Week 4-5

● Key Concepts of Income-Based Method of Valuation for Decision-Making

● Apply key Concepts of market-based valuation method for decision making.
Asset based valuation
• Asset-based valuation primarily focuses on the company's tangible and intangible
assets.
• Most suitable for businesses with significant tangible assets, such as real estate or
manufacturing companies.

●Straightforward for companies with ●May not account for the true earning
substantial tangible assets. potential or intangible assets.
●Useful for liquidation or distressed ●Ignores the market's perception and
business scenarios. expectations.
●Provides a floor value for the ●May undervalue businesses with
business. strong intangible assets or future
growth potential.
Income based valuation
• Income-based valuation considers a business's future earnings or cash flows.
• Applicable to businesses with established financial track records, growth
potential, and clear cash flow projections.

●Takes into account the company's ●Highly dependent on accurate

ability to generate income. financial projections.
●Reflects the market's perception of ●Sensitivity to changes in discount rates
future earnings. and growth assumptions.
●Suitable for both growing and ●May not work well for businesses with
mature businesses. erratic cash flows or startups without
proven revenue streams.
Market based valuation
• Market-based valuation compares a business to similar businesses in the
market.
• Ideal when there are comparable companies or recent transactions in the
market, common in real estate, mergers, and acquisitions.

●Based on real market data and ●Limited applicability if there are no

pricing trends. direct comparables.
●Reflects current market sentiment ●Requires careful selection of truly
and valuations. comparable businesses or transactions.
●Suitable for businesses with readily ●May not account for unique factors
available comparable data. affecting the subject business.
General Consideration
Accuracy and Data Requirements: Asset-based valuations are relatively straightforward but may not
provide a fair reflection of a company's value. Income-based valuations depend heavily on accurate
financial projections and discount rate selection. Market-based valuations rely on the availability of
relevant market data.
Time Horizon: Asset-based and market-based valuations are typically more static, focusing on the
current state, while income-based valuations consider future cash flows and growth potential.
Risk and Growth: Asset-based valuations don't account for growth potential or risk. Income-based
valuations incorporate these factors through cash flow projections and discount rates. Market-based
valuations reflect market perceptions of growth and risk.
Applicability: The choice of valuation method depends on the nature of the business, its life cycle
stage, the availability of data, and the specific purpose of the valuation.

In practice, a comprehensive valuation may use a combination of these methods to triangulate the
value of a business. The choice of method depends on the unique characteristics of the subject
company and the goals of the valuation.
 ABC Manufacturing Company
ABC Manufacturing Company is a small manufacturing company that produces custom-made machinery
parts. You've been tasked with valuing the business for potential investors. The following information is
available:
Total Tangible Assets: $1.5 million Comparable Company Analysis (CCA) reveals
Intangible Assets (patents, trademarks): $500,000 that similar manufacturing companies trade at a
Total Liabilities: $400,000 Price-to-Earnings (P/E) ratio of 12x.
Earnings Before Interest and Taxes (EBIT): $200,000
Estimated Growth Rate of Earnings: 5% per year Comparable Transaction Analysis (CTA) indicates
Risk-Free Rate: 3% that recent transactions in the industry have
Beta (for the industry) = 1.2; Market Risk Premium: 6%; been valued at an Enterprise Value (EV) to
Tax rate=30% EBITDA multiple of 8x.

Calculate the asset-based valuation of ABC Manufacturing using the Book Value Method.
income-based valuation using the Discounted Cash Flow (DCF) method.
market-based valuation using the Comparable Company Analysis (CCA) method.
market-based valuation using the Comparable Transaction Analysis (CTA) method.
Asset Valuation
●Asset-Based Valuation (Book Value Method):

= Total Tangible Assets + Intangible Assets - Total Liabilities

= $1.5 million + $500,000 - $400,000
= $1.6 million
 Income-Based Valuation (DCF Method):
Calculate the discount rate using the Capital Asset Calculate the terminal value at the end of
Pricing Model (CAPM): Year 5:
Risk-Free Rate = 3% Terminal Value = EBIT Year 5 * (1 + Growth
Equity Risk Premium = Market Risk Premium = 6% Rate) / (Ke - Growth Rate)
Beta (for the industry) = 1.2 Terminal Value = $247,609 * (1.05) / (0.102
Cost of Equity (Ke) = 3% + 1.2 * 6% = 10.2% - 0.05) = $2,352,658

