Capital Budget

A plan to finance long-term outlays, such as for fixed assets like facilities and equipment.


IRR

Internal Rate of Return: The rate of return that would make the present value of future cash flows plus the final market value of an investment or business opportunity equal the current market price of the investment or opportunity. Also called dollar-weighted rate of return.


Portfolio Management

The process of managing the assets of a mutual fund, including choosing and monitoring appropriate investments and allocating funds accordingly.


Networth

Net worth is the amount by which total assets exceed total liabilities. Also known as shareholder’s equity or book value, net worth is what would be left over for shareholders if the company were sold and its debt retired.


Valuation:
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What is a Business Valuation?

A business valuation determines the estimated market value of a business entity. A valuation estimates the complex economic benefits that arise from combining a group of physical assets with a group of intangible assets of the business as a going concern. The valuation, which is part art and part science, estimates the price that hypothetical informed buyers and sellers would negotiate at arms length for an entire business or a partial equity interest.


Business Valuations are Usually Performed for Five Primary Reasons


To establish a price for a transaction
Business planning
Attract capital
Aid in estate and gift planning
Meet governmental requirements


The Components of a Business Valuation

IRS Revenue Ruling 59-60 states that valuations should address the following issues:

The nature and history of the business
The general economic outlook and the conditions of the specific industry
The book value of the stock
The financial condition of the company
The earnings capacity of the company
The dividend paying capacity of the company
Whether the company has goodwill or other intangible value
Previous sales of stock
The market price of publicly traded companies who are engaged in the same or similar lines of business


How is a Business Valuation Conducted?

The business valuation process can be broken down into four components:

Engagement process
Research and data gathering
Analysis and estimate of value
Reporting Engagement Process

There are several issues that must be addressed at the start of the business valuation process.


Definition of the legal interest to be valued - (e.g., 100% of the company's common stock)
Valuation date - the date of the estimate of value

Purpose of the valuation (e.g., estate tax, sale of a business, business planning, etc.)

Define standard of value: Fair market value - the value in an exchange between a willing buyer and a willing seller with a reasonable understanding of the facts. Fair market value is the most common standard of value and the IRS requires it; Investment value - the value to a particular investor based on individual investment requirements. This standard is often used in merger transactions.

Define the premise of value: Value as a going concern - this is the value of a business assuming it will continue to operate as a going concern; Liquidation value - this is the value of a business that is not operating as a going concern, but has commenced an orderly disposition of its assets.

Form and content of the report


Research and Data Gathering

At this point the valuator will request certain information from the client. This request may include the following.


Financial statements
Tax returns
Accounts receivable, accounts payable and inventory detail
Contracts/leases
Budgets/forecasts
Board of directors minutes
Organization chart
Marketing material/price lists

While this information is being gathered the valuator will be performing industry and comparable company research.


Analysis and Estimate of Value

During this phase the valuator puts together and analyzes all of the internal company information in conjunction with the industry and comparable company research. This analysis will then enable the valuator to synthesize an estimate of value.


Reporting

In the reporting phase the valuator will issue his or her report. There are three basic types of reports.

Oral report - issued when time does not permit a written report to be issued
Limited scope report - provides a well-documented estimate of value that can be used for many purposes, while taking into consideration the cost of the report preparation.
Full scope report - the most detailed and costly estimate of value. This type of report is often used for litigation purposes.

At the end of the valuation process the valuator will ask the client to sign a client representation letter that states, in effect, that everything that the client supplied to the valuator is true and accurate to the best of the client's knowledge and abilities.



Company Valuation Methods:
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1) Book Value => firm value = book value of all assets

2) Comparable Companies or Earnings Multiple Method

3) Liquidation Value

4) Discounted Cash Flow Method => APV Model & Equity DCF Model

5) Economic Profit Method

6) Option Valuation Method


I. Book Value

One of the most widely used methods
Based on historical numbers
Ignores future
Accounting numbers are flawed and can be easily manipulated
Ignores intangibles
Ignores risk
Price paid for an asset may have no relation to its value in operation or if it had to be sold or replaced


II. Comparable Companies Method

Most common multiple used:

Market value of the company Debt+Equity
= --------------------------- = ----------------
EBIT EBIT


Other multiples used: Price/Net Earnings, Price/Sales, Market Value/Book Value, Asset Value/ EBIT,

III. Discounted Cash Flow Method

Procedure:

1. Forecast free cash flows during forecast horizon
2. Estimate the cost of capital => weighted average cost of capital (WACC)
3. Estimate continuing value (= value after forecast horizon)
4. Discount to the present
5. Add the value of excess cash and other non-operating assets
6. Deduct financial debt to get market value of equity


III. Economic Profit Method


Economic Value Added (EVA) = Invested Capital x (ROIC - WACC)

ROIC = Rate of Return On Invested Capital => Invested Capital = Long-Term Assets + Working Capital)


IV. Free Cash Flow