Valuation Models
Major categories of valuation models
Market Asset based
Present value approach/Share model
models price multiples Accounting
Price to Earnings
Discounted Price to book
book value
cash flow ratios Sensitivity
Free cash flow Trading analysis
comparable Cost of capital
Valuation using Discounted Cash Flow
• Value of the firm = Value of the Equity+Value of Debt
• Value of the firm is the value of its operating activities
• This value is divided among its claimants-Equity holders
& debt holders
• Value of equity can be calculated directly by forecasting
cash flowing to equity holders (Dividend discount model)
• Alternatively, one can forecast the cash flowing from the
firm’s operating activities and deduct the value of debt
• Value of operations/ value of firm can be forecasted by
calculating the PV of expected cash flow.
Free cash Flow
• The cash flow after deducting capital
expenditure and working capital changes
Example
Year 2020 2021 2022 2023 2024
/Particular
PBDIT 121.60 131.40 136.31 109.75 105.33
CAPEX 13.69 10.91 10.91 5.17 4.62
DEPRECIAT 61.41 53.59 42.34 41.09 39.53
ION
CHANGE 8.35 8.80 7.04 7.38 5.50
NWC
Ke =25%, Ko=19%, Kd=10, Value of debt =50, Tax=20%
TV=FCF/WACC
Trading Comparables/Multiple
Comparison analysis-COMPS
• A multiple is simply the ratio of the stock price
to a particular item in financial statement
• The most common ratios used are Price
earnings, price to book and Price to sales
• Similar firms assumed to have similar
multiples
• It is easy to calculate
• Minimal steps involved
Steps in Trading Comparable
• Identify comparable firms that have operation
similar to target firm whose value is in question
• Identify measures for comparable firms in
financial statements- earnings, book value,
sales, cash flow and calculate multiple
• Apply an Average or median of these multiples
to the corresponding measures for the target
firm to get that firm’s value
Example
Company Sales Earnings Book Value Market Value
Hewlett-Packard Co 84,229 7,264 38,526 1,15,700
Lenovo group ltd 14,590 161 1,134 6,381
Dell Inc 61,133 2,947 3,735 ?
Limitations
• Identifying comps with same operating
characteristics is difficult
• Difficult multiple give different valuation
• Negative denominators can occur. When the
comps has a loss, the P/E has little meaning
Share price multiples
• Price Earnings Ratio
– Market price/EPS
• Price to book ratio
– Market price /book value per share
– Book value= (Total assets-Total liabilities)/No of
shares
Sensitivity Analysis
• how independent variable values will impact a
particular dependent variable under a given set
of assumptions is defined as sensitive analysis
• It is also known as the what – if analysis
• It helps in analyzing how sensitive the output is,
by the changes in one input while keeping the
other inputs constant.
• Change the model and observe the behaviour.