Calculate the present value of future cash flows Calculate the present value of all cash
using the EBIT and growth rate: flows:
EBIT Year 1 = $200,000 * 1.05 = $210,000 PV of Cash Flows = $210,000 / (1.102) +
EBIT Year 2 = $210,000 * 1.05 = $220,500 $220,500 / (1.102)^2 + ... + $2,352,658 /
... (1.102)^5 ≈ $1,663,868
EBIT Year 5 = $247,609 (rounded)
Market Based Valuation
Calculate the market-based valuation using Calculate the market-based valuation using
the P/E ratio from comparable companies: the EBITDA multiple from comparable
●Earnings (P/E Method) = EBIT * (1 - Tax transactions:
Rate) = $200,000 * (1 - 0.3) = $140,000 ●Enterprise Value = EBIT * Comparable
●Market Value = Earnings (P/E Method) * P/E EV/EBITDA Multiple
Ratio = $140,000 * 12 = $1,680,000 ●Enterprise Value (CTA Method) =
$200,000 * 8 = $1,600,000
Tax rate is 30%
 Comparison and Final Valuation:
The asset-based valuation yields a value of $1.6 million.
The income-based valuation using the DCF method gives a value of approximately
$1.66 million.
The market-based valuations using CCA and CTA methods result in values of $1.68
million and $1.6 million, respectively.

Considering all three methods, the estimated value of ABC Manufacturing is

approximately $1.66 million, assuming a weighted average of these valuations.
 Income Based
Valuation
● Key Concepts Discounted Cash Flow Method
● and Capitalization of Earnings Method
 Income approach or
Discounted Cash Flow
(DCF) Method “EFC” stands for the expected cash flows
“i” stands for the discount rate “t” stands
for the number of periods
“TV”stands for the terminal value.
Expected Cash Flows
The most important part of this method is the
Expected Cash Flows (ECF). Estimating the ECF is
quite challenging given that the degree of uncertainty is
high.
The following factors affect
expected cash flows:
● Characteristics and Stability of the industry
● Management’s ability to predict how the business will
evolve
● Comparability between future and past results:
Asset-Side and Equity-Side Valuation
Equity-side Valuation (Levered valuation)

Asset-side Valuation (Unlevered valuation)

Beta (β)
Beta pertains to the risk associated with the investment. Beta
consists of two elements:
● Systematic risk- risk associated to the general market. All firms in the
same industry have the same systematic risk.
● Unsystematic risk- this is the risk unrelated to the general market. This
type of risk is commonly linked to the firm’s specific characteristics
such as operations, profitability, investments, and so on.
Levered vs. Unlevered Beta
Levered data is the aggregate figure based on the beta of listed companies. the
levered data pertains to the total risk of a security (operating and financial risk).
On the other hand, unlevered beta pertains to beta without considering financial
risk. The formula for unlevered beta is as follows:

Note: In case of multi-business company beta, the beta of each business must be calculated and weighted
according to a representative variable (e.g. investments, number of employees, FCF, revenues).
The Terminal Value
ECF has two types: the ECF within the forecast period and ECF beyond the explicit
forecast period. This means that the computation of ECF is required. Terminal value is
the value of an asset/project/business beyond the forecasted period in which the cash
flows can be estimated. The formula to compute for the terminal value is as follows:

Cash flowt+x = ECFs beyond the explicit forecast period

i = Discount rate
g = Growth rate

If we are to compute the terminal value

under asset-side approach, the formula
would be like this:
Remember that asset-side approach uses WACC as its discount rate. If
the equity-side approach is used, it is the CAPM that will be used as
discount rate. The formula under equity-side approach is as follows:

Accordingly, the computation of terminal value can also be done using the Gordon
growth model in case of a two-stage or three-stage growth model.
Alternative Methods for Calculating the TV

There are two alternative methods in calculating terminal value: market value and
salvage value.

Under market value, the terminal value is calculated as a multiple. For the asset-
side valuation, common multiples are EV/revenue, EV/EBITDA, EV/EBIT. For
equity-side valuation, common multiples used are P/E and P/BV.

