Question

QUESTION.

a)Using relevant examples, discuss Five value drivers for a manufacturing firms

b)You are an employee of venture valuers limited and you have been tasked to value a private company XYZ Ltd using relative valuation.You have chosen the price/Earning multiple to execute the assignment.What assumptions will youmake when using the industry average price /Earning ratio in valuing XYZ ltd

Answer 1

Ans a).In case of modern manufacturing organization the creation of value is about not just making things but much more than this. The value creation requires a range of expertise to be brought together to convincingly deliver value in an area of focus. It appears valuation is a quantitative science which includes forecasts, multiples, financial statements and rates of return, but in reality it is actually more qualitative in nature. Valuation is all about the prediction of future expectations for a business. In order to accurately reflect those expectations it is significantly important for a business owner to identify and understand the value drivers, which are factors that reduce risk associated with a business and increase cash flows. There are hundreds of value drivers attributable to a business, some of which are industry-specific. For conciseness we will discuss five value factors we consider essential for the manufacturing firm.

1. Customer Base. A strong and solid customer base is the first and foremost requirement of a manufacturing concern. Customers are essential for the long life and stability of a manufacturing firm. But the companies should not be dependent on too few customers for a large chunk of revenue as it may prove dangerous for the survival of a firm. The companies must manage the allocation of customer concentration as this will help to reduce the risk of losing a large source of revenues.
2. Economies of Scale. Economies of scale means as the lowering the cost per unit with increase in production output. As the output increases the cost per unit start decreasing this is called economies of scale. For example. In a hospital, it is still a 20-minute visit with a doctor, but all the business overhead costs of hospital system are spread across more doctor visits and the person assisting the doctor is no longer a degreed nurse, but a technician or nursing aide. Whether through quantity discounts or spreading capacity costs over higher volumes, larger companies possess distinct advantages in certain operations and markets.
3. Financial Performance. Financial analysis includes identification of the assets and liabilities of a company, measurement of trends, and comparison of the financial performance and condition of the company to other, similarly-positioned firms. Internally prepared and compiled financial statements may obstruct management’s assessment of performance, causing potential buyers to possibly question the quality of this data.
4. Human Capital. Human resources are the asset of the company.A company’s employees is the heart of an organization. The main value drivers include the knowledge, skills, experience, training, and creative abilities employees bring to a business and the health of its company culture.
5. Market Environment. Every business is influenced by the market economic trends and developments in the industry in which it operates. So it become important for the management that it must understand how the industry is impacted by economic factors and how the industry is structured to minimize the impact of macro trends on the business.

Ans b) foor the purpose of valuation of XYZ ltd. using the P/E ratio is done using comparable company approach.But first we must understand the price earning ratio.This ratio indicates the price of an equity share to the earnings per share.It measure the number of times the earnings per share discounts the market price of an equity share.the ratio indcates how much an investor is prepared to pay per rupee of earnings.

Price Earning ratio= Market price per share/Earning per share

The ratio helps to ascertain the value of equity share, if the EPS and the probable Price Earning ratio of the inustry to which the company belongs.The intrinsic value of share may be more or lss than the market value which is influenced by company's track record and dividend distribution policy, speculative trading, state of economy, effcincy of management, capital gearing etc.Price earning appraoch to share valuation is simple and more popular.This ratio refelcts the market's assessment of the future earnings potential of the company.A ratio reflects high earnings potential and low ratio reflects the low earnings potential.The ratio reflects the market's conficdence on company's equity.

The specific valuation metric in widespread usage for comparable transaction analysis is the EV-to-EBITDA multiple. EV is enterprise value and EBITDA is earnings before interest, taxes, depreciation and amortization. EBITDA is usually measured on an LTM (last twelve months) basis. A comparable transaction approach is generally used in conjunction with other valuation techniques including the discounted cash flow, price-to-earnings, price-to-sales, price-to-cash flow ratios and others the may be relevant to a particular industry. Data that is publicly available makes it possible to estimate the valuation of a target, but if many of the past transactions being used as comps are among private companies, there would likely be limited data to serve as guidance.