CIIF

Working Paper WP no 449 January, 2002 Rev. February, 2007

COMPANY VA UA!ION ME!"O#S$ !"E MOS! COMMON E%%O%S IN VA UA!IONS

Pablo Fernnde

IESE Business School & University of Navarra !vda. Pear"on, 2# $ 0%0&4 'ar(elona, )pain. *el.+ ,-&4. 9& 2/& 42 00 Fa0+ ,-&4. 9& 2/& 4& 4& Ca1ino del Cerro del 2guila, & ,C3ra. de Ca"3illa, k1 /,#%0. $ 2%02& 4adrid, )pain. *el.+ ,-&4. 9# &/7 0% 09 Fa0+ ,-&4. 9# &/7 29 #& Copyrig53 6 2004 I7)7 'u"ine"" )(5ool.
IESE Business School-University of Navarra - 1

*5e CIIF, In3erna3ional Cen3er 8or Finan(ial Re"ear(5, i" an in3erdi"(iplinary (en3er 9i35 an in3erna3ional ou3look and a 8o(u" on 3ea(5ing and re"ear(5 in 8inan(e. I3 9a" (rea3ed a3 35e beginning o8 #992 3o (5annel 35e 8inan(ial re"ear(5 in3ere"3" o8 a 1ul3idi"(iplinary group o8 pro8e""or" a3 I7)7 'u"ine"" )(5ool and 5a" e"3abli"5ed i3"el8 a" a nu(leu" o8 "3udy 9i35in 35e )(5ool:" a(3ivi3ie". *en year" on, our (5ie8 ob;e(3ive" re1ain 35e "a1e+ < Find an"9er" 3o 35e =ue"3ion" 35a3 (on8ron3 35e o9ner" and 1anager" o8 8inan(e (o1panie" and 35e 8inan(ial dire(3or" o8 all kind" o8 (o1panie" in 35e per8or1an(e o8 35eir du3ie". >evelop ne9 3ool" 8or 8inan(ial 1anage1en3. )3udy in dep35 35e (5ange" 35a3 o((ur in 35e 1arke3 and 35eir e88e(3" on 35e 8inan(ial di1en"ion o8 bu"ine"" a(3ivi3y.

< <

!ll o8 35e"e a(3ivi3ie" are progra11ed and (arried ou3 9i35 35e "uppor3 o8 our "pon"oring (o1panie". !par3 8ro1 providing vi3al 8inan(ial a""i"3an(e, our "pon"or" al"o 5elp 3o de8ine 35e Cen3er:" re"ear(5 pro;e(3", en"uring 35eir pra(3i(al relevan(e. *5e (o1panie" in =ue"3ion, 3o 95i(5 9e rei3era3e our 35ank", are+ !ena, !.*. ?earney, Ca;a 4adrid, Funda(i@n Ra1@n !re(e", Arupo 7nde"a, Royal 'ank o8 )(o3land and Bni@n Feno"a. 533p+CC999.ie"e.eduC(ii8C

