ADVANCED VALUATION

CONCEPTS, METHODS and

TECHNIQUES
A Presentation By Group 7
 Course Objectives:

1 2 3

To gain understanding To know the significance of To learn when and how to

about different advanced different advanced use advanced valuation
valuation concepts and valuation techniqus. techniques
methods.
 ADVANCED VALUATION CONCEPTS AND
ADVANCED VALUATION TECHNIQUES
METHODS

A. Adjusting for non-operating A. Real Options Valuation

assets and liabilities B. Relative Valuation
B. Synergy and control premiums C. Monte Carlo Simulation
in valuation
C. Valuation on special situations
D. Real Options analysis in
valuation.
ADVA N C E D
VALU A T I O N
CONC E P T S &
MET H O D S
ADVANCED VALUATION CONCEPTS, METHODS & TECHNIQUES
General term that is used to assess the company’s value. These
methods also give insight at critical decision points such as those
can be used to assess the riskiness of an investment.
These methods provides more accurate data, generally used by
professionals and provides more reliable information.
● ADJUSTING FOR
● NON OPERATING
ASSETS AND
LIABILITIES
ADJUSTING FOR NON-OPERATING ASSETS AND
LIABILITIES
Non- Operating Assets and Liabilites
Assets and liabilities that are not required
in the normal operations of a business but
WHAT?
that can generate income nonetheless.
The assets are recorded in the balance
sheet and may be listed separately or as
part of operating assets. Because these items are not essential to
operations they need to be isolated and
removed (and any income or expense
associated with them removed) from the
determination of the operational value of a

HOW? business. Typically, non-operating assets are an

add-back to the valuation
methodologies after determining the operating
value of the business.
 UNUTILIZED ASSET
A plot of land owned, but not currently used, EXAMPLE
by the business.
Although the land may have accumulated
substantial market value, it does not bring in any
cash flows yet and may be excluded when
estimating the value of the company on the basis
of the potential cash flows.

Another form of non-operating assets (or

liabilities) can be shareholder receivables or
loans. For many privately-owned businesses,
owners fund operations through shareholder
loans. These transactions are typically viewed as
“equity” transactions from a valuation
perspective and are thus excluded from the
operating value of a business.
SYNERGY AND
CONTROL
PREMIUMS IN
VALUATION
 Synergy and Control Premiums in
SYNERGY
Valuation
combined value and performance WHAT?
of two companies will be greater
than the sum of the separate
individual parts.
When a company acquires another business,
it is often justified by the argument that the
investment will create synergies.
The primary source of synergy in an
acquisition is in the presumption that the target
HOW? firm controls a specialized resource that
becomes more valuable if combined with the
acquiring firm’s resources.
Synergy and Control Premiums in Valuation
TYPES OF SYNERGIES:
OPERATING SYNERGY
• when the value and
performance of two firms
combined is greater than the

FINANCIAL SYNERGY
sum of the separate firms
apart and, as such, allows for
• improvements in financial the firms to increase their
activities and conditions for a operating income and achieve
company that come about as a higher growth.
result of a transaction. Such as
revenue, debt capacity, cost of
capital, profitability, etc..
 CONTROL PREMIUM

• Control premium refers to an amount that a buyer is willing

to pay in excess of the fair market value of shares in order
to gain a controlling ownership interest in a publicly traded
company.

• To acquire a larger interest in the company, the buyer has to

offer an additional price than the market price so that the
existing shareholders would show interest in selling the
shares.
Synergy and Control Premiums in Valuation

Synergy and Control Premium is a term that is commonly used in

the context of mergers and acquisition. The difference is that,
Synergy is a combined value and performance of two companies
will be greater than the sum of the separate individual parts, while
Control Premium is an acquisition of shares to gain a controlling
By separating out the value of control from the
interest over the company. And the main purpose for these is the
value of synergy, we accomplish an objective.
goal for the improvement of the company. We ensure that there is no double counting. If,
for instance, a firm has a low return on capital
In valuation, synergy and control premium are valued separately. because its assets are inefficiently deployed, we
And knowing such value can provide more reliable data that can show the increase in value that accrues from
affect the decision making of the company. redeploying the assets and increasing the return
on capital as part of the value of control.

