Question

Please answer the following without plagiarizing and with academic sources

What do you find to be the most challenging when working with valuation? Why do you think that is? Also, consider what you think to be the most appropriate valuation method. Explain.

Answer 1

The process of valuing a business combines both art and science and can be arduous. Generally speaking, a detailed, comprehensive analysis and the ability to develop accurate projections and assumptions are necessities. Business valuation also requires the application of finance theory in the appropriate places and using professional judgment.

With that said, some of the most common challenges facing business valuation professionals include:

• Developing reasonable assumptions for projections based on historical trends and expected future occurrences and documenting the reasoning behind those assumption choices

• Requesting, tracking and reviewing the necessary documents

• Spreading the tax returns and financial statements

• Finding robust private-company industry data against which to benchmark the subject entity

• Gathering the appropriate market comparables (both public and private) and documenting the reasoning behind the market comparable choices

• Calculating a discount rate that appropriately reflects the risk inherent in the subject entity and documenting the reasons for using (or not using) the methods used for calculating the WACC • Building a comprehensive valuation report

For most professionals the real challenge comes in compiling a robust, fundamentally sound valuation report. The written report is often the only tangible product delivered to the client and typically serves as the cornerstone of professional credibility

When valuing a company as a going concern there are three main valuation methods used by industry practitioners: (1) DCF analysis, (2) comparable company analysis, and (3) precedent transactions. These are the most common methods of valuation used in investment banking, equity research, private equity, corporate development, mergers & acquisitions (M&A), leveraged buyouts (LBO) and most areas of finance.

Method 1: Comparable Analysis (“Comps”)

Comparable company analysis (also called “trading multiples” or “peer group analysis” or “equity comps” or “public market multiples”) is a relative valuation method in which you compare the current value of a business to other similar businesses by looking at trading multiples like P/E, EV/EBITDA, or other ratios. Multiples of EBITDA are the most common valuation method.

The “comps” valuation method provides an observable value for the business, based on what companies are currently worth. Comps are the most widely used approach, as they are easy to calculate and always current.

Method 2: Precedent Transactions

Precedent transactions analysis is another form of relative valuation where you compare the company in question to other businesses that have recently been sold or acquired in the same industry. These transaction values include the take-over premium included in the price for which they were acquired.

These values represent the en bloc value of a business. They are useful for M&A transactions, but can easily become stale-dated and no longer reflective of the current market as time passes. They are less commonly used than Comps or market trading multiples.

Method 3: DCF Analysis

Discounted Cash Flow (DCF) analysis is an intrinsic value approach where an analyst forecasts the business’ unlevered free cash flow into the future and discount it back to today at the firm’s Weighted Average Cost of Captial (WACC).

A DCF analysis is performed by building a financial model in Excel and requires an extensive amount of detail and analysis. It is the most detailed of the three approaches, requires the most assumptions and often produces the highest value. However, the effort required for preparing a DCF model will also often result in the most accurate valuation. A DCF model allows the analyst to forecast value based on different scenarios, and even perform a sensitivity analysis.