Valuation for Mergers & Acquisitions

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Questions and Answers

Why is it necessary to calculate the value of shares for unlisted companies?

Market prices are always available.

Market prices may not accurately reflect fair value. (correct)

Investors prefer paying higher prices.

Unlisted companies are always more profitable.

Which valuation method focuses on the relationship between a company's assets and liabilities?

Present Value of free cash flows

CAPM based valuation

Earnings-based valuation

Asset-based valuation (correct)

What is a potential disadvantage of using asset-based valuation?

It overestimates the value of intangible assets.

It is based on subjective estimates.

It considers fair market value.

It relies on historical cost, which may not relate to current market value. (correct)

How is the value calculated in asset-based valuation when the total assets and liabilities are known?

Total assets - Total liabilities Signup and view all the answers

What must a target company follow for asset-based valuation to be meaningful?

Regular depreciation and revaluation policies. Signup and view all the answers

In a scenario where total assets are $107 billion and liabilities are $60 billion, what is the calculated value?

$47 billion Signup and view all the answers

For which type of business valuation can the study of a firm's working capital be essential?

Asset-based valuation Signup and view all the answers

What is the total asset value derived from a book value of $50,000 with an added fair market value of $76,000?

$86,000 Signup and view all the answers

What does ROCE stand for?

Return on Capital Employed Signup and view all the answers

Which formula is used when there is no growth in dividends?

S = D1 / Ke Signup and view all the answers

What are the components of the CAPM formula?

Ke = Rf + beta (Rm - Rf) Signup and view all the answers

What does the free cash flow model primarily analyze?

Distributable cash surpluses and required investments Signup and view all the answers

In computing average return on capital employed, which two values are involved?

Return and Capital Employed Signup and view all the answers

If dividends are expected to grow, which formula is used to calculate share price?

S = [Do(1+g)] / (Ke - g) Signup and view all the answers

Why is ROCE more meaningful when expressed in current cost figures?

It accounts for inflation effects. Signup and view all the answers

What is a critical step in the free cash flow model's three-step procedure?

Estimate working capital requirements Signup and view all the answers

What is the total liabilities amount after adding the contingent liabilities of $7,000?

$47,000 Signup and view all the answers

Which of the following is NOT a characteristic of the earnings-based valuation approach?

It includes earnings of the company. Signup and view all the answers

In the PE based valuation, what is the relationship between earnings per share (EPS) and the price-earnings (PE) ratio?

Market value equals the product of EPS and PE ratio. Signup and view all the answers

What factor is likely to make the PE multiple lower for unlisted companies compared to listed companies?

Restricted marketability Signup and view all the answers

Which method calculates the value per share using the formula for earning per share and the normal return on investment?

Capitalization of earnings Signup and view all the answers

What is the primary consideration for valuing intangible assets in an earnings-based valuation method?

Attention to detail during valuation Signup and view all the answers

What is a potential drawback of using numerous assets when assessing business profitability?

It may not reflect the business's operational efficiency. Signup and view all the answers

In calculating the company's value using the ROCE driven model, what must be assigned to arrive at a weighted average?

Past capital employed and past profits Signup and view all the answers

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

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.
Earnings Based Valuation
- Methods include Capitalization of Earnings and Price-Earnings (PE) based valuation.
- 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.
- 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.
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.
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.
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.
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.