For synergy to create value, there has to be a

further increase in return on capital to the
combined firm.
Valuation in
Special
Situations
A special situation is an
unusual event that compels
investors to buy a stock or
Special situation investment opportunities
other asset in the belief that its
can take many forms and involve a number
price will rise. of asset classes. They often arise from
breaking news stories or rumors of news
about to break. They may concern spinoffs,
tender offers, mergers, acquisitions,
bankruptcy, litigation, capital structure
dislocations, shareholder activism, stock

Valuation in buybacks, and any other event that might

affect a company's short-term prospects.

Special
Situations
 START-UPS AND DISTRESSED COMPANY

Start-ups are .new business

ventures that focus on
developing unique ideas or
technologies. Special
valuations are methods to Why estimate the
estimate the worth of a value of a startup?
start-up based on different
factors, such as future
potential, market demand,
risk, etc.
of business valuation
CHALLENGES IN VALUING START-UP VENTURES

01 Lack of Historical Financial Information

02 Uncertain Future Performance

03 Lack of Comparables

04 Dependence on Funding Rounds

05 Subjectivity and Biases

 START-UPS AND DISTRESSED
COMPANY
ADVANTAGES OF STARTUP

• Agility DISADVANTAGES OF
• Efficiency (Lean and Mean) STARTUP
• Team Culture • Risk
• Personalization • Compensation
• Versatility • Market Access
• Flexibility • Team Composition
• Resources
• Processes
START-UPS AND DISTRESSED COMPANY

. Financial Distressed
is a condition in which a company or individual cannot
generate sufficient revenues or income, making it
unable to meet or pay its financial obligations.

This is generally due to high fixed costs, a large degree of

illiquid assets, or revenues sensitive to economic
downturns.
 START-UPS AND DISTRESSED COMPANY
SIGNS OF FINANCIAL DISTRESSED:

• Cash flows
If a business is spending more than it earns, it will
lead to problems, unless it is deliberate and
well-funded • Extended payment days
If business has to delay payments to its creditors,
• Poor sales growth or decline in revenues this can force some suppliers to stop supplying
If revenue is dipping or it is not growing, chances and it may cause delays in your
are that the business will be under pressure to sell production/delivery of service which can be bad
its product or service at lower margins or even at for your reputation and that of your business.
loss leading towards the sorry state of financial
distress. • Difficulty in raising capital
If a company is constantly borrowing and asking
its investors to inject more capital, this is an
underlying sign that it is increasingly finding it
difficult to self-sustain.
START-UPS AND DISTRESSED COMPANY
DEALING WITH FINANCIAL DISTRESSED

Management information system

Good management information system will provide accurate and timely
information that can often be the essential ingredient to success and this
information can ensure you are prepared for the crisis and have time to
turn the business around.

Learn to forecast
Forecasting helps create more predictable financial outcomes.

Cash is king
If your business owes money to your creditors and cannot pay them on
time, is it because your debtors are not paying you? Be active in chasing
them. If they are in difficulty too, treat them as you would expect to be
treated, firm but fair.
START-UPS AND DISTRESSED COMPANY
DEALING WITH FINANCIAL DISTRESSED

Communication with creditors and lenders

Effective and timely communication with creditors will be considered as a
sense of responsibility and they may be able to help you in stretching
payment terms.
Consultation and seeking advice
Finance specialists can give you better insights about the financial health
of the company and as a result, you can draw a better financial plan
according to the situation and befitting your business plan.
Be proactive
Do a detailed review of the company’s assets and holdings to determine if
any liquidation is needed for the non-revenue generating investments. If
cash shortfall is expected, then the company will need to consider
renegotiation of the payment terms with creditors, before approaching the
due dates.
REAL OPTIONS
ANALYSIS IN
VALUATION
Using real options value analysis
(ROV), managers can estimate the
opportunity cost of continuing or
abandoning a project and make (ROV or ROA) applies option valuation
better decisions accordingly.
techniques to capital budgeting
decisions. A real option itself, is the
right but not the obligation to
undertake certain business initiatives,
such as deferring, abandoning,
expanding, staging, or contracting a
capital investment project.
REAL OPTIONS
ANALYSIS
 REAL OPTIONS ANALYSIS
Real options may be classified into different groups:
Option to expand is the option to make an investment or undertake a project in
the future to expand the business operations

Option to abandon is the option to cease a project or an asset to realize its

salvage value.

