Valuation

Special Case

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Cyclical Firms
n n

Volatile; dependent on economy; Base Year Earnings

n n

Adjust base year for cyclical effects Adjust expected growth rate to reflect economic cycle Used normalised earnings for base year

Volatility
n

Handle volatility through the discount rate

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Firms in Financial Distress

n

Characteristics
n n n n

Negative cash flows inability to meet debt payments no dividends high debt equity ratios Hope No Hope

Is the firm terminal

n n

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Firms in Distress
n

Hope
n n

Use normalised earnings from happier terms Make detailed cash flow estimates for transition period from illness to health Liquidation Value = Liquidation value of Assets - Value of Debt Option Pricing Model . In Firms with high leverage where the value of the firm is lower than the debt equity can be considered as out of money call option on the underlying firm and can be so valued.

No Hope
n

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Firms with Product Options

n n

Value = Value of assets in place + future possibilities Three approaches

n

Value the product option in the open market and add it to the DCF valuation. Use a higher growth rate capturing the impact of the product option Use option pricing models

Beware double counting

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Private Firms
n

Estimating Discount Rate

n

comparable firms accounting betas n estimate the beta by regressing earnings with the market index of earnings use financial fundamentals

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Private Firms - Cash Flows

n

Cash Flows
n

n n

Difficulty in estimating management compensation and return on capital Substantially less information Past history unreliable Management Expenses Tax Rates Increase in expenses, legal, record keeping etc

Estimating Cash Flows

n n n

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Valuation of Public Enterprises

n n n

n n n n

Monopolies n Prelude to introduction of competition in the field Special Status helps access markets Manpower n Productivity n Size and Efficiency n Middle Management Strong/ Top Management Weak Technical Manpower Quality High Benefits and Hidden liabilities Real Estate Access to Markets

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Building Up Discount Rates

n n n n

20 Year Long Bond Yield to Maturity + Long horizon equity risk premium + (if applicable) small stock premium + additional risk premium = discount rate

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Minority Interest
n n

Relationship between the interest being valued and the total enterprise. Key Question
n

How much control does the minority interest have?

n n

It reflects lack of control The base from which it is subtracted is its proportionate share in the total entity value including all rights of control

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Marketability Discount
n

It is the liquidity of the interest

n

How quickly can it be converted into cash

The base is the value of an entity which is otherwise comparable Mean Discount (1990): 42% Max 342.3% Duracell

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Illustration:
Rs.10/share 40% minority interest discount Rs. 6 per share Control Premium/ Minority Discount Value of Minority Share if Freely Traded Marketability Discount Value of Non Marketrable Minority Share Value of Control Share

40% discount for lack of Mktbility Rs. 3.60 / share

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Control Premia in the US

Industry Mining Construction Manufacturing Transport Communication Electricity and Gas WholeSale Retail Financial Services Premia 43% 23% 47% 24% 26% 33% 44% 32% 47%

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Other Methods of Valuation

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Adjusted Book Value Method

n

Adjust all assets and liabilities from historical cost to current value
n

Fair market value on a going concern basis

Identify, value and bring on to the balance sheet all off balance sheet assets and liabilities
n

Intangible assets never recorded and contingent liabilities

Subtract recast liabilities from assets

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Excess Earnings Method

n

Capitalize the excess earnings after Adjusting for WACC Taxes

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