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    Firm Valuation

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    IA M.
    There are two main categories of valuation methods - absolute and relative. Absolute models value a company based only on its fundamentals such as cash flows and growth rates, while relative models compare ratios of the company to similar companies to determine if it is undervalued. Relative models are quicker to calculate but may not be as accurate. Firm value, also called enterprise value, represents the total value of a company as a going concern and can be calculated as the market value of equity, debt, and cash minus debt. It is a more comprehensive measure than market capitalization alone. Firm value can also be calculated by finding the present value of the company's future operating cash flows.

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    Firm Valuation

    Uploaded by

    IA M.
    37 views3 pages
    There are two main categories of valuation methods - absolute and relative. Absolute models value a company based only on its fundamentals such as cash flows and growth rates, while relative models compare ratios of the company to similar companies to determine if it is undervalued. Relative models are quicker to calculate but may not be as accurate. Firm value, also called enterprise value, represents the total value of a company as a going concern and can be calculated as the market value of equity, debt, and cash minus debt. It is a more comprehensive measure than market capitalization alone. Firm value can also be calculated by finding the present value of the company's future operating cash flows.

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    There are two main categories of valuation methods - absolute and relative. Absolute models value a company based only on its fundamentals such as cash flows and growth rates, while relative models compare ratios of the company to similar companies to determine if it is undervalued. Relative models are quicker to calculate but may not be as accurate. Firm value, also called enterprise value, represents the total value of a company as a going concern and can be calculated as the market value of equity, debt, and cash minus debt. It is a more comprehensive measure than market capitalization alone. Firm value can also be calculated by finding the present value of the company's future operating cash flows.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    37 views3 pages

    Firm Valuation

    Uploaded by

    IA M.
    There are two main categories of valuation methods - absolute and relative. Absolute models value a company based only on its fundamentals such as cash flows and growth rates, while relative models compare ratios of the company to similar companies to determine if it is undervalued. Relative models are quicker to calculate but may not be as accurate. Firm value, also called enterprise value, represents the total value of a company as a going concern and can be calculated as the market value of equity, debt, and cash minus debt. It is a more comprehensive measure than market capitalization alone. Firm value can also be calculated by finding the present value of the company's future operating cash flows.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 3

    The Two Main Categories of Valuation Methods

    Absolute valuation models attempt to find the intrinsic or "true" value of an


    investment based only on fundamentals. Looking at fundamentals simply means you
    would only focus on such things as dividends, cash flow, and the growth rate for a
    single company, and not worry about any other companies. Valuation models that fall
    into this category include the dividend discount model, discounted cash flow
    model, residual income model, and asset-based model.

    Relative valuation models, in contrast, operate by comparing the company in question


    to other similar companies. These methods involve calculating multiples and ratios,
    such as the price-to-earnings multiple, and comparing them to the multiples of similar
    companies.

    For example, if the P/E of a company is lower than the P/E multiple of a comparable
    company, the original company might be considered undervalued. Typically, the
    relative valuation model is a lot easier and quicker to calculate than the
    absolute valuation model, which is why many investors and analysts begin their
    analysis with this model.

    Source: https://www.investopedia.com/terms/v/valuation.asp

    FIRM VALUATION:

    A firm’s value, also known as Firm Value (FV), Enterprise Value (EV). It is an
    economic concept that reflects the value of a business. It is the value that a business is
    worthy of at a particular date. Theoretically, it is an amount that one needs to pay to
    buy/take over a business entity. Like an asset, the value of a firm can be determined
    on the basis of either book value or market value. But generally, it refers to the market
    value of a company. EV is a more comprehensive substitute for market capitalization
    and can be calculated by following more than one approach.

    Calculating a Firm’s Value

    The value of a firm is basically the sum of claims of its creditors and shareholders.
    Therefore, one of the simplest ways to measure the value of a firm is by adding the
    market value of its debt, equity, and minority interest. Cash and cash equivalents
    would be then deducted to arrive at the net value.

    EV = market value of common equity + market value of preferred equity + market


    value of debt + minority interest – cash and investments.

    One of the reasons why the concept of EV has gained more importance than market
    capitalization is because the former is more inclusive. Besides equity, it includes the
    value of debt as well as cash reserves which have an important role to play in a
    corporation’s valuation. A buyer would have to pay off a firm’s debt when taking
    over the firm. And the same could be net off from the cash and cash equivalents
    available with the firm.
    Another sound approach towards computing the value of a firm is to determine the
    present value of its future operating free cash flows. The idea is to draw a comparison
    between two similar firms. By similar firms, we mean similar in size, same industry,
    etc. The firm whose present value of future operating cash flows is better than the
    other is more likely to attract higher valuation from the investors. Operating Free
    Cash Flow (OFCF) is calculated by adjusting the tax rate, adding back depreciation
    and deducting the amount of capital expenditure, working capital and changes in other
    assets from earnings before interest and taxes. The formula for computing OFCF is as
    below –

    OFCF = EBIT (1-T) + Depreciation – CAPEX – working capital – any other assets

    Where,

    EBIT = earnings before interest and taxes,

    T = tax rate

    CAPEX = capital expenditure

    Calculating OFCF in such a way gives a more accurate picture of cash generating
    capabilities of a firm. Once OFCF is computed, one can use a suitable discount rate to
    find the present value of OFCF. On the basis of the sum of all the present value of
    future operating cash flows, one can decide on whether to take over a firm or not.
    Source: https://efinancemanagement.com/investment-decisions/value-of-a-firm

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