IESE Business School-University of Navarra

COMPANY VA UA!ION ME!"O#S$ !"E MOS! COMMON E%%O%S IN VA UA!IONS

Pablo Fernnde D

A'strac t
In 35i" paper, 9e de"(ribe 35e 8our 1ain group" (o1pri"ing 35e 1o"3 9idely u"ed (o1pany valua3ion 1e35od"+ balan(e "5ee3Eba"ed 1e35od", in(o1e "3a3e1en3Eba"ed 1e35od", 1i0ed 1e35od", and (a"5 8lo9 di"(oun3ingEba"ed 1e35od". *5e 1e35od" 35a3 are (on(ep3ually F(orre(3G are 35o"e ba"ed on (a"5 8lo9 di"(oun3ing. We 9ill brie8ly (o11en3 on o35er 1e35od" "in(e E even 35oug5 35ey are (on(ep3ually Fin(orre(3G E 35ey (on3inue 3o be u"ed 8re=uen3ly. We al"o pre"en3 a realEli8e e0a1ple 3o illu"3ra3e 35e valua3ion o8 a (o1pany a" 35e "u1 o8 35e value o8 di88eren3 bu"ine""e", 95i(5 i" u"ually (alled 35e break-up value. We (on(lude 35e paper 9i35 35e 1o"3 (o11on error" in valua3ion"+ a li"3 35a3 (on3ain" 35e 1o"3 (o11on error" 35a3 35e au35or 5a" de3e(3ed in 1ore 35an one 35ou"and valua3ion" 5e 5a" 5ad a((e"" 3o in 5i" (apa(i3y a" bu"ine"" (on"ul3an3 or 3ea(5er.

D Pro8e""or Finan(ial 4anage1en3, Pri(e9a3er5ou"eCooper" C5air o8 Finan(e, I7)7

J7H Cla""i8i(a3ion+ A#2, A&#, 42#

(ey)or*s+ Ialue, Pri(e, Free (a"5 8lo9, 7=ui3y (a"5 8lo9, Capi3al (a"5 8lo9, 'ook value, 4arke3 value, P7R, Aood9ill, Re=uired re3urn 3o e=ui3y, Working (api3al re=uire1en3".

IESE Business School-University of Navarra

COMPANY VA UA!ION ME!"O#S$ !"E MOS! COMMON E%%O%S IN VA UA!IONS

For anyone involved in 35e 8ield o8 (orpora3e 8inan(e, under"3anding 35e 1e(5ani"1" o8 (o1pany valua3ion i" an indi"pen"able re=ui"i3e. *5i" i" no3 only be(au"e o8 35e i1por3an(e o8 valua3ion in a(=ui"i3ion" and 1erger" bu3 al"o be(au"e 35e pro(e"" o8 valuing 35e (o1pany and i3" bu"ine"" uni3" 5elp" iden3i8y "our(e" o8 e(ono1i( value (rea3ion and de"3ru(3ion 9i35in 35e (o1pany. *5e 1e35od" 8or valuing (o1panie" (an be (la""i8ied in "i0 group"+

BALANCE INCOME SHEET STATEMENT Book value Multiples Adjusted book PER value Sales Liquidation P/EBITDA value Othe Substantial !ultiples value

MAIN VALUATION METHODS MIXED CASH FLOW (GOODWILL) DISCOUNTING Equity ca ! "lassi# "#$% $nion o% Di&i'()' Eu opean A##ountin& F*(( ca ! "#$% E'pe ts Ca+ita# ca ! Abb eviated "#$% in#o!e APV Othe s

VALUE CREATION E(A E#ono!i# p o%it "ash value added ")ROI

OPTIONS Bla#k and S#holes Invest!ent option E'pand the p oje#t Dela* the invest!ent Alte native uses

In 35i" paper, 9e 9ill brie8ly de"(ribe 35e 8our 1ain group" (o1pri"ing 35e 1o"3 9idely u"ed (o1pany valua3ion 1e35od". 7a(5 o8 35e"e group" i" di"(u""ed in a "epara3e "e(3ion+ balan(e "5ee3Eba"ed 1e35od" ,)e(3ion 2., in(o1e "3a3e1en3Eba"ed 1e35od" ,)e(3ion &., 1i0ed 1e35od" # ,)e(3ion 4., and (a"5 8lo9 di"(oun3ingEba"ed 1e35od" ,)e(3ion /.. )e(3ion 7 u"e" a realEli8e e0a1ple 3o illu"3ra3e 35e valua3ion o8 a (o1pany a" 35e "u1 o8 35e value o8 di88eren3 bu"ine""e", 95i(5 i" u"ually (alled 35e break-up value. )e(3ion % "5o9" 35e 1e35od" 1o"3 9idely u"ed by analy"3" 8or di88eren3 3ype" o8 indu"3ry.