Under salvage value, the terminal value is considered to be the amount a company
expects to receive from the sale of an asset at the end of its useful life. This
method is effective if the terminal value has insignificant or no relationship to cash
flows.
Market Valuation
Market approach or market multiple
method
● is a valuation method that computes the value of a
firm by comparing it with similar business having
available price/value.
● Unlike DCF approach, market approach uses the
current price of comparable business to express the
value of the firm.
According to IVS 105, market approach is applicable under the
following circumstances:

• “the subject asset or substantially similar assets are actively publicly

traded; and/or
• the subject asset has recently been sold in a transaction appropriate
for consideration under the basis of value;
• there are frequent and/or recent observable transactions in
substantially similar assets”
 On the other hand, market approach cannot
be used under the following circumstances:
○ “transactions involving the subject asset or substantially similar assets are not recent
enough considering the levels of volatility and activity in the market.
○ the asset or substantially similar assets are publicly traded, but not actively.
○ information on market transactions is available, but the comparable assets have
significant differences to the subject asset, potentially requiring subjective
adjustments.
○ information on recent transactions is not reliable (i.e. hearsay, missing information,
synergistic purchaser, not arm’s-length, distressed sale, etc.).
○ the critical element affecting the value of the asset is the price it would achieve in the
market rather than the cost of reproduction or its income-producing ability.”
Assumptions
Under market approach, the following assumptions are used in the
valuation process:
● Performance measures are correlated with value of the firm;
● The correlation is homogenous across the companies in the same
industry which are comparable as to size, profitability, and other
parameters.
● There is a constant multiple between the enterprise value and
performance measure.
● The market multiple is applicable to the target company.
Formula

According to the assumptions of market approach, market multiple play a big

role in the valuation process. Wherein, market multiple is:
Advantages and Disadvantages of Market Approach

Advantages: Disadvantages:
• No recent comparable data can be
• User-friendly
found
• It uses actual data • The standard of value of may be
• It is relatively simple to unclear
• Some assumptions are hidden
apply • Costly approach
• It does not rely on • Not flexible or adaptable as other
forecasts approaches
• Reliability of data are questionable
Asset-Side Multiples : The most common performance measure used in asset-side approach are sales, EBITDA, EBIT, FCF.

Performance Advantage Disadvantage

Measure
• Revenues do not provide sufficient
feedback on the firm’s efficiency,
• Has a good correlation with the
attitude to generate cash flows, and
EV/Sales multiples of companies in the
ability to meet its obligations.
peer group.
• Not able to grasp the complexity of a
company.
• Relatively neutral multiple through
which firms in the same industry
can be easily compared because • Since investments are not considered,
EV/EBITDA not significantly influenced by EV/EBITDA may lead to an over- or
accounting policies. undervaluation
• Most common method
Performance Advantage Disadvantage
Measure

• More exposed to the influence

• Considers the effects of amortization and of accounting policies, as each
depreciation; it therefore provides more company may have different
complete information, as it also takes into levels of amortization as a
EV/EBIT
account the firm’s investments and result of different accounting
evaluates a business based on operating standards, different investment
profit. policies, and different business
models

• subject to a certain degree of

• Neutral, since it is not influenced by either volatility over time
EV/Free Cash Flow accounting standards or accounting policies; • cash flow does not have the
objective, because it measures value based same stability as EBIT and
on data that are certain. EBITDA
INCOME STATEMENT COMPANY A COMPANY B

Sales P 850,000 P 900,000

Operating Expenses (550,000) (600,000)

Gross Margin 300,000 300,000

Other Expenses (130,000) (130,000)

EBITDA 170,000 170,000

AMORTIZATION (60,000 (20,000)

EBIT 110,000 150,000

INTEREST (10,000) (10,000)

EARNINGS BEFORE TAX 100,000 140,000

FREE CASH FLOW 170,000 170,000

ASSUMING that the peer average EV/Sales= 1.5x, EV/EBITDA= 5.0x, EV/EBIT= 8.3x, EV/Free Cash
Flow= 4.0
ASSUMING that the peer average EV/Sales= 1.5x, EV/EBITDA= 5.0x, EV/EBIT= 8.3x, EV/Free Cash
Flow= 4.0

MULTIPLE ENTERPRISE VALUE: ENTERPRISE VALUE:

USED COMPANY A COMPANY B

EV/Sales 850,000 x 1.5 = 1,275,000 900,000 x 1.5 = 1,350,000

EV/EBITDA 170,000 x 5.0 = 850,000 170,000 x 5.0 = 850,000

EV/EBIT 110,000 x 8.3 = 913,000 150,000 x 8.3 = 1,245,000

EV/Free 170,000 x 4.0 = 680,000 170,000 x 4.0 = 680,000

Cash Flow
Equity-Side Multiples :The most commonly used performance measures are earnings, earnings growth, BV, FCF to equity.

