Valuation approaches and methods

Abhirup Ghosh

abhirup@vinodkothari.com

Approach MethodDescriptionApplication
Cost/ Asset based approachReplacement cost methodThis method is based on the concept of replacement i.e. Similar Utility. It considers the cost involved in replacing the assets of the Company at the same level on the date of valuation as the value of the Business of the Company. It is also known as substantial value.·      The subject company is not directly income generating or application of income approach or market approach is not feasible.

·      The basis of value used in valuation assignment is dependent on the cost approach. E.g. replacement value, liquidation value.

·      For checking the reasonableness of the value derived from other approaches.

Reproduction cost methodIn this approach the value of the Company is the cost involved in creating the exact replica of the subject Company from scratch as on the date of valuation.
Summation methodIt is also called as the Underlying assets approach. Summation Method involves the separate valuation of each category or component of assets of the subject Company. The total value of the subject Company is the additive sum (therefore the name summation) of the values of the individual asset categories. Whatever categories of assets are encompassed in the subject Company are summed (or added in) the summation valuation.
Net assets value method/ Book value methodHere the book value assets and liabilities are considered. The liabilities and fictitious assets are reduced from the total assets arrive at the net assets value of the Company. This value is also equivalent to the net worth of the Company.
Adjusted net asset value methodA variation of the NAV method. Here the assets and liabilities are adjusted and considered at their fair values instead of their book values.
Market approachComparable company methodHere the value of a company is evaluated by using trading multiples derived from publicly traded companies like the subject Company.

 

Some common multiples used for valuing a company under this method are:

 

·        Price to sales Multiple

·        Price Earnings Ratio

·        Price to Book Value

·        EV/Sales

·        EV/EBITDA

·      Subject Asset or Similar asset is actively publicly traded.

·      Subject assets or substantially similar asset has been sold transaction appropriate for consideration under basis of value.

·      There are recent / frequent transactions in substantially similar assets.

Comparable transaction methodIn this method the value is derived based on pricing metrics of mergers and acquisitions involving controlling interests in companies (public and private) in the same or similar line of business as the subject company.
Income approachCapitalisation of earnings methodIn this method, the past profits of the Company are capitalized at expected return on equity. Also known as Profit Earning Capacity Value. Alternatively, instead of the capitalization at the expected return on equity, the PE multiple is also applied to arrive at the value of the Company.Can be applied where there is no market comparable for the subject company.
Discounted cash flow methodUnder Discounted cash flow (DCF) Method, the total value of a business is calculated as the present value of its expected future cash flows over the projected period and present value of terminal value / Cash flows i.e. the free cash flows are discounted by an appropriate discounting factor. Under DCF method, two variants are used to value a company and its equity one is free cash flow to the firm (FCFF) and other is free cash flow to equity (FCFE).

 

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