VALUATION
LECTURE 1: KEY VALUATION CONCEPTS AND MAIN VALUATION METHODS
There are three types of decisions that need to be made, investment decisions, financing decisions and
dividend decisions. When you are a manager who makes investment decisions, you need to look if the NPV is
higher than the hurdle rate. If you are a manager that makes financing decisions, you are going to try to match
assets and liabilities (long term liabilities to finance (long term) fixed assets etc.) and look for the appropriate
types of funding.
These three types of decisions all rely on the principle that as a financial manager you should maximize the
value of the business. Maximizing the value of the business IN THE LONG TERM, not in the short term. If you
are making decisions which are not sustainable that might even damage the value of your company.
VALUATION
The need for valuation emerges from two things:
Decisions in the corporate finance domain
o Capital increase
o M&As
o IPOs
o Management buy-outs
Evaluation of corporate strategy
BASIC VALUATION PRINCIPLES
1. Entity: If we are valuing the company, we should look at the company as a whole and not forget
specific parts. E.g. people look at the tangible assets but forget to look at the intangible assets
(brand names, patents, trademarks etc.) these contribute to the value of the company as well.
1
, 2. Equity: In most of the cases we are most interested in the value of the shares, even though we
need to look at the entire company. Shareholders are the ultimate owners of the company.
3. Subject dependence: Imagine that an entrepreneur and venture capital specialist are going to
conduct a valuation. They have the same image about how the future is going to look like but still
come up with different valuations, why? The VC has diversified risk, he might invest in other firms as
well. For the entrepreneur typically the entire world is in the organization. Therefore they can get to
different valuations.
4. Future oriented: If we look at the accounting methods, that is looking backwards. In CF we look
forwards. That is a problem with accounting-based valuation techniques, they are not future
oriented.
5. Time dependence: You always incorporate the most recent information, which is out there, that
might mean that you need to collect information at different points in time. But you need
information that is forward looking, as much forward looking as possible or as recent as possible.
(The world does not end at December 2017. If you conduct a valuation which is forward looking you
try to incorporate as much as the information about 2018, that is forward looking as well.)
6. Going concern: We are conducting a valuation assuming that the company is going to survive
until infinity. If companies are in financial problems, we will need to account for that in our valuation
techniques.
VALUATION MYTHS
“A valuation is an objective search for ‘true’ value”
There is no such thing as true value. Take for example M&A’s, you have an acquiror and a target. Both of
them have financial advisors which will perform a financial valuation of the target company. But the
advisor of the target will always come up with a higher valuation and the acquiror will come up with a
lower valuation. Even if you have 2 potential acquirors that have the same image of what the future is
going to look like, they still can come to very different valuations, because once the target is integrated in
the acquiring company it can create synergies etc. with one company but not with the other.
“A good valuation provides a precise estimate of value”
It is better to have a range for the estimated value. You use different valuation methods and that provides
you with a range. Then you need to look what drives the differences between the valuation’s outcomes of the
different techniques.
“The more quantitative a model, the better the valuation”
Some people say that they make valuations models based on feelings, this is questionable. In other valuation
models you just put something in, and the valuation comes out, but nobody knows what happens in between,
this isn’t optimal either. Another thing that can happen is that you make so much assumptions and look at so
many different aspects that you forget to look at the big picture, so you end up making assumptions that
aren’t compatible.
2
LECTURE 1: KEY VALUATION CONCEPTS AND MAIN VALUATION METHODS
There are three types of decisions that need to be made, investment decisions, financing decisions and
dividend decisions. When you are a manager who makes investment decisions, you need to look if the NPV is
higher than the hurdle rate. If you are a manager that makes financing decisions, you are going to try to match
assets and liabilities (long term liabilities to finance (long term) fixed assets etc.) and look for the appropriate
types of funding.
These three types of decisions all rely on the principle that as a financial manager you should maximize the
value of the business. Maximizing the value of the business IN THE LONG TERM, not in the short term. If you
are making decisions which are not sustainable that might even damage the value of your company.
VALUATION
The need for valuation emerges from two things:
Decisions in the corporate finance domain
o Capital increase
o M&As
o IPOs
o Management buy-outs
Evaluation of corporate strategy
BASIC VALUATION PRINCIPLES
1. Entity: If we are valuing the company, we should look at the company as a whole and not forget
specific parts. E.g. people look at the tangible assets but forget to look at the intangible assets
(brand names, patents, trademarks etc.) these contribute to the value of the company as well.
1
, 2. Equity: In most of the cases we are most interested in the value of the shares, even though we
need to look at the entire company. Shareholders are the ultimate owners of the company.
3. Subject dependence: Imagine that an entrepreneur and venture capital specialist are going to
conduct a valuation. They have the same image about how the future is going to look like but still
come up with different valuations, why? The VC has diversified risk, he might invest in other firms as
well. For the entrepreneur typically the entire world is in the organization. Therefore they can get to
different valuations.
4. Future oriented: If we look at the accounting methods, that is looking backwards. In CF we look
forwards. That is a problem with accounting-based valuation techniques, they are not future
oriented.
5. Time dependence: You always incorporate the most recent information, which is out there, that
might mean that you need to collect information at different points in time. But you need
information that is forward looking, as much forward looking as possible or as recent as possible.
(The world does not end at December 2017. If you conduct a valuation which is forward looking you
try to incorporate as much as the information about 2018, that is forward looking as well.)
6. Going concern: We are conducting a valuation assuming that the company is going to survive
until infinity. If companies are in financial problems, we will need to account for that in our valuation
techniques.
VALUATION MYTHS
“A valuation is an objective search for ‘true’ value”
There is no such thing as true value. Take for example M&A’s, you have an acquiror and a target. Both of
them have financial advisors which will perform a financial valuation of the target company. But the
advisor of the target will always come up with a higher valuation and the acquiror will come up with a
lower valuation. Even if you have 2 potential acquirors that have the same image of what the future is
going to look like, they still can come to very different valuations, because once the target is integrated in
the acquiring company it can create synergies etc. with one company but not with the other.
“A good valuation provides a precise estimate of value”
It is better to have a range for the estimated value. You use different valuation methods and that provides
you with a range. Then you need to look what drives the differences between the valuation’s outcomes of the
different techniques.
“The more quantitative a model, the better the valuation”
Some people say that they make valuations models based on feelings, this is questionable. In other valuation
models you just put something in, and the valuation comes out, but nobody knows what happens in between,
this isn’t optimal either. Another thing that can happen is that you make so much assumptions and look at so
many different aspects that you forget to look at the big picture, so you end up making assumptions that
aren’t compatible.
2
