Business Evaluation Models Paper Example

Introduction

It is often said that a business has a worth of what the owner is willing to pay for it, although there are other ways of reaching a sensible figure for the business. Investors, especially in a publicly-traded company have the privilege of knowing the value of their investment at any time they wish to. Due to technological advancement, investors may only need an internet connected computers and few clicks would give them the answers they need. Investors in privately-held companies do not enjoy the same pleasure, as their assets in those enterprises must be valued using a number of ways. Valuing a business does not only benefit the owners and entrepreneurs who may be interested in buying it, but it also serves other purposes. Valuing a business can help when securing an investment; when investors are interested in seeing a realistic figure and value in the deal given to them. Also, business valuation is useful when setting a fair price for employees, in case they want to buy or sell shares in the company. While there are a number of ways through which business valuation can be done, this study focuses on adjusted present value, its differences with net present value, as well as identifying two other valuation models that are popular.

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Adjusted Present Value

The adjusted present value (APV) is the net present value (NPV) of a company if it gets it gets its financing only from equity and any present value of financing benefits, which are additional debt effects. Tax shields are included in the APV by taking into account financing benefits, especially those provided by deductible interests (Cigola & Peccati, 2005). Calculating APV requires the first one calculates the NPV of the company without debt, and then it is adjusted to include the benefits of financing. While the formula that calculates the APV is the same as that of discounted cash flow, the AP cash flow does not capture taxes or any effects of financing. Ideally, the APV is not used as much as much as discounted cash flow; it is more of an academic calculation or method of valuation, although it considered to yield more accurate valuations (Cigola & Peccati, 2005). In calculating APV, there are three major steps that must be followed. The first step entails the estimation of the company's value without leverage, by the means of calculating NPV as the discount rate, at the expense of equity (Goncalves, Marujo, Cosenza, Doria & Lima, 2012). Secondly, the calculation of the tax benefit expected, from a certain level of financing debt. The effect of borrowing must be evaluated, as well as the expected cost of bankruptcy and the probability that the business will go bankrupt.

Difference between APV and NPV

While APV and NPV may be depended on each, there are a few differences between the two methods of valuing business. One of the differences that surface between these two methods of valuing business is that while APV utilizes equity when calculating the equation, NPV does not (Sabal, 2008). Although there are similarities between APV and NPV, a difference between the two is that APV uses the cost of equity as the discount rate as opposed to a weighted average cost of capital (WACC). Further, APV allows the inclusion of tax shields such as the one provided by deductible interests (Sabal, 2008). Therefore, although both of the methods are utilized to determine the value of the business in question, and that they both give a valuable and useful result to that effect, they use a different set of data to determine if the business is worth investing and if it would yield returns on investment.

Other Business Valuation Models

Comparable Company Analysis

A company comparable analysis (CCA) is a process that is used to value a company using the metrics of another company that is similar in size, and in the same market (How, Lam & Yeo, 2007). CCA operates under the assumption that similar companies will have the same valuation multiples, where the analysts make a list of available data on the companies being valued and calculate the multiple for comparison (How, Lam & Yeo, 2007). The information obtained can be used to calculate important ratios, and can also be used to determine a company's enterprise value.

Precedent Transaction Analysis

In precedent transaction analysis as a means of valuing a company, the analysts use the price paid for similar companies in the past, which acts as the main indicator of the company's worth (Hill, Kamma & Karam, 2008). An estimate of share of the stock is created by this method, in the event of the acquisition of the company. One of the most important tenets of this method of valuation is the identification of the most relevant transactions, and for the companies which have the same financial characteristics as the one being valued.

Conclusion

Valuing a company requires the analysts to have relevant and detailed information about the firm to be valued to avoid mistakes in valuation. The analysts may opt to use the APV or the NPV, but whichever of the two methods used they would arrive at the same results. Other than those two methods, comparable company analysis, as well as precedent transaction analysis, is other popular company valuation methods available.

References

Cigola, M., & Peccati, L. (2005). On the comparison between the APV and the NPV computed via the WACC. European Journal of Operational Research, 161(2), 377-385. doi: 10.1016/j.ejor.2003.08.049

Goncalves N., A., Marujo, L., Cosenza, C., Doria, F., & Lima, J. (2012). Using fuzzy NPV evaluation to justify the acquisition of business interruption insurance. Expert Systems with Applications, 39(12), 10821-10831. doi: 10.1016/j.eswa.2012.03.011

Hill, J., Kamma, S., & Karam, Y. (2008). Valuing complex stock options containing reloadfeatures. Journal of Business Valuation and Economic Loss Analysis, 3(1). doi: 10.2202/1932-9156.1051

How, J., Lam, J., & Yeo, J. (2007). The use of the comparable firm approach in valuing Australian IPOs. International Review of Financial Analysis, 16(2), 99-115. doi: 10.1016/j.irfa.2006.09.003

Sabal, J. (2008). WACC or APV?. Journal of Business Valuation And Economic Loss Analysis, 2(2). doi: 10.2202/1932-9156.1016