COMPANY VALUATION METHODS. THE MOST COMMON ERRORS IN VALUATIONS (original) (raw)
Introduction to Business Valuation
Advances in Business Information Systems and Analytics, 2020
This chapter is an introduction to the book and provides basic information to help readers in the following chapters. This book analyzes all kinds of problems and develops solutions in firm valuation process. The needs and purposes of firm valuation are briefly explained. Basic Concepts, such as Cost, Price, Value, Valuation, Evaluation, Free Cash Flow, and different types of value, are explained. Face value, issue price, fair value, intrinsic value, market value, book value, going-concern value, liquidation value, replacement value, enterprise value, and equity value are explained within the different types of value. Then, “financial statements” and “elements of financial statements”, which will form the basis of all valuation approaches, are explained and emphasized. The value drivers for businesses are discussed. Business valuation approaches' general features are given.
CORPORATE VALUATION: A LITERATURE REVIEW
This article discusses the ways and methods of corporate valuations that include the discounted cash flow models, the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Models (APM), Tobin's q, sales accelerator and cash flow models of investment, and economic base performance measures such as Economic Rent and Excess Market Value. It seems that more innovated methods to detect changes in companies' financial positions are needed. Also, managers' financial experiences are essential for companies to compete in a world with a constant change.
EQUITY VALUATION USING ACCOUNTING NUMBERS
This research primarily focuses on the valuation methodologies used to value firms with high and low intangibles as scaled by the total assets of the firm. In doing so a structured positive approach is applied in all chapters to explain the outcomes. Various statistical tools and databases have also been used to support the results and give them a strong base. Chapter two gives a brief overview of valuation literature explaining the different valuation models in practice. Chapter three deals with an exhaustive study of a small sample of twenty-one firms and their analyst reports. Strict investigation of the analysts‟ reports reveal that Discounted Cash Flow (DCF) model is the most commonly used valuation model across the firms of the sample. However, multiples-based approach has also been used frequently, but DCF supersedes as the dominant model in most of the cases. The analysis is extended to a large sample of 1140 observations in chapter four and involves empirical study to find out the valuation technique that gives the most approximate estimate of price. The mean valuation errors are minimal for the harmonic mean multiple after the REVM model. This analysis
Mergers and Acquisitions : A Review of Valuation Methods
2017
Globally, mergers and acquisitions (M&A) have grown dramatically in recent years. M&A offer companies the opportunity to grow rapidly and successfully. One of the most critical elements in M&A is the valuation of companies as the success of an M&A is closely related to determining the fair value of the companies. Determining the value of a company is one of the most complex and difficult subjects in financial management. Corporate executives face many choices and complications as they try to assess a company’s value. There are a variety of ways to value a company. In this study I discussed the main methods of business valuation and I analyzed how to use the Discounted Cash Flow Method in M&A. This Method determines a company’s current value according to its estimated future cash flows and is often used in the valuation of companies. Finally I tried to determine which method would be appropriate in an M&A.
Advances in Equity Valuation: Research on Accounting Valuation
Abacus, 2016
This special issue of Abacus was prompted and made possible through the annual conference of our research group MEAFA 1 at the University of Sydney, and especially by the contributions of visitors to MEAFA and their collaborations with members of the group. The six papers and added commentaries in this special issue of Abacus contain surveys and original contributions on the theory and empirical testing of a class of valuation models that is unique to accounting. Beginning with works such as Edwards et al. (1987) and Feltham and Ohlson (1995), a mathematical reconciliation is now widely known between the present value of cash flows and the present value of accounting residual incomes. 2 The only rule of accounting practice (asset valuation) required by this analogy is the clean surplus rule, whereby the period change in book value of equity, after allowing for dividends, shows up exactly in each period's accounting income or profit. This requirement says nothing about how assets need to be valued (e.g., how depreciation is calculated). It is only when a finite time series of residual income numbers is used to value the firm, or, in other words, to predict the firm's future, that policy-based accounting rules (e.g., depreciated historical cost versus fair market value) start to matter. Seeing that accounting valuation methods coincide mathematically with discounted cash flow models, researchers in accounting have returned to questions like why and how accruals accounting might produce 'accounting numbers' that anticipate or hint at the future prospects and current value of the firm. That way of thinking sets up the discipline of accounting as a science, with both theory and empirical results, each withstanding criticism and gaining respectability via the other. Whether that theory or testing is now sufficiently advanced to bring practical benefits is not the question. Any science in its development has to pass that stage. The papers in this issue of Abacus all celebrate what an 'accounting science' of firm valuation and prediction has to offer, both at present and in terms of ideas for further development. The six papers and commentaries are written by highlyrespected contributors to accounting valuation theory and testing, and together 1
Errors in 110 common errors in company valuations
In the review paper Fernández and Bilan suggest corrections for a spectrum of errors identified in actual valuations performed by the financial analysts, investment banks and financial consultants, thus providing a valuable insights for both academia and practitioners. However, their instructive example of a proper valuation in the section 1.D "Wrong Calculation of WACC" contains errors itself. This note discusses the origin of these errors and the way to eliminate them.
