UNIVERSITY OF SAINT LOUIS

Tuguegarao City

SCHOOL OF ACCOUNTANCY, BUSINESS and HOSPITALITY

Accountancy Department

COURSE LEARNING MODULE

VCAM 1013 / MACT 1033 - Valuation Concepts and Methods

Lesson 1: Introduction to Valuation

Topic: Introduction to Valuation

a. Concept of Value and Valuation
b. Principles and Techniques of Valuation
c. Introduction to Valuation Approaches
Learning Outcomes:  Discuss the concept of value and valuation and the application of valuation methods.

LEARNING CONTENT

 Value
- the actual worth or price of something, whether it's the amount of money it can be sold for or its
usefulness to people.
- the monetary worth of an asset, business entity, goods sold, services rendered, or liability or obligation
acquired. In economic terms, value is the sum of all the benefits and rights arising from ownership.
- monetary, material, or assessed worth of an asset, good, or service. Some common types of value in
accounting include:
a. Shareholder Value
b. Value of a firm
c. Historical Cost: The original cost incurred to acquire an asset, which does not change over time
unless impairment occurs.
d. Fair Value: The price at which an asset could be bought or sold in an orderly transaction between
market participants at the measurement date. It reflects current market conditions.
e. Market Value: The price at which an asset is traded in an open market.
f. Net Realizable Value: The amount expected to be received from the sale of an asset, less any costs
associated with its sale.
g. Present Value: The current value of future cash flows discounted at an appropriate rate, often used
in valuing long-term assets or liabilities.

 Valuation
- The process of calculating and assigning a value to a company or an asset.
a. Cost Approach: This approach determines the value of an asset based on the cost to replace it
or reproduce it, minus depreciation.

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 b. Market Approach: The value is derived from comparing the asset to similar items in the market.
This method is commonly used for valuing publicly traded securities.
c. Income Approach: The value is determined based on the income or cash flow that an asset
generates, often involving discounted cash flow (DCF) analysis.

- The current value of any asset is the present value of the future cash flows it is expected to generate
- Liabilities are recorded at the amount of the proceeds received in exchange for the obligation. Liability is
recorded at the amount of proceeds received in exchange for an obligation.
- Provide the business with the insights needed to navigate complex ownership dynamics and plan for
sustainable success across generations. They inform strategic choices about growth, investment, and
long-term planning, helping to secure your business's future for years to come.
- Valuation is crucial for various purposes such as financial reporting, mergers and acquisitions, taxation,
and asset management. It helps investors, auditors, and companies make informed decisions based on a
clear understanding of the true value of assets and liabilities.

Principles and Techniques of Valuation

 The principles of valuation provide a framework for determining the value of assets, liabilities, and companies
in a consistent and reliable manner. These include
 Future Profitability. Future profitability is the only thing that determines the current value. ...
 Cash Flow. ...
 Potential Risk. ...
 Objectivity vs Subjectivity. ...
 Motivation and Determination.

 These principles guide accountants, financial analysts, and appraisers in conducting valuations and ensure that
the valuation process is transparent, fair, and reflects the true value of the subject being assessed.
1. The Principle of Objectivity
- Valuations should be based on objective and verifiable data, rather than subjective opinions or
assumptions. This ensures that the process is free from personal bias and that the results are credible
and reliable.
2. The Principle of Consistency
- The valuation method and approach used should be consistent over time. When comparing values over
multiple periods, the same methodology should be applied unless there is a valid reason to change it
(e.g., changes in the market or regulatory requirements).
- Consistency is important for providing comparable and meaningful financial statements.
3. The Principle of Market Evidence
- The value of an asset should reflect the price it could reasonably be sold for in the market. This
principle supports the use of observable market prices (market value) when available.
- If no direct market data is available, valuation must rely on indirect evidence or alternative methods,
such as income or cost-based approaches.
4. The Principle of Transparency
- The valuation process and the methods used should be transparent, meaning that all relevant
assumptions, data, and calculations should be disclosed.

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 - Transparency allows stakeholders (such as investors, regulators, and auditors) to understand how the
valuation was determined and assess its validity.
5. The Principle of Going Concern
- When valuing a business or an asset, the assumption is often made that the entity will continue
operating in the foreseeable future. This principle is particularly relevant in business valuations, where
the ability of a company to generate future cash flows impacts its value.
- If the business is not considered a going concern (e.g., if it's being liquidated), this principle does not
apply.
6. The Principle of Fairness
- The valuation should represent a fair and reasonable estimate of value, reflecting the true worth of the
asset or business under normal circumstances.
- This principle is especially important for financial reporting, where values are used for decision-making
by a wide range of users, including investors, creditors, and regulators.
7. The Principle of Risk and Return
- The value of an asset or business should incorporate the relationship between risk and return. The
higher the risk associated with an asset, the lower its value might be, as investors demand a higher
return for taking on additional risk.
- In valuation models like Discounted Cash Flow (DCF), the required rate of return often reflects the
asset's risk profile.
8. The Principle of Time
- Valuations should reflect the time value of money. This means that the value of future cash flows
should be discounted to account for the fact that money today is worth more than money in the future
due to the potential for earning interest or returns.
- This principle is particularly important in the income approach, where future income streams are
discounted to their present value.
9. The Principle of Highest and Best Use
- In real estate and certain business valuations, the value of an asset should be determined based on its
highest and best use—i.e., the use that is legally permissible, physically possible, financially feasible,
and maximally productive.
- This principle ensures that the value reflects the optimal potential of the asset rather than its current
or existing use.
10. The Principle of Economic Utility
- The value of an asset is often linked to its utility or the benefits it can provide to the owner or user. For
example, the value of machinery might be tied to how effectively it contributes to production.
- This principle applies especially in valuing assets where their utility and contribution to income
generation are key factors.

