billion, Total liabilities = $60 billion, Value = $47 billion.
- Alternative example: Book value of assets = $50,000, Fair market value of total assets = $86,000, Total liabilities = $40,000.
- Pros: Preferred in critical scenarios like liquidation; straightforward calculations; includes off-balance-sheet items.
- Cons: Historical costs may not represent current values; valuing intangible assets complicates the process.
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Earnings Based Valuation
- Methods include Capitalization of Earnings and Price-Earnings (PE) based valuation.
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Capitalization of Earnings:
- Example: Profit for equity shareholders = Rs 225,000, No. of shares = 10,000, EPS = Rs 22.5, Normal ROI = 16%, Value per share = Rs 140.625.
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PE Based Valuation:
- Values based on the product of EPS and PE ratio.
- Merger effect on EPS may be dilutive or positive; PE ratios may vary based on the target company's size and marketability.
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Earnings Based Model - ROCE Driven
- Uses market return on assets as a benchmark.
- Steps include calculating current ROCE, averaging past capital employed and profits, and capitalizing using market ROI for firm valuation.
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Dividend Based Valuation
- Value derived from dividend payments:
- No growth: S = D1/Ke
- Constant growth: S = [Do(1+g)] / (Ke-g)
- S = Current share price, D1 = Dividend, Ke = Cost of equity, Do = Last year’s dividend, g = Expected growth rate.
- Value derived from dividend payments:
-
CAPM Based Valuation
- Uses Capital Asset Pricing Model for share valuation.
- Critical for estimating prices during initial public offerings.
- Formula: ke = Rf + β (Rm - Rf), where Rf = risk-free rate, ke = cost of equity, Rm = market return.
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Free Cash Flow Model
- Estimates the maximum price for acquiring a business.
- Analyzes financial statements to assess distributable cash surpluses.
- Involves:
- Determining free cash flows: Net operating income + Depreciation - Incremental investments.
- Estimating terminal cash flows based on growth assumptions.
- Present value calculations of these cash flows for acquisition price comparison.
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Description
This quiz explores the critical need for valuing shares in unlisted companies, especially in the context of mergers and acquisitions. Understanding the valuation process is essential for making informed decisions when market data is not readily available. Dive into the methodologies and reasons behind business valuations.
