Corporate Valuation

In the wake of economic liberalisation, a critical issue to be addressed among issues concerning corporate restructuring, mergers and joint ventures is - how a company should be valued.

There are several approaches to valuation. These are briefly described as below:  

This is the most popularly used method for valuing a company. This method involves the following steps.

o        Forecasting the free cash flow (FCF):  

FCF= free cash flow from operations + non operating cash flow

Free cash flow from operations= Gross cash flow- Gross investment  

Gross Cash Flow= EBIT- taxes on EBIT-change in deferred taxes=Net Operating Profit less adjusted taxes (NOPLAT)+Depreciation. 

Gross Investment= Increase in fixed assets + current assets + other assets.  

o        Computing the cost of capital:  

Cost of capital= Ke*E/V+Kd(1-t)*D/V+Kp*P/V  

Where :  

     Ke is the cost of equity capital

            Kd is the cost of debt

            Kp is the cost of preference capital

            E is the market value of equity

            D is the market value of debt

            P is the market value of preference capital 

            V is the market value of the firm  

o        Estimating the continuing value: this can be calculated as follows:  

Continuing value (CV)= PV of free cash flow during the explicit period+ PV of free cash flow after the explicit forecast period. 

Cash flow as well as non-cash flow methods can be used to calculate continuing value.

The Cash Flow methods include:  

§          Growing Free Cash Flow Perpetuity Method: this method assumes that the free cash flow grows at a constant rate after the explicit forecast period.

§          Value Driver Method: this method uses the same logic as the above method but the connotations of the formula are different. 

The Non Cash Flow methods include:  

§          Replacement cost method

§          Price-to-earnings ratio method

§          Market to book ratio method  

Steps to calculate the value of the company include:

§          Discount the projected free cash flow and the continuing value, using the cost of capital.

§          Deduct the market value of all debt claims.  

This approach involves valuing a company on the basis of how similar companies are valued. This approach involves the following steps: 

o        Analyse the economy: this provides a basis for evaluating the individual companies within an industry.

o        Analyse the industry: this involves studying various aspects like the relationship between the industry and the economy, profit potential of the industry, nature of regulations applicable etc.

o        Analyse the subject company: this involves studying the various functional aspects of the company life manufacturing, human resources, technological position, financial aspects etc.

o        Select comparable companies: companies, which are similar to the subject company in the various respects mentioned earlier, must be selected.

o        Analyse the financial aspects of the subject and comparable companies

o        Analyse the multiples: the multiples to be considered include price to cash flow, price to earnings, price to EBIT, price to EBDIT, price to sales, price to book value.  

• Adjusted book value approach

This approach involves determining the fair market value of the assets and liabilities of the company as a going concern.

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