These principles form the foundation of the valuation process across various disciplines, ensuring that
valuations are accurate, consistent, and reflect true economic realities. They guide valuation professionals and
are embedded in standards like the International Valuation Standards (IVS), International Financial Reporting
Standards (IFRS), and Financial Accounting Standards Board (FASB) guidelines.

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 Valuation Techniques/Approaches

 These are broad methodologies employed to determine or estimate the value of assets, liabilities,
businesses, or companies. These techniques vary depending on the type of asset being valued, the
purpose of the valuation, and the availability of data. Moreover, these would guide the selection of
specific valuation techniques based on the context, purpose, and type of asset being valued.

1. Market Approach (Market-Based Valuation)

 This method determines value based on the market prices of comparable assets or companies. It is
particularly useful when there is an active market with frequent transactions.
 The market approach is based on the principle of substitution, meaning the value of an asset or entity is
determined by comparing it to similar assets or entities that have recently been bought or sold in the
market.
 Key Techniques:
 Comparable Company Analysis (CCA): Involves comparing the target company to similar publicly
traded companies with similar characteristics using financial metrics like price-to-earnings (P/E)
ratio, enterprise value-to-EBITDA (EV/EBITDA), etc.
o Precedent Transactions Analysis: This technique compares the subject asset or business to historical
transactions of similar entities, adjusting for differences in size, timing, market conditions and
establish valuation multiples that can be applied to the target.

2. Income Approach (Income-Based Valuation)

 Definition: The income approach is based on the premise that the value of an asset or business is
derived from the future economic benefits (cash flows or earnings) it can generate. The method
calculates the present value of these future cash flows. This approach is commonly used to value
businesses or income-generating assets.
 Key Techniques:
 Discounted Cash Flow (DCF) Method: The most widely used income-based technique. It estimates
the value of an asset based on the expected future free cash flows, which are discounted back to
the present value using an appropriate discount rate.
o Capitalization of Earnings: This method involves capitalizing an expected constant stream of
earnings or cash flow at a fixed rate of return, often used for stable, mature companies. This
method is similar to DCF but assumes a constant stream of earnings or cash flow, capitalized at a
fixed rate of return to estimate the value of the asset.

3. Cost Approach (Cost-Based Valuation)

 Definition: The cost approach values an asset based on the costs incurred to replace or reproduce it,
minus depreciation or obsolescence. This technique is often used for assets that are unique or have
limited market comparable.
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  Key Techniques:
o Replacement Cost Method: Estimates the cost to replace an asset with a similar one of equivalent
utility, adjusting for depreciation, physical wear, and obsolescence.
o Reproduction Cost Method: Similar to the replacement method but assumes that an exact replica
of the asset is built using the same materials and processes, often used for unique or historical
assets.

4. Asset-Based Approach
 Definition: This approach involves calculating the value of a company or business by determining the
value of its individual assets and liabilities. It is often used for companies with significant tangible assets
or when the business is being liquidated.
 Key Techniques:
 Adjusted Net Asset Method: This method calculates the net asset value (assets minus liabilities),
adjusting for factors like market value of assets and liabilities.
 Liquidation Value: This technique estimates the value of assets if the company were to be
liquidated, considering that assets may sell for less than their book value.

5. Excess Earnings Method (for Intangible Assets)

 Definition: The excess earnings method is used primarily to value intangible assets, such as goodwill,
trademarks, or patents. It estimates the value of intangible assets by calculating the excess earnings that
are attributable to them.
 Key Techniques:
 The method calculates the total earnings of the business, deducts a fair return on tangible assets,
and the remaining earnings are attributed to intangible assets.

6. Real Options Valuation

 Definition: The real options valuation approach applies financial options theory to investment
opportunities. It is particularly useful when valuing companies or projects that involve significant future
uncertainty and the ability to adapt or modify decisions. This approach is useful for projects or
investments with high potential for growth or adaptation.
 Key Techniques:
 Binomial Option Pricing Model (BOPM): This model is used to evaluate real options by considering
the possible future states of a project and the strategic flexibility of the decision-maker.

7. Comparable Transaction Method

 Definition: Similar to the Comparable Company Analysis, the Comparable Transaction Method looks at
the sale prices of businesses that are similar to the one being valued, adjusting for size, timing, and
market conditions.
 Key Techniques:

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  This technique uses multiples from comparable transactions (e.g., EV/EBITDA) to estimate the value
of the target company.

The valuation of assets, companies, and liabilities is a critical task in financial analysis and decision-making. The
methods outlined above are fundamental in this process, with each technique offering distinct advantages
depending on the nature of the asset being valued and the available data.

The three primary valuation approaches — Market, Income, and Cost — provide different perspectives on the
value of assets, each with its advantages and applications. Market-based methods are useful for valuing assets
with active markets or comparable, while income-based methods focus on future cash flows and earnings
potential. The cost-based approach is typically used for tangible assets where market or income data is
unavailable.

*** END of LESSON 1***

REFERENCES

Textbooks

1. Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset,
Wiley.
2. Koller, G., Goedhart, M., & Wessels, D. (2015). Valuation: Measuring and Managing the Value of Companies.

Online Reference

 International Valuation Standards (IVS) Council, 2020. International Valuation Standards

 Financial Accounting Standards Board (FASB), ASC 820: Fair Value Measurement
 The International Financial Reporting Standards (IFRS) 13, Fair Value Measurement
 International Accounting Standards Board (IASB), IAS 1, "Presentation of Financial Statement"
 Appraisal Institute (2015). "The Appraisal of Real Estate," 14th Edition

Assessment (Drill)

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WARNING: No part of this E-module or LMS content can be reproduced or transported or
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