The Value Examiner, 2020
Much literature exists on methods that can be used to estimate the fair market value (FMV)—as conventionally defined by the standards of professional organizations1—of going concerns (defined below). Limited literature, however, covers methods or mechanisms that can be used to reconcile indications of going concern FMV derived from multiple valuation methods. This article summarizes the gaps in the literature on this subject and introduces an alternative practice mechanism (APM) (Salter 2020) that is configured to provide a more substantive defense of going concern FMV conclusions. We believe the APM proposed in this article clarifies the issues associated with reconciling separate business value indications from multiple methods, enhances the practice of business valuation, and ties academic research more closely with these enhanced practices.
Understanding Business Valuations, Shares, and Other Proprietary Interests
2004
This customized coaching module addresses business valuation theories and practices from the standpoint of corporate managers, external financiers and investors, and valuation specialists. Users of valuation technologies seek to utilize all available knowledge to the extent that their resources, efforts, and exposures can be minimized. With unlimited access to the sources of internal information, corporate managers have employed an "economic-based valuation approach" to capture direct contributions of certain operating, investment, and financing activities on firm value. Creditors and shareholders who lack a direct control over the firm’s operations often rely on an "accounting-based valuation approach" to evaluate financial statements and establish the linkage between the firm’s performance and its market value. Valuation specialists such as corporate lenders, investment bankers, professional fund managers, and portfolio investment advisors have utilized a wide range of sophisticated valuation techniques subject to their unique analytical styles and resource limitations. With an advance in computer technology, however, many valuation specialists have turned their attention to a "quantitative-based valuation approach" that allow them to not only accurately measure the independent and joint impacts of internal business activities and external market events on firm value based on sophisticated mathematical models but also identify the mispriced assets or “valuation gaps” that may occur from persistent market imperfections and the sub-rational behavior of some groups of market participants.
A Practical Guide for Consistency in Valuation: Cash Flows, Terminal Value and Cost of Capital
SSRN Electronic Journal, 2000
Practitioners and teachers very easily break some consistency rules when doing or teaching valuation of assets. In this short and simple note we present a practical guide to call the attention upon the most frequent broken consistency rules. They have to do firstly with the consistency in the matching of the cash flows, this is, the free cash flow (FCF), the cash flow to debt (CFD), the cash flow to equity (CFE) and the tax savings or tax shield (TS). Secondly, they have to do with the proper expression for the cost of unlevered equity with finite cash flows and perpetuities. Thirdly, they have to do with the consistency between the terminal value and growth for the FCF and the terminal value and growth for the CFE, when there is a jump in the CFE due to the adjustment of debt to comply with the leverage at perpetuity. And finally, the proper determination of the cost of capital either departing from the cost of unlevered equity (Ku) or the cost of levered equity (Ke). In the Appendixes we show some algebraic derivations and an example.
Company Valuation. How to Deal with a Range of Values
2011
Company valuation is not done after having generated a few values being a result of applying different valuation methods. In many cases institutions ordering the valuation request a value which can be an equivalent of a market, transactional value. Often the one method (and the valuation resulting from the method) can be indicated, since the valuer claims that it gives the most precise value of the company. However, it is safer to consider the range of values and then try to determine the final value which is the result of a combination of several methods. However, the question is how to consistently deal with a range of values. One of the solutions are so-called mixed methods of company valuation. They are criticized in this paper as they are too subjective. Instead we suggest considering a portfolio approach -PATEV (Portfolio Approach to Equity Valuation). In addition to having to choose a method of defining one value, the value is subject to further corrections: liquidity and control discounts.
Application of Alternative Valuation Formulas for a Company Sale
Global Economy and Finance Journal, 2015
In this paper, a company owner (valuation subject) is interested in selling a company (valuation object). The potential seller must conduct a business valuation to determine what minimum price he must demand without the transaction proving disadvantageous. The purpose of our paper is to show how alternative valuation formulas solve this valuation problem under realistic imperfect market conditions. As a main conclusion, the business value can usually not be calculated using the future earnings method.
