Question

Describe the asset-based valuation approach, Name and describe the main drivers of a company value, Describe the advantages and disadvantages of the income-based approach and Describe the main limitations of the market-based valuation approach.?

Answer 1

Bussiness Valuation

Valuation is the task of estimating the value of assets , securities , Business. the price an investor willing to pay for assets , securities / business dependence on such valuation . Busin ess valutaion requires valuation of tangible assets (Land & machinery ), intangible assets ( patent) , human resources who runs such business. It needs to consider all recorded lioabilities and unrecorded contigent liabilities so that the buyer shall aware of total sum payable on purchase of business.

Methods of Business Valuations

1. Asset based valuation

2. Earnings based valuation

3. Market based valuation

4.Market value added method

5. Faire value method

6. Economic Value added method

Asset based valuation

Asset based valuation focuses on determine the value of net asset from prospective equity share valuation . Assets are valued based on bookvalue . ie, value assets recorded in the financial statements of the firm . It is normally intial acquisition cost less depriciation . It follws going concern principle. Apart from tangible assets , intangible such as goodwill , patent are need to be v alued. It may used super profit method to value such assets.

To arrive atnet asset value , total external liabilities (including preferenace sharer capital ) payable are deductaed from total assets (excluding fictious assets).

Net assets = Total assets - Total liabilities

The value of net asset is also known as Net worth or equity . If the figure of net asset to be positive , it implies that the value availalble to equity shareholders after payment of all external liabilities . Net asset per share is obtained by dividing net assets by no of equity shares issued .

The net asset vasluation is based on book value is in tune eith the going concern principle of accounting. In contrast , liquidation value measure is quided by the realisable value available on winding up of a firm. Liquidation value is the net final asset value if any per share available to the equity shareholders. In the case of liquidation , assets are likely to be sold through auction . Inm generally , they are likely to realise much less tah their ,markety values. The net asset value per share will be the lowest under the liquidation value measure.

Earnings based approach

Under the income approach, the valuation is based on the economic benefit stream (typically a form of net income or cash flows) produced by the business. This benefit stream is either capitalized or discounted to a present value, and this amount becomes the foundation for the valuation of the company.

Two common valuation methods under this approach are the capitalization of earnings method and the discounted cash flows (DCF) method. The capitalization of earnings methods takes a single economic benefit (usually net income or cash flow for the most recent period or an average of activity from the previous three to five periods) and divides it by a capitalization rate, which represents the required rate of return necessary to earn that return given the risks of investing in the business. In the DCF method, the benefit stream is projected for a certain number of periods into the future (including a “terminal” value meant to represent value for an infinite number of periods in the future) and then discounted to present value.

Pros & Cons: The capitalization of earnings method is best used for stable or mature business where the benefit stream is expected to grow at a consistent rate into the future. The DCF method is most appropriate for companies with uneven growth in their future benefit streams or businesses with a lack of earnings history.

The major positive of the income approach is that it utilizes in the valuation calculation the benefit streams produced by an enterprise. Since a business’s value is commonly considered to be the present value of its future earnings or cash flows, these methods emphasize the elements that are generally valued by the investor in a business.

One significant downside to the income approach is the degree of estimation involved in the calculations. The forecasting of future benefit streams and determination of a capitalization or discount rate often involve a high degree of professional judgment, which can subject the valuation to debate from other parties.

The market approach

The term ‘market approach’ is a valuation method that is used to determine the appraisal value of any particular asset, intangible asset, interest on the business ownership or the security, etc of any given business firm. This whole determination is based on the selling prices of the other similar items that are there.

The market approach is a valuation method with the help of which it becomes possible to do the calculation of the value of a particular property. It can also be used as a small part of the entire process of valuation in which there are other closely helps businesses. With the help of the market approach, it becomes easy to conduct a study on the sales of the assets that are similar to the one which is being studied, if required they can also make adjustments depending upon the various parameters like quantity, size or quality. On top of it, the market approach is also used to value the interest of the business owner or to value the security or value the intangible assets. In this approach, one tries to study the recent sales that have happened in other similar kinds of assets even though whichever asset is being valued or not. With the help of the market approach; one can easily determine the appraisal value of the business. Also during the process of the market approach being carried out, there are several price related indicators that are carried out, for example, the sales, the value of the books and even the price to earnings. All of these factors are effectively utilized when it comes to going ahead with the market approach. Now there are two primary types of the market approach which is the Guidelines transaction method and the guideline public company method. In the guideline transaction method, the prices of the similar companies that sold the same type of assets are evaluated. While in the case of the guideline public company method, it utilizes the prices of similar companies which are being publicly traded. So, in general, the market approach does not put much emphasis on the assets which are undervaluation. It takes care of those prices which are of a similar kind of the assets that are the comparable assets. Once it compares the prices of the same type of assets, then it further goes on to make proper adjustments by categorizing things into segments by their size, quality or quantity. So for instance, if somebody wants to look at the selling prices of the shares of stock that have happened recently, then one should try to look at the selling prices of other similar kinds of shares of stocks. Now that usually it has been seen that the ownership share of any company is all almost the same, the most recent selling price of that share will provide a perfect estimate of what the fair value should be.

The various advantages of the market approach are as follows-

1. This approach is quite straightforward, and also there is no need for any complicated calculations. With the help f simple calculation, this approach can be carried out.
2. While using the market approach, the data is used is quite real and also public.
3. Also, the market approach is not at all dependent on subjective forecasts.  

The disadvantages are as follows –

1. While carrying out the market approach, it becomes quite difficult in identifying the transactions or the companies that are to be compared. There is usually a lesser number of companies or transactions that can be used for comparison.
2. The method to carry out a market approach is generally considered to be less flexible as compared to the other techniques or strategies.
3. The method is also not able to clear out the doubt about what quantity of data is available and how good the data can be.