A Review of Valuation Tech - 13-1-09

8/2/2019 A Review of Valuation Tech - 13-1-09

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BDO Capital ConsultantsSdn Bhd

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A Review of

VALUATION

TECHNIQUES


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VALUATION TECHNIQUES

Dividend Discount Model (DDM) Method

Discounted Cash Flow (DCF) Method Net Tangible Asset (NTA) Method

Relative Valuation Methods


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DCF Method

General Formula

Value of asset =CF1

(1+r)1

CF2

(1+r)2

CF3

(1+r)3

CF4

(1+r)4

.....CFn

(1+r)n


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Key Elements of DCF Method

Discount rate, r

Forecast periodic cashflows, CF1n Number of periods, n

Terminal value


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DDM Method- Two-Stage DDM

DPSn+1where Pn = kegn

t = n

DPSt Pn+(1+ ke)

t (1+ ke)

n

t = 1


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DEFINITIONS OF CASH FLOWS

Net income (after taxes) Dividends

Free Cash Flow to Equity (FCFE)

Free Cash Flow to Firm (FCFF)


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FCFE

Net Income (after taxes)

+ Non-cash charges (Depn & Amortizn)- Capital expenditures

- Changes in Net Working Capital

+ Net changes in long-term Debt= Free Cash Flow to Equity


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FCFF

Net Income (after taxes)

+ Non-cash charges (Depr. & Amortizn)- Capital expenditures

- Changes in Net Working Capital

+ Interest expense (net of taxes)

+ Preferred dividends

= Free Cash Flow to Firm


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How to derive FCFE from FCFF

FCFFLess

Market value of all Outstanding Debts

= FCFE


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Which discount rate (r) to use?

ke E kd (1tc) D

WACC = E+D + E+D

The discount rate of return is the Weighted AverageCost of Capital (WACC), which can be computedas follows:


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Key Elements of WACC

WACC = Weighted Average Cost of Capital ke = cost of equity

kd = cost of debt tc = corporate tax rate E = Total equities D = Total debts E/(E+D) = proportion of company

funded by equity D/(E+D) = proportion of companyfunded by debt


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Cost of Equity, ke

The Cost of Equity is usually derived from the

Capital Asset Pricing Model (CAPM), which isas follows:-

Ke

= Rf+ (R

m R

f)


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Key Elements of CAPM

Rf is the rate of return on risk-free assets

such as Malaysian Government Securities (MGS) Rm is the rate of return of the market

such as the long-term annualised return of stock market

(Rm Rf) is the market risk premium

is the measure of volatility of the individualasset in relation to the overall market


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Relative Valuation Methods- Valuation Philosophy

Based upon how similar assets are currently

priced in the market relative to a commonvariable such as earnings, cashflows, bookvalue or sales


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Relative Valuation Methods- General Application

Two components:-

Standardization of Prices Find Comparative Companies

How to Apply: After standardizing the share price of

the company with the chosen variable, compare thestandardized value with values of comparativecompanies


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How to Standardize Prices

Prices need to be standardized by converting pricesinto multiples of earnings, book values or sales such

as:- Price-Earnings (P/E) Multiple Price-to-Book (P/B) Multiple Price-Sales (P/S) Multiple

A Variant

Enterprise Value (EV) Multiple = Enterprise Value

EBITDA


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Computation of P/E Multiple

Earnings are taken as net profit after minority

interest and preference share dividends Earnings has to be maintainable -

Non-recurring one-off expense items have tobe added back

Non-recurring one-off revenue items have tobe stripped off


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How to Find COMPARATIVE COMPANIES

Scan through universe of listed companies in

same industry/sector Failing which, scan through universe of listed

companies in industries/sectors that has stronglinkages with the company to be valued

Failing which, can adopt the broad market pricemultiple as a proxy (use with care)


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Points to Consider in Using Multiples

Ensure the multiple is defined consistentlyeg. based on forward or trailing earnings

Remove outliers from basket of similar firms

Drop non-meaningful negative multiples fromthe basket

Merits of weighing the multiples by size offirms but beware of skewness of data


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Enterprise Value (EV) Multiple- Valuation Philosophy

Look at a firm from a potential acquirer viewpoint asit takes debts into account

Eliminates distorting effect of individual companystaxation, financing and accounting policies

EV can be viewed as the theoretical takeover price

as the acquirer has to assume the acquireecompanys debts but would pocket its cash


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Computation of EV Multiple

Key Elements:-

Enterprise Value = Total Market Capitalization +Total Debts + Minority Interest + PreferredShares - Cash

EBITDA = Earnings before Interest, Taxes,Depreciation and Amortization

or Net Operating Income


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Computation of EV Multiple (Simplified)

Enterprise Value (or firm value)

= Total equity value+ Total Debts

- Cash

A Review of Valuation Tech - 13-1-09

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