!no35er ver"ion o8 35i" paper 1ay be 8ound in (5ap3er 2 o8 35e au35orJ" book FIalua3ion 4e35od" and )5are5older Ialue Crea3ion,G !(ade1i( Pre"", )an >iego, C!, 2002.
+

*5e reader in3ere"3ed in 1e35od" ba"ed on value (rea3ion 1ea"ure" (an "ee Fernnde ,2002, (5ap3er" #, #& and #4.. *5e reader in3ere"3ed in valua3ion u"ing op3ion" 35eory (an "ee Fernnde ,200#(..
IESE Business School-University of Navarra

*5e 1e35od" 35a3 are be(o1ing in(rea"ingly popular ,and are (on(ep3ually F(orre(3G. are 35o"e ba"ed on (a"5 8lo9 di"(oun3ing. *5e"e 1e35od" vie9 35e (o1pany a" a (a"5 8lo9 genera3or and, 35ere8ore, a""e""able a" a 8inan(ial a""e3. We 9ill brie8ly (o11en3 on o35er 1e35od" "in(e E even 35oug5 35ey are (on(ep3ually Fin(orre(3G E 35ey (on3inue 3o be u"ed 8re=uen3ly. )e(3ion #2 (on3ain" 35e 1o"3 (o11on error" in valua3ion"+ a li"3 35a3 (on3ain" 35e 1o"3 (o11on error" 35a3 35e au35or 5a" de3e(3ed in 1ore 35an one 35ou"and valua3ion" 5e 5a" 5ad a((e"" 3o in 5i" (apa(i3y a" bu"ine"" (on"ul3an3 or 3ea(5er.

1$ Value an* Price$ ,hat Pur-ose #oes a Valuation Serve.

Aenerally "peaking, a (o1pany:" value i" di88eren3 8or di88eren3 buyer" and i3 1ay al"o be di88eren3 8or 35e buyer and 35e "eller. Ialue "5ould no3 be (on8u"ed 9i35 pri(e, 95i(5 i" 35e =uan3i3y agreed be39een 35e "eller and 35e buyer in 35e "ale o8 a (o1pany. *5i" di88eren(e in a "pe(i8i( (o1pany:" value 1ay be due 3o a 1ul3i3ude o8 rea"on". For e0a1ple, a large and 3e(5nologi(ally 5ig5ly advan(ed 8oreign (o1pany 9i"5e" 3o buy a 9ellEkno9n na3ional (o1pany in order 3o gain en3ry in3o 35e lo(al 1arke3, u"ing 35e repu3a3ion o8 35e lo(al brand. In 35i" (a"e, 35e 8oreign buyer 9ill only value 35e brand bu3 no3 35e plan3, 1a(5inery, e3(. a" i3 5a" 1ore advan(ed a""e3" o8 i3" o9n. Ko9ever, 35e "eller 9ill give a very 5ig5 value 3o i3" 1a3erial re"our(e", a" 35ey are able 3o (on3inue produ(ing. Fro1 35e buyer:" vie9poin3, 35e ba"i( ai1 i" 3o de3er1ine 35e 1a0i1u1 value i3 "5ould be prepared 3o pay 8or 95a3 35e (o1pany i3 9i"5e" 3o buy i" able 3o (on3ribu3e. Fro1 35e "eller:" vie9poin3, 35e ai1 i" 3o a"(er3ain 95a3 "5ould be 35e 1ini1u1 value a3 95i(5 i3 "5ould a((ep3 35e opera3ion. *5e"e are 35e 39o 8igure" 35a3 8a(e ea(5 o35er a(ro"" 35e 3able in a nego3ia3ion un3il a pri(e i" 8inally agreed on, 95i(5 i" u"ually "o1e95ere be39een 35e 39o 2 e03re1e". ! (o1pany 1ay al"o 5ave di88eren3 value" 8or di88eren3 buyer" due 3o e(ono1ie" o8 "(ale, e(ono1ie" o8 "(ope, or di88eren3 per(ep3ion" abou3 35e indu"3ry and 35e (o1pany. ! valua3ion 1ay be u"ed 8or a 9ide range o8 purpo"e"+ #. In (o1pany buying and "elling opera3ion"+ For 35e buyer, 35e valua3ion 9ill 3ell 5i1 35e 5ig5e"3 pri(e 5e "5ould pay. For 35e "eller, 35e valua3ion 9ill 3ell 5i1 35e lo9e"3 pri(e a3 95i(5 5e "5ould be prepared 3o "ell.

