Question

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 discus

Answer 1

The major valuation methods used for valuing a business are following:-

• Intrinsic value analysis using the discounted cash flow method: In this method the projection of the company’s future earning potential and free cash flow is done. The free cash flow is then discounted using the appropriate discount rate to arrive at the firm value. This method is a scientific method and provides a definite value of the firm based on projected growth. Since it is obtained through a lot of rigor and projection of cash flows, it gets a lot of buy in from investors and other analysts. IT also captures adequately the firm’s ability generate cash flows which may be different from the industry average norms. However, this method is very sensitive to the projected growth rate and the firm’s ability to generate cash and the discount rate. Since it is difficult to predict these parameters, the accuracy of the model is completely dependent on how accurate are these predictions for the future and what economic assumptions hold in the future. This method is also very computationally intensive.
• Comparable business method: In this method a Price to Book Value or Price to Earnings multiple or Price to Ebitda is used to value a company based on the valuation of similar companies. The major advantage is that it computationally simple and easy to understand. The disadvantage of the method is that it does not capture firm specific advantages or disadvantages and values the firm based on industry averages.
• Comparable transactions method: The comparable transaction method is a method to value a business based on purchase price paid by buyers of similar businesses elsewhere. Thus based on a benchmark price and transaction, the value of a firm is found out. This is again a computationally simple method, but it may be difficult to find a comparable transaction. Also it does not capture the value of a firm’s unique advantages or disadvantages.