Option to wait is the option of deferring the business decision to the future.

Option to contract is the option to shut down a project at some point in the
future if conditions are unfavorable.

Option to switch is the option to shut down a project at some point in the future
if the conditions are unfavorable and resume it when the conditions are favorable.
 REAL OPTIONS
ADVANTAGES ANALYSIS DISADVANTAGES
• ROV is an excellent risk
• While ROV is an excellent technique to gauge
management technique. risk and support decision-making, its efficiency
• Decision-making becomes easier as a standalone method is questionable.
with ROV. • Making a decision is easy, but executing it
• It is more comprehensive and involves a lot of financial, structural, legal, and
works well in volatile and flexible technical challenges.
markets. • ROV isn’t specifically beneficial in stable and
rigid environments.
• ROV requires sufficient information and a
strong financial position to utilize opportunities.
• Overall, real options analysis is a powerful
valuation technique that can be used to value
a wide variety of investments. However, it is
important to be aware of the limitations of
ROA before using it.
ADVA N C E D
VAL U A T I O N
TECH N I Q U E S
ADVANCED VALUATION TECHNIQUES
Best practices for measuring the fair value of intangible assets
continue to evolve.

These methods may also be useful in measuring the fair value of

contingent assets, contingent liabilities, and contingent consideration
in a business combination. This chapter explains several advanced
methods for estimating fair value, particularly those methods that can
be used in measuring the fair value of certain identified intangible
assets.
REAL OPTIONS
VALUATION
 REAL OPTIONS VALUATION
INTRODUCTION TO REAL OPTIONS VALUATION:

Real options valuation, also often termed real options analysis, applies option
valuation techniques to capital budgeting decisions. A real option itself is the right, but
not the obligation, to undertake certain business initiatives, such as deferring,
abandoning, expanding, staging, or contracting a capital investment project.

Real options are generally distinguished from conventional financial options in that
they are not typically traded as securities and do not usually involve decisions on an
underlying asset that is traded as a financial security.

Real options analysis extends from its application in corporate finance to decision
making under uncertainty in general, adapting the techniques developed for
financial options to “real-life” decisions.
 REAL OPTIONS VALUATION
Real options are opportunities that a business may or may not take advantage of
or realize. Some examples of real options include:

Determining whether to build a new factory

Changing the machinery and technology on a production line
Deciding whether to buy potentially lucrative oil fields and when to start
drilling or pumping
Making an investment or undertaking a new project
Deferring a decision until a later point
Shutting down a project due to unfavorable conditions and then resuming
those operations when conditions become favorable again

Real options do not include derivative financial instruments such as stocks or bonds.
 REAL OPTIONS VALUATION
Incorporating Real Options in Valuation Models

Here are some of the most common methods used to value real options:
1. The Binomial Model: This is a simple model that can be used to value options
with two possible outcomes.
2. The Black-Scholes model: This is a more complex model that can be used to
value options with a continuous range of outcomes.
3. Monte Carlo Simulation: This is a technique that can be used to value options
by simulating the possible outcomes of the investment.
RELATIVE
VALUATION
 RELATIVE VALUATION

A relative valuation, also referred to as a comparable valuation,

is an approach for evaluating a company's financial value by
comparing it with its competitors or other companies within the
same industry.