2. Ialua3ion" o8 li"3ed (o1panie"+ *5e valua3ion i" u"ed 3o (o1pare 35e value ob3ained 9i35 35e "5are:" pri(e on 35e "3o(k 1arke3 and 3o de(ide 95e35er 3o "ell, buy or 5old 35e "5are". *5e valua3ion o8 "everal (o1panie" i" u"ed 3o de(ide 35e "e(uri3ie" 35a3 35e por38olio "5ould (on(en3ra3e on+ 35o"e 35a3 "ee1 3o i3 3o be undervalued by 35e 1arke3.

*5ere i" al"o 35e 1iddle po"i3ion 35a3 (on"ider" bo35 35e buyer:" and "eller:" vie9poin3" and i" repre"en3ed by 35e 8igure o8 35e neu3ral arbi3ra3or. !rbi3ra3ion i" o83en ne(e""ary in li3iga3ion, 8or e0a1ple, 95en dividing e"3a3e" be39een 5eir" or de(iding divor(e "e33le1en3".

/ - IESE Business School-University of Navarra

*5e valua3ion o8 "everal (o1panie" i" al"o u"ed 3o 1ake (o1pari"on" be39een (o1panie". For e0a1ple, i8 an inve"3or 35ink" 35a3 35e 8u3ure (our"e o8 A7:" "5are pri(e 9ill be be33er 35an 35a3 o8 !1a on, 5e 1ay buy A7 "5are" and "5or3E"ell !1a on "5are". Wi35 35i" po"i3ion, 5e 9ill gain provided 35a3 A7:" "5are pri(e doe" be33er ,ri"e" 1ore or 8all" le"". 35an 35a3 o8 !1a on.

&. Publi( o88ering"+ *5e valua3ion i" u"ed 3o ;u"3i8y 35e pri(e a3 95i(5 35e "5are" are o88ered 3o 35e publi(.

4. In5eri3an(e" and 9ill"+ *5e valua3ion i" u"ed 3o (o1pare 35e "5are": value 9i35 35a3 o8 35e o35er a""e3".

/. Co1pen"a3ion "(5e1e" ba"ed on value (rea3ion+ *5e valua3ion o8 a (o1pany or bu"ine"" uni3 i" 8unda1en3al 8or =uan3i8ying 35e value (rea3ion a33ribu3able 3o 35e e0e(u3ive" being a""e""ed.

L. Iden3i8i(a3ion o8 value driver"+ *5e valua3ion o8 a (o1pany or bu"ine"" uni3 i" 8unda1en3al 8or iden3i8ying and "3ra3i8ying 35e 1ain value driver".

7. )3ra3egi( de(i"ion" on 35e (o1pany:" (on3inued e0i"3en(e+ *5e valua3ion o8 a (o1pany or bu"ine"" uni3 i" a prior "3ep in 35e de(i"ion 3o (on3inue in 35e bu"ine"", "ell, 1erge, 1ilk, gro9 or buy o35er (o1panie".

