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Review questions

  • A present value approach
  • A relative valuation approach
  • An asset based approach
  • A contingent claim valuation approach (real options)

Attractive value attributes:

  • Precision (unbiased estimates)
  • Realistic assumptions

Attractive user attributes

  • User friendly
  • Understandable output

The dividend discount model

Because they are theoretical equivalent; i.e. they can all be derived from the dividend discount model

Multiples are a method which can be used to value firms. There are different ways that multiples can be applied. One way of carrying out a valuation is by using a multiple of a comparable firm on ‘the target’ firm’s earnings. For instance, if P/E of a comparable firm is 15 and net earnings of ‘the target’ firm are 100 the estimated market value of ‘target’ firm is calculated as 15 x 100 = 1,500.

Firms, which are compared, must have similar:

  • Profitability
  • Growth
  • Risk
  • Accounting policies

Furthermore, the multiples assume an efficient capital market

The asset based value represents the value of the alternative uses of the assets. In a healthy industry with attractive growth rates and attractive returns, a firm’s asset based value is typically less than its value as a going concern. In an industry with negative outlooks and poor returns, a firm’s asset based value may exceed its value as a going concern.

There are three types of asset based values:

  • Net Asset Value (NAV) uses the market or fair values of the assets and liabilities
  • ‘Sum-of-parts’ valuation is the sum of the value (using different techniques) of each segment or business unit in a firm
  • The liquidation value method is the net proceeds that a firm can obtain if it liquidates all its assets and settle all its liabilities in a forced sale situation