Understanding Business Valuation, Shares, and Proprietary Interests
This customized coaching module addresses business valuation practices from the standpoint of corporate managers, external financiers and investors, and valuation specialists. Users of valuation technologies seek to utilize all available knowledge to the extent that their resources, efforts, and exposures can be minimized. With unlimited access to the sources of internal information, corporate managers have employed an "economic-based valuation approach" to capture direct contributions of certain operating, investment, and financing activities on firm value. Creditors and shareholders who lack a direct control over the firm’s operations often rely on an "accounting-based valuation approach" to evaluate financial statements and establish the linkage between the firm’s performance and its market value. Valuation specialists such as corporate lenders, investment bankers, professional fund managers, and portfolio investment advisors have utilized a wide range of sophisticated valuation techniques subject to their unique analytical styles and resource limitations. With an advance in computer technology, however, many valuation specialists have turned their attention to a "quantitative-based valuation approach" that allow them to not only accurately measure the independent and joint impacts of internal business activities and external market events on firm value based on sophisticated mathematical models but also identify the mispriced assets or “valuation gaps” that may occur from persistent market imperfections and the sub-rational behavior of some groups of market participants.
Theory and practice in M&A valuations
Academics and practitioners are in relative agreement on what drives a company’s fundamental value, primarily it’s current assets and future cash flows. The practice of paying a premium may thus be due to the non-tangible factors associated with perceived value that currently are not incorporated into the assets of the company and the expected growth of the cash flows. This paper looks at the most common theoretical models used in the calculation of the value of a firm. It then explains how human factors can cause divergence in the original price set. Empirical evidence proves that the price paid for a company can easily reach 40-50 per cent above this calculation of the current value. Until valuation models can account for the factors that drive premium pricing, it is necessary to recognize that intangible and, in some cases, emotional aspects will have a great influence on the final price.
The Valuation Accuracy of the Price-Earnings and Price-Book Benchmark Valuation Methods
2000
Performance of the benchmark valuation methods relies on the de®nition of comparable ®rms. In this paper, comparable ®rms are selected based on industry membership, size and return on equity as well as combinations of industry membership with size and with return on equity. We ®nd that within the P/E and P/B benchmark valuation methods, the best de®nition of the comparable ®rms are based on industry membership combined with return on equity. However, only the industry membership is necessary to de®ne the comparable ®rms for the combined P/E-P/B method. In sum, the results suggest that, when ®rm's value is unknown, the combined P/E-P/B valuation approach selecting comparable ®rms based on industry membership performs the best among all the approaches evaluated in this paper. We also ®nd that the P/E benchmark valuation method performs better than the P/B benchmark valuation method and the combined method outperforms either the P/E or the P/B method. These results imply that earnings are more important than book value as a single-number ®rm valuator over our sample years (from 1973 to 1992) and that both earnings and book values are value relevant, one does not substitute perfectly for the other.
Applied Sciences
The Discounted Cash Flow (DCF) method is probably the most extended approach used in company valuation, its main drawbacks being probably the known extreme sensitivity to key variables such as Weighted Average Cost of Capital (WACC) and Free Cash Flow (FCF) estimations not unquestionably obtained. In this paper we propose an unbiased and systematic DCF method which allows us to value private equity by leveraging on stock markets evidences, based on a twofold approach: First, the use of the inverse method assesses the existence of a coherent WACC that positively compares with market observations; second, different FCF forecasting methods are benchmarked and shown to correspond with actual valuations. We use financial historical data including 42 companies in five sectors, extracted from Eikon-Reuters. Our results show that WACC and FCF forecasting are not coherent with market expectations along time, with sectors, or with market regions, when only historical and endogenous variables ...
A VALUATION FORMULA FOR FIRMS IN THE
We develop a valuation formula for analyzing high growth firms using the stages of an industry lifecycle. Our model is best suited for start-up firms with low (or negative) earnings and low sales. Our formula uses start-up firm data and captures the firm's growth potential by incorporating data about two key stages along the lifecycle. One stage corresponds to the largest firm in the industry and the other to the firm situated at the inflection point of the S-shaped curve describing the lifecycle. We test the formula by examining the biotechnology industry in the late 1990s. An empirical analysis of the biotechnology industry reveals an important correlation between market values growth rates and assets growth rates, which is predicted by our formula. We find that, on average, our formula underestimates the actual market value of biotechnology start-up firms by about 15%.