This method helps gauge the worth of the firm in relation to its
peers. By comparing the valuation of an asset to similar ones in
the market, investors seek to recognize assets that might be
overvalued or undervalued concerning their fundamental
characteristics.
 RELATIVE VALUATION
Advantages of Relative Valuation

1. It's easy to understand and apply.

2. It's flexible and can be used with any type of business or industry.

3. It doesn't require a lot of information about the company or its industry.

4. It doesn't require much time from management and analysts.

 RELATIVE VALUATION
Disadvantages of Relative Valuation

1. It assumes that all companies are equal in terms of quality and growth
potential (which isn’t true).
2. The challenge with this method is that it requires market research and
analysis to determine which companies are truly comparable to yours.
3. The relative valuation method is only as good as the comparable you use. If
you use a bad comparable, your valuation will be inaccurate.
4. Startups that have yet to prove themselves may be overvalued than they
should be by this approach. It's easy for companies to manipulate their numbers
to make them look better than they are.
Weighted
Average Cost of
Capital
(WACC)
 Weighted Average Cost of Capital (WACC)

When conducting relative valuation, analysts

often use WACC to discount future cash flows
in order to determine the present value of a
company's projected earnings. By applying
WACC to these cash flows, investors can
compare different companies more accurately
A company that has a
since it accounts for their capital structure and
lower WACC is typically the cost of financing.
considered to be the MORE
VALUABLE company.
Weighted Average Cost of Capital (WACC)

The formula for calculating WACC is as follows:

WACC = (E/V * Re) + (D/V * Rd * (1 - Tc))

Where:
E is the market value of equity (market capitalization).
V is the total market value of the firm's equity and debt.
Re is the cost of equity (required rate of return by
investors).
D is the market value of debt.
Rd is the cost of debt (interest rate on debt).
Tc is the corporate tax rate
 Weighted Average Cost of Capital (WACC)
Company A:
Equity Value (E) = $1,000,000
Debt Value (D) = $500,000
Example: Total Value (V) = E + D =
$1,500,000
Let's consider two Cost of Equity (Re) = 10%
companies in the same Cost of Debt (Rd) = 5%
industry: Company A and Corporate Tax Rate (Tc) = 30%
Company B. Both
companies have similar Company B:
Equity Value (E) = $1,200,000
risk profiles and growth
Debt Value (D) = $300,000
prospects, but they have Total Value (V) = E + D =
different capital $1,500,000
structures. Cost of Equity (Re) = 8%
Cost of Debt (Rd) = 4%
Corporate Tax Rate (Tc) = 30%
Weighted Average Cost of Capital (WACC)

Solution:

Company A:
WACC = [(1,000,000/1,500,000 * 10%) +
(500,000/1,500,000 * 5% * (1 - 30%))]
WACC = 7.83%
Company B:
WACC = [(1,200,000/1,500,000 * 8%) +
(300,000/1,500,000 * 4% * (1 - 30%))]
WACC = 6.96%
 Weighted Average Cost of Capital (WACC)
Company X:
Company Y:
Operating Income = $7
Example: Operating Income = $12 million
million
Equity Value = $70 million
Equity Value = $50 million
Debt Value = $30 million
You are a financial Debt Value = $20 million
Cost of Equity = 10%
analyst evaluating two Cost of Equity = 12%
Cost of Debt = 4%
companies in the Cost of Debt = 5%
Corporate Tax Rate = 30%
technology industry, Corporate Tax Rate = 25%
Company X
and Company Y. Here are
the relevant financial
details for both
companies:
Using the provided information, calculate the WACC for each company.
 Weighted Average Cost of Capital (WACC)

a) 14.64% and 3.84%

b) 12% and 8%
c) 9.64% and 7.84%
d) 8.44% and 5.34%
 Weighted Average Cost of Capital (WACC)

C. 9.64% and 7.84%

Solution: Solution:

WACC Company Y =
WACC Company X =
(70/100) * 10% +
(50/70) * 12% + (20/70)
(30/100) * 4% * (1 -
* 5% * (1 - 25%)
30%)
≈ 9.64%
≈ 7.84%
 ECONOMIC
VALUE ADDED
(EVA)
 ECONOMIC VALUE ADDED (EVA)

Economic Value Added is a performance metric

that evaluates a company's ability to generate
value for its shareholders. It calculates the
amount of profit a company generates in excess
of its cost of capital. EVA is determined by
deducting the company's total capital cost from its
net operating profit after taxes (NOPAT).
 ECONOMIC VALUE ADDED (EVA)
The formula for calculating EVA is as follows:

