Question

3. Describe how conducting a valuation analysis on your company’s stock can assist in “measuring” maximization of stockholder wealth.

4. Describe three ways in which an IPO maximizes stockholder wealth

Answer 1

3.One can do a stocks valuation by applying different methods which maybe Comparable Analysis, Precedent Transactions and DCF Analysis. Below is an explanation of one of these methods.

Comparable Analysis involves relative valuation where one compares the current value of a business to other similar businesses. This involves applying P/E, EV/EBITDA. So one needs to identify using this technique if the company at whatever price its currently valued is it a fair price or not meaning is it overvalued, fairly priced or undervalued. So you are simply deriving it's intrinsic value. For ex a company with an enterprise value of 100 and EBITDA of 10 would have EV/EBITDA of 10X. But if we find that other similar companies are trading at say 15X. Hence the company has the potential to trade higher where its EV/EBITDA can become 15X and will have higher market price in the future and hence is an undervalued company and could be worth investing. But obviously we need to derive the enterprise value and the EBITDA by using the financials of the company in question and the peer company with which we want to compare.

4.(i) A company which can have a huge presence in the future and can serve beyond its current market will have a strong competitive advantage and will create more wealth for its shareholders by going public. This can then lead to higher share price in the future. ii) Taking a company public makes it more transparent and hence receive more favourable credit rating which will help it provide better borrowing terms and hence can expand further which will create more value for it in the future and become more valuable. iii) IPO can give a company lower cost of capital which will help reduce its cost and improve its margins which can later translate in the future in divided payouts to the shareholders.