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Revise Lecture 26. Business Valuations Why we do valuation of firm or share? What are the different methods?

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Presentation on theme: "Revise Lecture 26. Business Valuations Why we do valuation of firm or share? What are the different methods?"— Presentation transcript:

1 Revise Lecture 26

2 Business Valuations Why we do valuation of firm or share? What are the different methods?

3 Business Valuations Valuations of shares in both public & private companies are needed for several purposes by investors included; To establish terms of takeovers and mergers etc. To be able to make ‘buy and hold’ decisions in general.

4 Business Valuations To value companies entering the stock market To establish values of shares held by retiring directors, which the articles of a company specify must be sold For fiscal purpose (capital gain tax CGT) inheritance Divorce settlement

5 Business Valuations Different methods 1.Book value 2.Assets basis 3.Dividend basis 4.Earnings basis 5.Discounted cash flow basis

6 Business Valuations Intrinsic Value A share’s intrinsic value is the price that is justified for it when the primary factors of value are considered. In other words, it is the real worth of the debt or equity instrument as distinguished from the current market price.

7 Business Valuations Intrinsic Value The financial manager estimates intrinsic value by carefully appraising the following factors that affect share values; Value of the firm’s assets: The physical assets held by the firm have some market value. They can be liquidated if need to be provide funds to repay debt and distribute to shareholders.

8 Business Valuations Intrinsic Value Likely future interest and dividends For debt, the firm is committed to pay future interest and repay principal. For preferred and common stock, the firm makes attempts to declare and pay dividends. The likelihood of these payments affects present value

9 Business Valuations Intrinsic Value Likely future earnings The expected future earnings of the firm are generally viewed as the most important single factor affecting share value. Without a reasonable level of earnings, interest and dividend payments may be in jeopardy

10 Business Valuations Intrinsic Value Likely future growth rate A firm’s prospects for future growth are carefully evaluated by investors and creditors and are a factor influencing intrinsic value

11 Business Valuations Intrinsic Value Analysis Intrinsic value analysis is the process of comparing the real worth of a share with the current market price or proposed purchase price. The primary goal of intrinsic value analysis is to locate clearly undervalued or clearly overvalued firms or shares.

12 Business Valuations Intrinsic Value Analysis Intrinsic value analysis will not work in all cases because of three major limitations: 1.Marketplace slow to recognize real value 2.Stock of highly speculative firms 3.High growth stocks

13 Value of Common Share (Stock) There are three approaches for valuing common shares? 1.Single-period model 2.Perpetual dividends, no growth 3.Perpetual dividends, constant growth

14 Value of Common Share (Stock) Single-period model The rate of return on an investment may be expressed solely in terms of the effects for one period, normally a year. It is assumed that the share is purchased at point 0 and sold at point 1. Any cash received during the year plus any increase in value represent the return from the investment.

15 Value of Common Share (Stock) The formula is:

16 Value of Common Share (Stock) Example: An investor purchases 100 shares of common share for Rs4000 plus a Rs100 commission. In a single year, he sells the stock for Rs4500, less a Rs100 commission. During the year, he received Rs250 in dividends. What was the rate of return?

17 Value of Common Share (Stock) Solution:

18 Value of Common Share (Stock) Perpetual dividends, No growth A second approach to the valuation of common share looks at more than one period. It is useful for firms that will perpetually pay dividends but will not grow in terms of earnings or dividends. Even though such firms are rarely, if ever, found, the valuation of such a share is relatively easy

19 Value of Common Share (Stock) In order for the growth rate to be 0, the percent of retained earnings must be zero. Thus all EPS is paid out as DPS and the value of the share can be expressed; Valo = DPS1 / Ke = EPS1/ Ke

20 Value of Common Share (Stock) Perpetual dividends, constant growth A third approach to the valuation of common share consider a situation where earnings and dividends are growing at a constant rate. In this situation, the firm retains a portion of its earnings to finance growth but maintains a constant dividend payout, which is defined as the relationship between dividends and earnings.

21 Value of Common Share (Stock) The formula is: Val0 = DPS / Ke –g Example: A firm has an earnings per share of Rs5 and a dividend payout of 44%. An investor requires a 16% return on this kind of stock. The growth rate equals 12%. What is the intrinsic value of the share?

22 Value of Common Share (Stock) Solution:

23 Practice question Angro Ltd summarized statement of financial position as at 31 December 2003 Rs(million) Fixed Assets Net current assets Financed by: Ordinary shares (Rs100 par value) Reserves Medium and Long term bank loans 33.10

24 Practice question Angro summarized Income Statement for the year ending 31 December 2003 Rs(million) Profit before interest and tax – PBIT 5.8 Interest expense 2.3 Taxable profit 3.5 Taxation (25%) 0.9 Profit after tax 2.6 Dividend 2.0

25 Practice question Other information: The dividend growth rate will be 3 % pa Angro’s cost of equity is estimated at 7.6% Angro’s share price is currently Rs4.30 Paramount International Ltd P/E is currently 21.2, Whilst the industry average is 19.5 You are a financial consultant of paramount International Ltd. Your company wants to acquire Angro Ltd. Your managing director has asked you to do Angro Ltd valuation. Therefore calculate asset basis, dividend basis, Earnings basis and market basis worth of Angro Ltd

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