Where:
NOPAT is the Net Operating Profit
After Taxes,
NOPAT – ( Capital x Capital is the total invested capital in
WACC) the company.
WACC is the weighted average cost
of capital.
 ECONOMIC VALUE ADDED (EVA)
You are a financial analyst evaluating two companies, Company A and Company B, in the
technology sector. Here are the relevant financial details for both companies:
Company A:
Operating Income = $20 million EXAMPLE:
Equity Value = $100 million
Debt Value = $40 million
Cost of Equity = 15%
Cost of Debt = 6%
Corporate Tax Rate = 25%
Company B:
Operating Income = $30 million
Equity Value = $120 million
Debt Value = $50 million
Cost of Equity = 12%
Cost of Debt = 5%
Corporate Tax Rate = 25%

Using the provided information, calculate the EVA for each company
 ECONOMIC VALUE ADDED (EVA)
Solution:

EVA = NOPAT - (Capital * WACC)

For Company A:
NOPAT = 20M * (1 - 0.25)
First, let's calculate the NOPAT NOPAT = 15M
for each company:
NOPAT = Operating Income *
(1 - Corporate Tax Rate) For Company B:
NOPAT = 30M * (1 - 0.25)
NOPAT = 22.5M
 ECONOMIC VALUE ADDED (EVA)
Next, we need to calculate the total capital for each company:

Total Capital (Capital) = Equity Value + Debt Value

For Company A:
Total Capital (Capital) = 100M + 40M = 140M
For Company B:
Total Capital (Capital) = 120M + 50M = 170M

Now, let's calculate the Weighted Average Cost of Capital (WACC) for each
company:
WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)
For Company A:
WACC = (100M/140M) * 15% + (40M/140M) * 6% * (1 - 25%) = 12%
For Company B:
WACC = (120M/170M) * 12% + (50M/170M) * 5% * (1 - 25%) = 9.57%
ECONOMIC VALUE ADDED (EVA)
Finally, calculate EVA for each company:

EVA = NOPAT - (Capital * WACC)

For Company A:
EVA = $15M - ($140M * 12%)
EVA = $15M - $16.8M
EVA = -$1.8M
For Company B:
EVA = $22.5M - ($170M * 9.57%)
EVA = $22.5M - $16.269M

EVA = $6.231M
 ECONOMIC VALUE ADDED (EVA)

Company X: Company Y:
Operating Income = $7 million Operating Income = $12 million
Equity Value = $50 million Equity Value = $70 million
Debt Value = $20 million Debt Value = $30 million
Cost of Equity = 12% Cost of Equity = 10%
Cost of Debt = 5% Cost of Debt = 4%
Corporate Tax Rate = 25% Corporate Tax Rate = 30%

Using the provided information, calculate the EVA for each company
 ECONOMIC VALUE ADDED (EVA)

a) 2.24M and (1M)

b) (530k) and (570k)
c) 2.55M and 1.30 M
d) (1.49M) and (560k)
 ECONOMIC VALUE ADDED (EVA)
EVA = NOPAT - (Capital * WACC)
For Company X:
NOPAT = $7 million * (1 - 0.25) For Company Y:
NOPAT = $7 million * 0.75 NOPAT = $12 million * (1 - 0.30)
NOPAT = $5.25 million NOPAT = $12 million * 0.70
Capital = $50 million + $20 million = $70 NOPAT = $8.4 million
million Capital = $70 million + $30 million =
WACC = (50/70) * 12% + (20/70) * 5% * (1 - $100M
25%) = 9.64%
WACC = (70/100) * 10% + (30/100) *
EVA = $5.25M - ($70M * 9.64%)
EVA = $5.25M - $6.748M 4% * (1 - 30%) = 7.84%
EVA = -$1.498M

SOLUTION
ECONOMIC VALUE ADDED (EVA)

EVA = $8.4M - ($100M * 7.84%)

EVA = 8.4M - $7.840M

EVA = $560K

SOLUTION
ADJUSTED
PRESENT
VALUE
 ADJUSTED PRESENT
APV VALUE
Embedded options are
rights, but not obligations,
that a company has to make
a decision in the future that
will affect the value of the
Adjusted present value (APV) is a company.
valuation method that combines
discounted cash flow (DCF) valuation
with the value of any embedded
options.
 ADJUSTED PRESENT
APV VALUE
To use APV in relative valuation,
1. Calculate the DCF value for each
company being compared.
2. Calculate the value of any embedded
options for each company.
3. Add the DCF value and the value of the
embedded options to get the APV for each
company.
 ADJUSTED PRESENT
APV VALUE
Let’s say you are comparing two companies, Company A and Company B. Company A has an expected
future cash flow of $100 million, a discount rate of 10%, and no embedded options. Company B has an
expected future cash flow of $100 million, a discount rate of 10%, and an embedded option that is worth
$10 million.

