Company Valuation Methods

Valuing a company helps investors, business owners, and stakeholders understand the company's worth and make informed decisions regarding investments, mergers, and acquisitions.

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1. Discounted Cash Flow (DCF) Valuation 
Estimates the present value of a company's future cash flows, taking into account the time value of money. 

Formula: 
DCF = (CF1 / (1 + r)¹) + (CF2 / (1 + r)²) + ... + (CFn / (1 + r)ⁿ) 

Where: 
- CF = Cash Flow in each future period 
- r = Discount rate (cost of capital) 
- n = Number of periods 

Example: 
A cable factory is expected to generate $100,000 in cash flow for the next 3 years. The discount rate is 10%. 

DCF = (100,000 / (1 + 0.10)¹) + (100,000 / (1 + 0.10)²) + (100,000 / (1 + 0.10)³) 

→ DCF = $90,909 + $82,644 + $75,131 = $248,684 

Pros: 
- Values a company based on expected future cash flows. 
- Widely used and accepted by analysts. 

Cons: 
- Requires detailed financial forecasts and assumptions. 
- Sensitive to changes in discount rate and growth predictions. 

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2. Comparable Company Analysis (CCA) 
Compares a company's valuation metrics to those of similar publicly traded companies to determine its fair market value. 

Formula: 
Valuation Multiple = (Company's Metric) ÷ (Comparable Company's Metric) 

Example: 
- Market price per share = $50 
- Earnings per share = $5 
- P/E Ratio = $50 ÷ $5 = 10x 

Pros: 
- Uses market prices and ratios for valuation. 
- Easier and quicker than DCF. 

Cons: 
- Relying on market comparables may not account for unique company factors. 
- Valuation is highly dependent on the accuracy of comparable company data. 

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3. Precedent Transactions Analysis 
Examines the target company's financial metrics in relation to metrics from past comparable transactions. 

Formula: 
Valuation Multiple = (Transaction Price) ÷ (Company's Relevant Metric) 

Example: 
- A similar cable company was sold for $2M with EBITDA of $500K. 
- Transaction multiple = $2M ÷ $500K = 4x 

Pros: 
- Based on real data from actual transactions. 
- Reflects market demand and conditions. 

Cons: 
- Availability of relevant precedent transactions may be limited. 
- Dependent on market conditions at the time of past transactions. 

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4. Asset-Based Valuation 
Calculates a company's worth based on its tangible and intangible assets. 

Formula: 
Asset Value = Fair Market Value of Assets – Liabilities 

Example: 
- Factory machinery value = $1M 
- Raw materials inventory = $300K 
- Liabilities = $400K 

→ Asset Value = ($1M + $300K) – $400K = $900K 

Pros: 
- Focuses on tangible assets. 
- Relatively simple for asset-heavy companies. 

Cons: 
- May ignore intangible assets like brand and goodwill. 
- Not suitable for dynamic industries with limited fixed assets. 

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5. Earnings Multiples 
Uses multiples of earnings or EBITDA to value a company in relation to its profitability. 

Formula: 
P/E Ratio = (Market Price per Share) ÷ (Earnings per Share) 
EV/EBITDA Ratio = (Enterprise Value) ÷ (EBITDA) 

Example: 
- Market price per share = $50 
- Earnings per share = $5 
- P/E Ratio = 50 ÷ 5 = 10x 

Pros: 
- Reflects market sentiment and expectations. 
- Provides a quick comparison between companies. 

Cons: 
- Ratios can be affected by external market factors. 
- Values vary significantly between industries. 

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6. Liquidation Valuation 
Estimates a company's worth based on the assumption that its assets are sold and liabilities paid off. 

Formula: 
Liquidation Value = Fair Market Value of Assets – Total Liabilities 

Example: 
- Asset value = $2M 
- Total liabilities = $1.5M 

→ Liquidation Value = $2M – $1.5M = $500K 

Pros: 
- Provides a valuation floor based on the assumption of liquidation. 
- Useful for distressed company valuations. 

Cons: 
- Assumes the company is being forced into bankruptcy. 
- Market value of assets in liquidation may differ. 

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7. Weighted Average Cost of Capital (WACC) 
Represents the average rate of return a company is expected to pay to its investors to finance assets. 

Formula: 
WACC = (E/V) * Re + (D/V) * Rd * (1 – Tc) 

Where: 
- E = Market value of equity 
- V = Total value of debt and equity 
- Re = Cost of equity 
- D = Market value of debt 
- Rd = Cost of debt 
- Tc = Corporate tax rate 

Example: 
- E = $5M, D = $2M, Re = 10%, Rd = 5%, Tc = 20% 

WACC = (5/7) * 0.10 + (2/7) * 0.05 * (1 – 0.20) 

→ WACC = 0.0714 + 0.0114 = 0.0828 or 8.28% 

Pros: 
- Reflects the real cost of capital for a company. 
- Commonly used for DCF analysis. 

Cons: 
- Requires detailed financial data and market inputs. 
- Sensitive to changes in debt and equity composition. 

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✅ Summary Example (Cable Factory): 

Method	Example
DCF	Estimated future cash flow = $248,684
CCA	P/E ratio of similar company = 10x
Asset-Based	Asset value after liabilities = $900K
Earnings Multiple	P/E ratio = 10x
Liquidation	Liquidation value = $500K
WACC	Cost of capital = 8.28%

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