1. Business Valuation
Session 3
Abhimanyu
August 30, 2009

2. Value and Price
• Value of a particular business or asset may be different for
different parties depending upon strategic intent, synergies or
for other reasons.
• Value must be clearly distinguished from price and businesses
may justifiably undertake to consummate a transaction at a
price which does not fall within an assessed fair value range.
• Given the valuations or valuation range / band suggested by
valuers, the prerogative to decide upon a specific price is
finally with the management and the Board of Directors of the
Company.
• The valuation is only a tool to aid management in decision-
making.
• The valuation is also time dependent.
September 12, 2009 Corporate Restructuring | Session 1 2

3. Valuation Methods
• Asset Approach
– Book Value, Adjusted Book Value, and Liquidation Value
• Income Approach
– Capitalization of Earnings, Capitalization of Excess Earnings, and
Discounted Future Earnings/Cash Flows, Discounted Future EVAs.
• Market Approach
– Current Market Prices, Historical Market Prices, Price to
Earnings, Price to Revenue, Price to Book Value, Price to
Enterprise Value
• Comparable Transactions/Relative Valuations
– Comparable International and Domestic Transactions.
• Sum-of-parts Method
• Real Options Value
September 12, 2009 Corporate Restructuring | Session 1 3

4. Asset Approach
• May be important in capital intensive industries
or in acquisitions where valuable non-operating
assets can be stripped after the purchase of the
company to recover part of acquisition cost.
• Where there are no (or very little) intangibles.
• This approach is inappropriate in case of
acquisition/sale of minority interests.
September 12, 2009 Corporate Restructuring | Session 1 4

5. Asset Approach: Premises of Value
• Sale as a going concern:
– Value-in-use
• Fair market value of assets and liabilities
• Sale on a liquidation premise:
– Liquidation value (value-in-exchange)
• Orderly liquidation.
• Forced liquidation
• Treatment of non-recurring/ non-operating assets and
liabilities in case of valuation of controlling/ minority interest.
September 12, 2009 Corporate Restructuring | Session 1 5

6. Income Approach
• It is more often used than market/asset
approaches.
• It is a preferred approach for closely held (and
also widely held) knowledge based companies.
• It is also used in case of service industries.
• Of course, it suffers from accounting
distortions. Hence caution is advised.
September 12, 2009 Corporate Restructuring | Session 1 6

7. Income Approach: Methods
• Single-period Capitalization Method:
– Valuation is based on the net income of one
year only and hence it can produce reliable
value only if the income chosen is
representative of the company’s anticipated
long-term future performance.
• Multi-period Discounting Method:
– Discussed under DCF method.
September 12, 2009 Corporate Restructuring | Session 1 7

8. DCF Method: Certain Issues
• Forecast Variables
• Forecast Horizon:
– Period should be long enough to portray all anticipated
variations in the entity’s cash flows and until a stabilized
cash flow is achieved.
• Continuing Value
• Cost of Capital
– Debt cost
– Equity cost
– Weighted Average Cost of Capital (WACC)
September 12, 2009 Corporate Restructuring | Session 1 8

9. Cost of Capital
• Cost of Debt:
– Direct Approach.
– Weighted Average Method.
• Cost of Equity: CAPM
– What is the risk-free rate?
• Logic of using a long-term rate.
– What is your equity beta?
– How much is the equity risk premium (ERP)?
September 12, 2009 Corporate Restructuring | Session 1 9

10. Cost of Equity
• CAPM:
– Re=Rf +β(ERP)
• Modified CAPM (used for closely held targets)
– Re=Rf +β(ERP)+SCP+SCRP
• Where SCP=Small company premium and SCRP=Specific
company risk premium (unsystematic risk- also known as ‘α’).
• Buildup Method (used for closely held targets)
– Re=Rf +ERP+SCP+SCRP
• The size of SCRP is usually smaller when used in MCAPM than when used
in buildup method.
September 12, 2009 Corporate Restructuring | Session 1 10

11. Risk Free Rate
10 Year Govt. of India Bond Yield
10.00
9.00
8.00
7.00
6.00
5.00
4.00
Nov-04 Jul-05 Mar-06 Nov-06 Jul-07 Mar-08 Nov-08 Jul-09
September 12, 2009 Corporate Restructuring | Session 1 11

12. Beta
Company Index 99-00 00-01 01-02 02-03 03-04 5-yearly
WIPRO NIFTY 0.98 2.34 1.96 2.05 1.33 1.58
CNX-500 1.39 2.03 2.12 1.64 1.19 1.61
RIL NIFTY 1.10 0.91 1.21 1.14 1.05 1.06
CNX-500 0.80 0.64 1.03 1.10 0.96 0.85
ITC NIFTY 1.15 0.60 0.75 0.37 0.67 0.79
CNX-500 0.84 0.47 0.60 0.40 0.60 0.63
BERGER NIFTY 0.38 0.16 0.17 0.38 0.65 0.38
CNX-500 0.35 0.10 0.14 0.43 0.65 0.34
HEROHONDA NIFTY 0.56 -1.05 0.90 0.60 0.86 0.34
CNX-500 0.43 -0.52 0.82 0.72 0.80 0.34
September 12, 2009 Corporate Restructuring | Session 1 12

13. ERP
Long-term Risk Premium SENSEX BSE 100
Year SENSEX BSE 100 Risk free ERP ERP
1990-91 47.74 38.07 12.30 35.44 25.77
1991-92 137.87 127.35 13.36 124.51 113.99
1992-93 -55.11 -60.54 13.23 -68.34 -73.77
1993-94 54.48 61.20 13.38 41.10 47.82
1994-95 -13.96 -12.05 15.39 -29.35 -27.44
1995-96 5.20 -2.13 15.67 -10.47 -17.80
1996-97 3.49 -1.32 14.01 -10.52 -15.33
1997-98 17.10 17.03 12.27 4.83 4.76
1998-99 0.51 1.67 12.03 -11.52 -10.36
1999-2000 33.84 95.02 11.30 22.54 83.72
10-yearly average 9.82 13.14
September 12, 2009 Corporate Restructuring | Session 1 13

14. Specific Company Risk Premium
• Should reflect the analysis of the competitive
conditions in which the company operates. Some
common company-specific risk factors:
– Lack of access to capital
– Ownership structure and stock transfer restrictions.
– Company’s market share and the market structure of the
industry
– Depth and breadth of the management
– Heavy reliance on individuals with key knowledge, skills or
contracts.
September 12, 2009 Corporate Restructuring | Session 1 14

15. Control Premium and Illiquidity Discount
• Such premium or discount should be applied in
adjusting cash flows rather than in the discount
factor.
• If the target is a closely held company in which a
controlling interest is being acquired, do not
automatically assume that a control premium and a
discount for lack of marketability must be applied to
each value determined for the company.
• The correct methodology is to identify the nature of
the value initially computed by each appraisal
method.
September 12, 2009 Corporate Restructuring | Session 1 15

16. Valuation: Concluding Remarks
• Valuation exercise involves more
judgments than precise facts.
• The success of a valuation exercise
depends on how scientific were you in
your intuitive judgments.
• Hence, valuation is an artistic science.
September 12, 2009 Corporate Restructuring | Session 1 16