Methods of company valuation (Essay Sample)

Valuation is the process of determining the worth of a company in terms of the assets, liabilities. This is done through the calculation of the total number of assets in comparison to the total number of liabilities. Assets are the properties that are in the possession of the company. They may include parcels of land, shares in another company, vehicles or machinery that is being used by the company. On the other hand liabilities are the responsibilities of the company. This may include loans lent to the company by financial institutions, supplies that have not been paid for, services that have been given on credit and properties acquired on hire purchase terms. The process of valuation is carried out by analyst who follows a given procedure to analyze various sectors of the given company and come up with a valuation report. The main aspects that are considered during this process are the management structure, the composition of the capital structure, the current market value of the assets in the company's ownership and the targeted earnings of the company from is activities. Valuation can be done using various techniques which include discounted cash flow analysis, comparable transactions method, multiples method and market valuation. Discounted Cash Flow Analysis The discounted cash flow analysis method is the most frequently used method of valuation. It is considered as the most thorough method of valuation. There are two approaches in using this method. The first the approach on this method is the adjusted present value. This method calculates the net property value of a company. This is the total amount of the value of the properties a company has acquired in the recent past. The calculations of the net property value are then adjusted for the benefit of financing. The formulae of APV is unlevered net property value of the free cash flows and terminal value added to the net property value of interest tax shield and the terminal value. The discount rate is used in the return on assets on equity if it is unlevered. This valuation includes the aspects of cash flow discounts at the uncalculated costs of the equities of the company. The main advantage of using this method of valuation is the issuance of a tax shield that accrues from the interest payments that were deducted in the past. A tax shield protects the company from extreme tax deductions from the company. Another benefit of the valuation method is subsidized borrowing at the local banks. The second approach to the discounted flow analysis method is the weighted average cost of capital. This is a calculation that shows the total capital that has been put into a business. The calculation includes all sources of capital ranging from the money, vehicles, land, debts and other forms of investments into the business. In calculating the weighted average cost of capital, each of the capital components is multiplied by its current market value and the sum is taken. Comparable Transactions Method Another valuation technique commonly used is the comparable transactions method. It is used in the valuation of the mergers that the company has been involved in. The technique is used to valuate the performance of an acquisition. A merger involves the joining of two companies to take on a given business venture while still maintaining their individuality. Mergers are controlled by laws and policies in a given country to avoid instances of unnecessary conflicts. Mergers do not last for a long time but their time periods can be renewed. An acquisition on the other hand is the acquiring of a given business or a company through buying shares amounting to about 50% plus 1 thus becoming a prime shareholder. Acquisitions can also be through buying a company cash on if it is up for sale. The valuation process is quite lengthy in such cases but it is still doable . The process involves the finding of a key parameter upon which the valuation will be based on. The transactions that take place in the merged company are studied and carefully rated. The properties that are owned jointly by the companies are also included in the study. The eventual report of the valuation will indicate the worth of the merged companies by evaluating their current worth and comparing it to the set future targets. This method is only compatible with mergers thus making it limited which is a disadvantage. A good valuation method should work with all forms of companies and not limited to one. The advantage of this method is that it is used for the conclusive valuation of mergers and acquisitions. It does this by comprehensively studying the worth of the companies in the merger and their performance in the merger. Multiples Method The other method of valuation is known as the multiples method. It is often used when there is not enough information about the company undergoing the valuation. The method uses the few traces of information that are available to measure the worth of the given company. The information used may be management structure, some of the assets of the company and some of the liabilities of the company. Through rough estimation, the approximate value of a company can be predicted. There is the use of formulas in this method that tend to use the aproximative approach. Market Valuation The fourth method of valuation is the market valuation. This type of valuation is based on economic rationale which states that in a free market the laws of demand and supply directly affect the value of a business or a company. The laws of demand and supply state that when the demand of a product is high, the supply of the product is usually low. On the other hand it also states that if the supply of a product is high, its demand goes down. The concept of market valuation is applied where the product of the company is put in comparison with other similar product and the customer is subjected to all of these goods in the same market, facing the s...