Business Valuation, Essay Example

The approach to business valuation can be made in a number of different ways. Two common accepted methods are Discount Cash Flow (DCF) and Market Multiple Analysis (MMA). In the example provided DCF application was based upon classic capital budgeting procedures applied against the entire business as opposed to a single project.  The MMA method is a less accurate means of estimating but uses the same discount cash flow techniques. Under the DCF model the firm was valued at $10,108,137 whereas at MMA it was $2.4 million.  As such both methods are considered problematic . Effective valuations should comprise use of both techniques with expert judgement on the balancing factors to reach a final estimate. ” Discounted cash flow models are powerful, but they do have shortcomings. DCF is merely a mechanical valuation tool, which makes it subject to the axiom “garbage in, garbage out”. Small changes in inputs can result in large changes in the value of a company” (Anon, 2009)

The DCF and MMA approaches are suggested for valuation purposes.  The DCF method is restricted to the valuation of the business operations, creating higher valuations where assets are directed in support of operations.  MMA tends to adopt the approach of proxy estimates and varies in approach and calculation to DCF, emphasising that neither should be used in isolation. With the DCF calculation the resultant value was $45 million and the MMA approach was $2.4 million. As such there can be wide variations depending upon the circumstances and the integrity of data used in each calculation ” This valuation method does not take into account important factors such as the profitability of the business and cashflow indicators for the company. Secondly, since this valuation is based on industry averages, it doesn’t factor in the differences between companies within an industry, which can be very different in size, brand value, customer-base, management efficiency and other “soft” factors. These differences make it difficult to substantiate the validity of a multiplier, which can throw off the accuracy of the valuation.” (King, 2007)

There are two important factors when valuing company acquisitions; the value of the company upon appraisal and the target acquisition value.  DCF looks at the Companies current value in accordance with its estimated future value.  Other valuations may include:

Price Earnings Ratio: Market Value per share / Earnings per share and;

Enterprise Value to Sales Ratio: Market Capitalisation + Debt + Preferred Shares – Cash & Equivalents /  Annual Sales

These are added techniques to that of DCF and MMA. In the example Madison Clinic was estimated at $2.4 million using DCF and $6.9 million using MMA. The conclusion being that other factors need to be considered other than just the numbers i.e. competition, location and the industry

The  concept of horizonal mergers e.g. as in this practice one business acquiring a similar one. The subsequent valuation of the merger depending on the type that occurs. Valuation often depends on motive as to whether it is for profit or not for profit.  With non profits the valuation can be impacted in a negative way owing to the difference in treatment of patients, as opposed to a profit motivated one.  Governing boards may also intervene in non profit organizations. Wealthy investors can be beneficial in providing capital to hospitals but their motives may not align with the hospital. They may be less concerned about patient care and service but more focused upon return on investment.

Deals specifically with the two DCF Methods : (1) Free operating cash flow and (2) Free cash flow to equity holders. As previously pointed out these methods can give very different results and it is important to consider other factors like location, unemployment rate etc.

Works Cited

C., G. L. (2007). Understanding Healthcare Financial Management. In G. L. .C., Understanding Healthcare Financial Management. Chicago: FACHE Health Admin Press.

Anon. (2009). Invesopedia. Retrieved 11 5, 2009, from Investopedia: http://www.investopedia.com/terms/d/dcf.asp

King, M. C. (2007). Valuation Formulas: Multiplier or Market Valuation. Retrieved 11 5, 2009, from Valuation Formulas: Multiplier or Market Valuation: http://www.canadaone.com/tools/buy_a_biz/section2d.html

L.C, G. (2006). Cases in Healthcare Finance. In G. L.C, Cases in Healthcare Finance. Arlington VA: AUPHA Administration.