Investment Basics: Corporate Valuation

The capitalized earnings method determines the business value using a single measure of the expected business economic benefit as the numerator. This is divided by the capitalization rate that represents the risk associated with receiving this benefit in the future. This method is useful is the future incomes of the business are easy to predict.

This is the favored valuation method for this specific valuation since it is not dependent on external factors which in this case are unknown.

 

The discounted cash flow valuation is normally the favored way of valuing a business. There are many estimates and assumptions required in order to calculate or example the WACC (weighted average cost of capital) which introduces some uncertainty. However the value of the future benefits of a business is the most important when thinking of investment.

Additionally the discounted cash flow valuation method bases on the forecasted sales numbers and the planned cost of capital. Thus, if there are no additional reliable indicators whether the WACC could increase or decrease in future, the discounted cash flow valuation method is not much worthier than the capitalized earnings method because it relies on the same numbers. If there was additional information given on interest rate development, the author would recommend using the discounted cash flow valuation method.

 

The valuation based on market multiple is a multiplier which converts a single-point business economic benefit into the business value. If a profound business valuation of a target business has to be done, the following five steps need to be gone through:

  1. Identify comparable companies.
  2. Calculate key ratios for the comparable companies.
  3. Average the key ratios.
  4. Apply the average ratio to obtain indicative value.
  5. Make a valuation judgment.

The most difficult part is to find a comparable company.

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