Performance Advantage Disadvantage

Measure
more exposed to the influence of
accounting policies
simple to calculate, as both price and  earnings are
Price/Earnings
earnings are easily available performance influenced by the financial structure influenced
(P/E)
measures. by the different tax rate

allows for better contextualization of the

P/E ratio because it is useful for start-up with a high growth rate and a still low
identifying overvalued and undervalued stock price could be considered undervalued,
PEG RATIO stocks based on the expected growth rate while a large and stable company may not be
of EPS. judged as attractive due to its low growth
Performance Advantage Disadvantage
Measure

used for investment- intensive companies, while Companies that apply different
Price/Book Value it is less significant for companies with low accounting standards cannot be
investment levels. valued using this multiple.

Price/Free Cash Flow

subject to a certain degree of
to Equity (P/FCFE)
neutral, since it is not influenced by either volatility over time
(Same application
accounting standards or accounting policies;  cash flow does not have the
with EV/Free Cash
 objective, because it measures value based same stability as EBIT and
Flow under asset-
on data that are certain. • EBITDA
side)
MORE SAMPLES
COMPREHENSIVE
(COMBINATION)
 You are tasked with comparing two companies, Company A and Company B, using both
income-based valuation and market-based valuation methods.

Company A: Company B:
EBIT : Php 5 million EBIT : Php 8 million
Total Debt : Php 10 million Total Debt : Php 15 million
Equity : Php 20 million Equity : Php 30 million
Number of Common Shares Outstanding: Number of Common Shares Outstanding:
1 million 1.5 million
Current Stock Price : P25 per share Current Stock Price : Php30 per share

●Calculate the Earnings Per Share (EPS) for both Company A and Company B.
●Use the Price-to-Earnings (P/E) ratio to estimate the market value of the common shares for each company.
●Calculate the market capitalization of both companies based on the P/E ratio method.
●Determine the Enterprise Value (EV) for both companies using the EBIT multiple method, assuming an industry average
EBIT multiple of 8x.
Solution
 For Company A: For Company B:
●EPS = EBIT / Number of Common Shares ●EPS = EBIT / Number of Common Shares
Outstanding = Php 5 million / 1 million shares Outstanding = Php 8 million / 1.5 million
= Php 5 per share. shares = Php 5.33 per share.
●P/E ratio for Company A = P25 / P5 = 5 ●P/E ratio for Company B = Php 30 / Php 5.33
= 5.63.

Company B has a higher P/E ratio (5.63 vs. 5) than Company A, which indicates
that investors are willing to pay a higher multiple of earnings for Company B's
shares. This may imply that Company B is perceived as having higher growth
prospects or a more favorable outlook by investors.
Calculate the market capitalization for both Company A and Company B based on the P/E ratio
method. Which company has a higher market capitalization, and why?

Market Capitalization = Current Stock Price x Number of Common Shares Outstanding.

For Company A: For Company B:

●Market Capitalization = Php 25 per share x 1 ●Market Capitalization = Php 30 per share
million shares = Php 25 million. x 1.5 million shares = Php 45 million.

Company B has a higher market capitalization (Php 45 million) compared to Company

A (Php 25 million) because its stock price is higher and it has more shares
outstanding. This suggests that investors value Company B more in terms of market
capitalization
 Calculate the enterprise value for both Company A and Company B using the EBIT multiple
method, assuming an industry average EBIT multiple of 8x.

Enterprise Value (EV) = EBIT x EBIT Multiple.

For Company A: For Company B:

●EV = Php 5 million x 8 = ●EV = Php 8 million x 8 =
Php 40 million. Php 64 million.

Company B has a higher enterprise value (Php 64 million) compared to

Company A (Php 40 million). This indicates that investors are willing to
pay more for Company B's total business value, potentially due to
expectations of higher growth or profitability.
Calculate the P/B ratio for both companies. What does the P/B ratio indicate about the relationship
between the market value of equity and the book value of equity for each company?
P/B ratio = Current Stock Price / (Equity / Number of Common Shares Outstanding).

