Business Valuation Training Guide

WHAT IS VALUE?
4
Valuations need to:
› Be forward looking
› Consider risk/reward profile
› Identify the asset being valued and its
associated earnings
The value of an asset is
the value of its future
earnings stream
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VALUATION DRIVERS
7
Size of
Business
Management
Sector
Vulnerability
Scarcity
Growth
Prospects
VA L U AT I O N

DCF DEFINITIONS
› Equity value = value of equity in a business
› Enterprise value = value of operations and non operating assets
› Net debt = debt claims against the business (excluding operating
payables), less cash and marketable securities
› Ke = cost of equity
› Kd = cost of debt
› WACC = Weighted Average Cost of Capital.
10

EXAMPLE OF FCFF CASH FLOWS
13
EBIT
Less: Tax
Add: Non-cash items (including depreciation)
Less: Working capital
Less: Capex
F R E E C A S H F L O W T O F I R M

CHOICE OF MODEL
DIVIDE N D DISCOU N T
MODEL (DDM)
Less robust
model than FCFF and
FCFE
Applied in the
valuation of
minority interests
16
› Future dividends forecast
› Discounts cash flows at ke
› Equity value calculated directly

VALUATION PROCESS – FCFF
19
Forecast
period FCF
Terminal
value
Value of
operations
Non-operating
assets
Enterprise
value
Debt and
debt-like items
Equity value pre
DLOM and DLOC
Ownership
% applied
Discount for
lack of control
Equity value
post DLOC
Discount for lack
of marketability
Equity value of
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FORECASTS – INCOME STATEMENT
22
› Not based on IFRS
› Adjust out all “funnies”
› Sensible grouping of accounts (cut the
data to identify trends and “tell the company’s
story”)
› Must always be reconciled back to management’s
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FORECASTS – OPERATING CASH FLOWS
25
REVENUE
Consider historical growth
rates, customers won /
lost, new product
launches, price growth,
market growth (volume
growth)
COST OF SALES
Consider historical margin
trends, fixed versus
variable, product mix
SUNDRY INCOME
Consider sustainability
OPERATING COSTS
Consider fixed vs variable,
step changes, normalising
volatile costs, historical
relationship with revenues

FORECASTS – OVERALL
REASONABLENESS
28
CALCULATE KEY RATIOS:
› Gross profit %
› EBITDA %
› Net profit %
COMPARE TO
INDUSTRY NORM

COMMON
MISTAKES
› Unrealistic growth assumptions
(especially volume growth)
› Focus placed on profit instead of
cash generation
› NWC and capex underestimated
› Forecast period not long enough to
reduce growth to "normal" level

COST OF DEBT (KD)
34
› Use company actual cost of debt ONLY if debt
recently raised
› Weight in accordance with current balances (based
on market values)
› Calculate after tax cost Kd x (1 – t)

COST OF EQUITY – RFR TO USE?
37
Yield on local
government bond
Match bond to
investment horizon
Bond must be
actively traded

COST OF EQUITY
40
› Observed equity beta’s un-levered
using formula:
– Asset ß = Observed beta /(1+(1 - t) x D/E)
› Asset beta then re-levered using inverse of
above formula
– Equity ß = Asset beta /(1+(1 - t) x D/E)

WACC
WEIGHTING
CHOICES
Book values of debt / Equity
Actual company debt / equity at
market values
Target debt / equity structure
based on industry average
43

CALCULATING VALUE
USING DCF
APPROACH

NON-OPERATING ASSETS
49
› Value of non-operating assets added to value of
operations to give enterprise value
› Typical non-operating assets include:
− Cash
− Loans receivable
− Investment property
− Any assets that are not core to the business
› Non-operating assets to be included at fair value

EQUITY VALUE
52
› Following the steps above will give you the value
of equity!
› If valuing a minority interest, apply further
discount at a rate of between 15% and 35%,
based on factors relevant to the shareholding:
− Presence of a majority shareholder
− History of abuse by majority
− Dividend history
− Shareholders agreement with exit / put option

› Liquidity discount not applied at all
or added into the discount rate
› Non-operating assets are omitted or
double counted by including income
in CF and then adding asset
› Inappropriate debt deducted (e.g.
Amounts already in NWC)
COMMON
MISTAKES

MAINTAINABLE EARNINGS
› Historic results used to assess
achievability of future forecasts
› Identify non-recurring/discretionary
expenses
› Establish “true underlying profitability”
58

CONCLUSION

1
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