Valuation for Mergers, Acquisitions and Leveraged Buyouts, Essay Example

Comparable Valuation Approach

The multiples approach is used to determine the values of comparable companies or comparable transactions. In this manner, it is possible to determine which organization holds the highest value. In the typical business setting, this often is done to compare rivals within the same industry. For example, comparing the values of Target and Walmart is reasonable because they are both large superstores. In addition, comparing the transactions they engage in will also provide similar information because they sell many of the same products to their customers. A common methods of making these calculations is by conducting “common market multiples include the following: enterprise value to sales (EV/S), enterprise multiple, price to earnings (P/E), price to book (P/B) and price to free cash flow (P/FCF)” (Fuhrmann, 2013).

The easiest way to conduct this form of comparison is by creating a chart that tracks all of these similarities and differences between the two organizations. The heading of this table should list the name of the comparable company, the price of the product being analysed, the EV, the revenue, the EPS, the EV plus the revenue, the price plus the FCF, the gross margin, and the operating margin. The companies can then be compared based on these characteristics. More than two companies could be compared using this method.

Intrinsic Valuation Approach

Broadly, the intrinsic valuation approach is determined “the value of an asset is estimated based upon its cash flows, growth potential and risk” (NYU Stern, n.d.). The discounted cash flow approach could be utilized to determine value. According to this definition, the value of a company is essentially a function of expected cash flows on the asset.

Where n represents the life of the asset, E(CF_t) represents the expected cash flow represented by the time period denoted as t, and r is the risk of the cash flow.

Based on this definition, it is plausible to determine which one of two or more companies has the highest value of asset. Overall, it could be said that the sum of all assets of a business are the value of that business. Therefore, it would be necessary to calculate these figures to determine which has more value. For a more thorough analysis, it is important to consider the assets that the company currently has in place, the growth assets, and the debt and liquidity liabilities. A financial balance sheet becomes useful when conducting these calculations.

Overall, in this method, it is important to consider that “cash flows are discounted back at a risk-adjusted discount rate” (NYU Stern, n.d.). In this manner we can reasonably compare the value of companies based on their assets and risks. This varies from the comparable valuation approach in which “an equity’s value should bear some resemblance to other equities in a similar class” (Fuhrmann, 2013).

Applications of Approaches

While accountants or business professionals regularly use the comparable valuation approach and the intrinsic valuation approach, researchers have used these principles in order to gain a greater understanding of economics and financial success. In one instance, “Comparable company analysis (CCA) has become the standard tool for measuring the beta of a non-traded firm or division” (Bowman & Bush, 2007). In this study, they used this method to estimate beta to a sample of 480 companies. Therefore, this analytical method could be used to make generalizations about an industry.

Other studies have found alternative ways to make similar predictions. It was found that intrinsic value can be calculated using the dividend growth model (Lan, 2014). Since intrinsic growth is a broad understanding, it is important to consider that it could be indicative of many diverse financial characteristics. In addition, these models can be used to resolve diverse understandings, such as globalization challenges and financial risks in countries around the world (Damodaran, 2006).

Additional studies show that “the intrinsic value approach can be very successful in picking future winners and losers by identifying firms whose stock price has deviated significantly from the intrinsic value” (Li et al., 2014). It is therefore important to consider that these financial techniques have many practical applications in the real world. In the current economic climate, it is reasonable to use this understanding to determine which stocks to invest in, where to work, where to shop, and more. It is important to understand that the comparable valuation approach and intrinsic valuation approach have many real world applications. Although these methods are not discussed in detail in the literature, it is likely that they will be analysed more frequently in the years to come. In particular, modifications of these approaches for additional purpose are of interest. Many different methods can be used to determine the value of a company, but it is important to establish the purposes for which each should be used. This will help generate a more comprehensive understanding of valuable financial tools that will contribute to a more efficient manner of conducting financial research.

References

Bowman RG, Bush SR. (2007). Using Comparable Companies to Estimate the Betas of Private Companies. Journal of Applied Finance. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=956443

Damodaran A. (2006). Valuation Approaches and Metrics: A Survey of the Theory and Evidence. Retrieved from http://people.stern.nyu.edu/adamodar/pdfiles/papers/valuesurvey.pdf

Fuhrmann RC. (2013). Equity Valuation: The Comparables Approach. Retrieved from http://www.investopedia.com/articles/investing/080913/equity-valuation-comparables-approach.asp

Lan J. (2014). Calculating Intrinsic Value With the Dividend Growth Model. Retrieved from http://www.aaii.com/journal/article/calculating-intrinsic-value-with-the-dividend-growth-model.touch

Li K, Mohanram P. (2014). Fundamental Analysis: A comparison of Financial Statement

Analysis Driven and Intrinsic Value Driven Approaches. Retrieved from http://business.uic.edu/docs/default-source/accounting-docs/paper_mohanram.pdf?sfvrsn=2

NYU Stern. (n.d.). The Little Book of Valuation. Retrieved from http://pages.stern.nyu.edu/~adamodar/New_Home_Page/littlebook/intrinsicvsrelative.htm