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Advanced Financial Accounting I

Advanced Financial Accounting I. Share and business valuation. Content. Business valuation Elements of business valuation Business valuation approaches Illustrations Conclusion. Business Valuation. process applied to determine the

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Advanced Financial Accounting I

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  1. Advanced Financial Accounting I Share and business valuation

  2. Content • Business valuation • Elements of business valuation • Business valuation approaches • Illustrations • Conclusion

  3. Business Valuation process applied to determine the of an owner’s interest in a business fair market value cash or equivalent price willing and able to consummate the transactions willing and able buyer and seller reasonably prudent and rational at arms length have reasonable knowledge of the relevant facts continue as going concern open and unrestricted market transaction will be in cash or equivalents

  4. Elements of Business Valuation • Economics conditions • national, regional and local • indicators discussed: stock market trends gross domestic product employment inflation interest rates consumer spending

  5. Elements of Business Valuation • Financial analysis • history of the business, description of the organization, business lines, products and services, its management, customers, competitors and employees and its financial performance • normalisation of financial statements

  6. Normalisation of Financial Statements • Comparability adjustments • Non-operating adjustments • Non-recurring adjustments • Discretionary adjustments

  7. Business Valuation Approaches • Income approach – net present value of the benefit stream generated by the business • Asset-based approach – adding sum of the parts in the business • Market approach – comparing subject company to other companies in the same industry, of the same size, and/or within the same region

  8. Income Approach • Capitalization of earnings or cash flows (capitalisation rates) • Discounted future cash flows (DCF) (discount rates) • Excess earnings method

  9. Asset-based Approach • Theory: value of business equal to its parts • Net book value method = book value adjusted to fair market value, wherever possible • Net tangible assets

  10. Market Approach • Economic principle of substitution: “buyers would not pay more for an item than the price at which they can obtain an equally desirable substitute” • Market price of the stock of publicly tradedcompanies engaged in the same or similar line of business - sufficiently comparable ???

  11. Guideline for public company method • Similarity: industry, product lines, market, growth and risk • Reasonable basis for comparison exists: • qualitative and quantitative investments and investor characteristics • reliable data is known about the transaction • price paid for the guideline companies was in arms-length transaction

  12. Business valuation methods True value Fixed price Book value Discounted earnings Adjusted book value Appraisal method Profit multiple Income capitalisation Price earnings multiple Dividend capitalisation Replacement value Discounted cash flow Liquidation value Sales multiple Cut throat method

  13. Illustration : A (i) RM’000 Book value of tangible assets 20,000 Adjustment of property 4,000 FV tangible assets 24,000 Less: FV liabilities ( 6,000) FV net tangible assets 18,000 Number of shares (‘000) 5,000 Value per share = RM3.60

  14. Illustration : A (ii) Super profit = RM2.5m – (10 x RM18m) = RM700,000 Goodwill = RM700,000 x 10 years = RM7,000,000 Value/share = (RM18m + RM7m) / 5m = RM5.00

  15. Illustration : A (iii) Total valuation = RM18m+[RM2.5m – (0.09 x RM18m)] 0.15 =RM18m + RM5,866,667m =RM23,866,667 Value per share = RM23,866,667 / 5m = RM4.77

  16. Illustration : B (i) • 3% growth rate = [RM0.14/0.7] X (1.03) = RM4.12 0.08 – 0.03 • Constant growth rate = RM0.20 / 0.08 = RM2.50

  17. Illustration : B (ii) Total valuation of shares = RM2.5m x 16 times = RM40m Value per share = RM40m / 5m = RM8.00

  18. Illustration : B (iii) 14,207 6 to infinity [RM3,000,000/0.15 x 0.497 9,940 PV of future CF 24,147 Value per share = RM24.147m / 5m = RM4.83

  19. Conclusion • Choose one that most suitable • Reconcile for confirmation • True value?????

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