Chapter 31
VALUE : Valuation techniques


Discounted cash flow is based on the notion that the value of the company is equal to the amount of free cash flows expected to be generated by the company in the future and discounted at a rate commensurate with its risk profile. The discount rate applied is the weighted average cost of capital (WACC). The DCF calculation is performed as follows:

  • future free cash flows are discounted over the explicit forecast period, i.e. the period over which there is visibility on the company’s operations;

  • a terminal value is calculated on the basis of an estimated growth rate carried to per- petuity, which must then be discounted;

  • the value of equity is the difference between the enterprise value obtained above and the value of the company’s net debt.

The peer group or multiples method is a comparative approach that sets off the company to be valued against other companies in the same sector. In this approach, the enterprise value of the company is estimated via a multiple of its profit-generating capacity before interest expense. EBIT and EBITDA multiples are among those commonly used. The multiple used in the comparison can be either a market multiple or a transaction multiple. The value of net debt is deducted from this enterprise value to get the value of equity. Equity can also be directly valued through a multiple of net income, cash flow or book equity.

The sum-of-the-parts method of valuation consists in valuing and summing up each of the company’s assets, subsidiaries or divisions and subtracting liabilities. There are several types of net asset value, from liquidation value to going-concern value, and there are important tax considerations. Either capital gains or losses will be subject to tax or depreciable assets will be undervalued and yearly taxes higher. Calculating net asset value makes sense only if it includes the company’s intangible assets, which can be particularly difficult to value.

No company valuation is complete without an analysis of the reasons for the differences in the results obtained by the various valuation methods. These differences give rise to decisions of financial engineering and evolve throughout the life of the company.

To the financial manager, the market for corporate control is nothing but a segment of the broader capital market. From this principle it follows that there is no such thing as control value, other than the strategic value deriving from synergies.

Industrial synergies generally make a company’s strategic value higher than its financial or standalone value. The essence of negotiation lies in determining how the strategic value pie will be divided between the buyer and the seller.