For Company A: For Company B:

●P/B ratio = Php 25 / (Php 20 million / 1 ●P/B ratio = Php30 / ($30 million / 1.5 million
million shares) = Php 25 / Php 20 = 1.25. shares) = Php 30 / Php 20 = 1.5.

The P/B ratio compares the market value of equity to the book value of equity. A
P/B ratio greater than 1 implies that the market values the company's equity
higher than its book value. Company B has a higher P/B ratio (1.5 vs. 1.25)
compared to Company A, indicating that investors are willing to pay a higher
premium for Company B's equity.
Determine the Total Enterprise Value (TEV) for both
companies based on the P/B ratio method.
For Company A: For Company B:
●TEV ==Php
TEV Market Capitalization
25 million (Market Cap) + Php+ Total
●TEV =Debt.
Php 30 million (Market Cap) +
10 million (Total Debt) = Php 35 million. Php 15 million (Total Debt) = Php 45
million.

Company B has a higher TEV ($45 million) compared to Company A ($35 million)
based on the P/B ratio method.
THANK
YOU
Scenario: XYZ Tech Startup

XYZ Tech Startup is a fast-growing technology company that develops innovative software solutions. You've
been tasked with valuing the business for potential investors. The following information is available:

Total Tangible Assets: $100,000

Intangible Assets (patents, software, intellectual property): $3 million
Total Liabilities: $500,000
Earnings Before Interest and Taxes (EBIT): Not applicable; the company is pre-revenue.
Estimated Revenue for the next 5 years: Year 1: $500,000, Year 2: $1 million, Year 3: $2 million, Year 4: $3
million, Year 5: $4 million.
Risk-Free Rate: 2%
Equity Risk Premium: 8%

Comparable Company Analysis (CCA) is challenging due to the uniqueness of the technology.
Comparable Transaction Analysis (CTA) reveals recent transactions in the tech industry at an Enterprise
Value (EV) to Revenue multiple of 5x.
Valuation Tasks:

Calculate the asset-based valuation of XYZ Tech Startup using the Adjusted Net Asset Value Method.
Calculate the income-based valuation using the Discounted Cash Flow (DCF) method.
Calculate the market-based valuation using the Comparable Transaction Analysis (CTA) method.
Compare and discuss the results from the three approaches and determine the estimated value of XYZ Tech
Solutions:

Asset-Based Valuation (Adjusted Net Asset Value Method):

Asset Value = Total Tangible Assets + Intangible Assets - Total Liabilities

Asset Value = $100,000 + $3 million - $500,000 = $2.6 million
Income-Based Valuation (DCF Method):

Calculate the discount rate using the Capital Asset Pricing Model (CAPM):
Risk-Free Rate = 2%
Equity Risk Premium = 8%
Beta (for the industry) = 1.3
Cost of Equity (Ke) = 2% + 1.3 * 8% = 12.4%
Calculate the present value of future revenue using the revenue projections:
Year 1: PV = $500,000 / (1.124)^1 ≈ $446,429
Year 2: PV = $1 million / (1.124)^2 ≈ $782,313
...
Year 5: PV = $4 million / (1.124)^5 ≈ $2,311,657
Sum the present values of all five years to get the estimated business value.
Market-Based Valuation (CTA Method):

Calculate the market-based valuation using the Revenue multiple from comparable transactions:
Enterprise Value (CTA Method) = Revenue * Comparable EV/Revenue Multiple
Enterprise Value (CTA Method) = $500,000 * 5 = $2.5 million
Comparison and Final Valuation:

The asset-based valuation yields a value of $2.6 million.

The income-based valuation using the DCF method provides an estimated value.
The market-based valuation using the CTA method results in a value of $2.5 million.

Considering all three methods, the estimated value of XYZ Tech Startup lies between $2.5 million and the DCF-calculated value.
In this sample problem, asset-based valuation and market-based valuation using CTA provide a narrow range of values, while the income-based valuation using DCF takes future revenue projections into
account. The estimated value of XYZ Tech Startup falls between these values, reflecting the interplay between its tangible and intangible assets, as well as its growth potential.