The DCF value of Company A is:

DCF = $100 million / (1 + 0.10)^1 = $90.91 million

The DCF value of Company B is:

DCF = $100 million / (1 + 0.10)^1 + $10 million = $100 million

The value of the embedded option for Company B is:

Value of embedded option = $100 million - $90.91 million = $9.09 million
 ADJUSTED PRESENT
APV VALUE
Let’s say you are comparing two companies, Company A and Company B. Company A has an expected
future cash flow of $100 million, a discount rate of 10%, and no embedded options. Company B has an
expected future cash flow of $100 million, a discount rate of 10%, and an embedded option that is worth
$10 million.

The APV for Company A is:

APV = $90.91 million + $0 million = $90.91 million

The APV for Company B is:

APV = $100 million + $9.09 million = $109.09 million

Because Company B has a higher APV than Company A, Company B is

typically considered to be the more valuable company.
 ADJUSTED PRESENT
APV VALUE
ADVANTAGES OF USING APV IN DISADVANTAGES OF USING APV IN
RELATIVE VALUATION: RELATIVE VALUATION:

It is a more comprehensive valuation It can be difficult to estimate the value of

method than DCF, as it takes into embedded options.
account the value of embedded options. APV can be sensitive to the discount
It can be used to adjust for differences in rate used.
the value of embedded options between APV is not a perfect measure of value
companies being compared. creation, and other factors, such as
It is a relatively simple concept to growth prospects, should also be
understand. considered.
MONTE CARLO
SIMULATION
MONTE CARLO Provides multiple possible outcomes
SIMULATION and the probability of each from a large
pool of random data samples.

Monte Carlo simulation is based on

??? repeatedly sampling random variables

from probability distributions and
simulating the model.
 MONTE CARLO SIMULATION
Monte Carlo simulation consists in the following series of steps:

• Determine the variables that represent a source of uncertainty

• Assume a distribution for each variable
• Generate some iterations with possible realizations of the random
variable
• Repeat these iterations a large number of times a joint distribution
 MONTE CARLO SIMULATION

RANDOM
SAMPLING
Is a type of probability sampling in
which the researcher randomly selects a
subset of participants from a population.
 MONTE CARLO SIMULATION
4 key steps to selecting a simple random sample

1. Define the population

2. Decide on the sample size
3. Randomly select the sample
4. Collect data from your sample
 MONTE CARLO SIMULATION
Application in valuation:

Option Pricing
Monte Carlo simulation is widely Project and Investment Valuation
used in option pricing models,
especially for options with complex Helps in valuing projects, estimating
payoffs or when dealing with net present value (NPV), internal rate
multiple underlying assets. of return (IRR), and assessing risk by
incorporating uncertainties related to
costs, discount rates, and other
factors.
 MONTE CARLO SIMULATION
Incorporating uncertainty and risk factors:

Market risk Economic Risk

Factors: Factors:

▪ Assets prices (stock prices, ▪ Inflation rates

currency exchange rates)
▪ Interest rates
 MONTE CARLO SIMULATION
Benefits of incorporating risk and uncertainty factors into Monte
Carlo simulation:

• More Realistic Results: By considering risk and uncertainty, Monte Carlo simulations
generate a range of possible outcomes rather than just a single deterministic
result. This reflects the complex and uncertain nature of real-world situations.

• Improved Decision Making: Decision-makers can better understand the potential

range of outcomes and associated probabilities. This enables more informed and
robust decision-making by considering not only the most likely outcome but also
the worst-case and best-case scenarios.
.
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