Question

In this paper, please discuss the major methods of company valuation that we have studied. In doing so, explain each method and compare their advantages and disadvantages with the other methods you choose to discuss. Support your discussion with references.

Papers will be assessed on the following criteria:

• Provide a narrative explaining the market capitalization method.
• Provide a narrative explaining the book value method.
• Provide a narrative explaining expected future earnings method.
• Provide a narrative on other methods.
• Provide a narrative that compares market capitalization, book value, and future earnings methods (and other methods mentioned) with each other.

please provide sources for the answers. thank you :)

yes, state all websites, journals, books or materials used in answering the questions. thank you

Answer 1

Expected future earnings method- This valuation method is based on the ability of the business to generate future earnings. Future income is calculated and then discounted back to its present value. It includes following steps:

1. Identify variables that impact income. Basically such variables are of two types:

a. Operations of the business. Determine operating cycle and its its effect on earnings, can be measured by ROI.

b. Financing of the business. The proportion of debt and new issue of equity.

2. Apply appropriate method of forecasting to determine the extent of change caused in income because of the variables identified in step 1.

Market capitalization method - It values companies on the basis of investor's expectations. It is calculated by multiplying share price by number of shares issued. Investor expectations play a major role in this method For example, if the earnings rise, the investors are willing to bid more for the stocks of that particular company and vice versa.

Book value method- In this method, the value of net assets is calculated by subtracting total liability from the total assets. This value is considered for valuing the business itself. The amount which analysts get after subtracting TL from TA is then divided by the number of shares outstanding in order to reach a per share amount which is called as Net Asset Value.

Other methods include:

Comparable company analysis- It is a method which relates the value of one company to another company in the same industry and of a similar size. This method uses the Price-to- earnings ratios and different multiples of EBITDA for valuation.

Cost approach- This method only takes into account the costs which have been incurred while building the business or would be incurred while rebuilding the business. It ignores everything other than costs.

COMPARISON OF ALL METHODS:

Advantages and disadvantages of methods-

1. The future earnings method is the most detailed method and provides highest value during valuation. It is also suitable for valuation during M&As as it provides accurate insights into the target firm. However this method

2. Comparable analysis always provides results for the current scenario of the business. It is also relatively easier to use as calculations are not very complex. Its disadvantage can be that it only provides results in comparison to other similar entities who themselves may be performing badly in the market. So if the company in question shows that it is performing better than the others, this does not mean that its performance is certainly upto the mark.

3. Market cap method works on the investor's point of view regarding a company's stock. It can be a good as well as bad indicator of a company's value because a company may actually be performing better/worse than the investor's expectations.

4. Book value method is most suitable for investment or real estate companies. Limitation of this method can be that it is often considered suitable for companies having lower profits and expensive assets. It is also often seen as a secondary method of valuation.

5. The cost approach method provides in depth insights into a company's costs. But this can also prove to be a limitation because it ignores value creation in the company and only calculates what the company has paid or has to pay.

REFERENCES:

Security analysis and portfolio management by Sudhindra Bhat

https://www.thebalance.com/market-capitalization-3305826

https://m.economictimes.com/small-biz/resources/startup-handbook/valuation-methods/articleshow/59368401.cms

https://corporatefinanceinstitute.com/resources/knowledge/valuation/valuation-methods/

https://businesstown.com/articles/the-book-value-approach-to-business-valuation/

Corporate Finance by Stephen A Ross, Randolph W Westerfield, Jeffrey Jaffe.