%. )3ra3egi( planning+ *5e valua3ion o8 35e (o1pany and 35e di88eren3 bu"ine"" uni3" i" 8unda1en3al 8or de(iding 95a3 produ(3"Cbu"ine"" line"C(oun3rie"C(u"3o1er"M 3o 1ain3ain, gro9 or abandon. *5e valua3ion provide" a 1ean" 8or 1ea"uring 35e i1pa(3 o8 35e (o1pany:" po""ible poli(ie" and "3ra3egie" on value (rea3ion and de"3ru(3ion.

/$ Balance E2uity3

Sheet-Base*

Metho*s

0Sharehol*ers1

*5e"e 1e35od" "eek 3o de3er1ine 35e (o1pany:" value by e"3i1a3ing 35e value o8 i3" a""e3". *5e"e are 3radi3ionally u"ed 1e35od" 35a3 (on"ider 35a3 a (o1pany:" value lie" ba"i(ally in i3" balan(e "5ee3. *5ey de3er1ine 35e value 8ro1 a "3a3i( vie9poin3, 95i(5, 35ere8ore, doe" no3 3ake in3o a((oun3 35e (o1pany:" po""ible 8u3ure evolu3ion or 1oney:" 3e1porary value. Nei35er do 35ey 3ake in3o a((oun3 o35er 8a(3or" 35a3 al"o a88e(3 35e value "u(5 a"+ 35e indu"3ry:" (urren3 "i3ua3ion, 5u1an re"our(e" or organi a3ional proble1", (on3ra(3", e3(. 35a3 do no3 appear in 35e a((oun3ing "3a3e1en3". )o1e o8 35e"e 1e35od" are 35e 8ollo9ing+ book value, ad;u"3ed book value, li=uida3ion value, and "ub"3an3ial value.

IESE Business School-University of Navarra - 4

/$1$ Value

Boo5

! (o1pany:" book value, or ne3 9or35, i" 35e value o8 35e "5are5older": e=ui3y "3a3ed in 35e balan(e "5ee3 ,(api3al and re"erve".. *5i" =uan3i3y i" al"o 35e di88eren(e be39een 3o3al a""e3" and liabili3ie", 35a3 i", 35e "urplu" o8 35e (o1pany:" 3o3al good" and rig53" over i3" 3o3al deb3" 9i35 35ird par3ie". He3 u" 3ake 35e (a"e o8 a 5ypo35e3i(al (o1pany 95o"e balan(e "5ee3 i" 35a3 "5o9n in *able #. *5e "5are": book value ,(api3al plu" re"erve". i" %0 1illion dollar". I3 (an al"o be (al(ula3ed a" 35e di88eren(e be39een 3o3al a""e3" ,#L0. and liabili3ie" ,40 - #0 - &0., 35a3 i", %0 1illion dollar".

!a'le 1
!l8a In(. O88i(ial 'alan(e )5ee3 ,4illion >ollar".
ASSETS "ash A##ounts e#eivable Invento ies )i'ed assets Total assets , +. -, +.. +3. LIABILITIES A##ounts pa*able Bank debt Lon&/te ! debt Sha eholde s1 equit* Total liabilities -. +. 0. 2. +3.

*5i" value "u88er" 8ro1 35e "5or3(o1ing o8 i3" o9n de8ini3ion (ri3erion+ a((oun3ing (ri3eria are "ub;e(3 3o a (er3ain degree o8 "ub;e(3ivi3y and di88er 8ro1 F1arke3G (ri3eria, 9i35 35e re"ul3 35a3 35e book value al1o"3 never 1a3(5e" 35e F1arke3G value.

/$/$ A*6uste* Boo5 Value

*5i" 1e35od "eek" 3o over(o1e 35e "5or3(o1ing" 35a3 appear 95en purely a((oun3ing (ri3eria are applied in 35e valua3ion. W5en 35e value" o8 a""e3" and liabili3ie" 1a3(5 35eir 1arke3 value, 35e ad;u"3ed ne3 9or35 i" ob3ained. Con3inuing 9i35 35e e0a1ple o8 *able #, 9e 9ill analy e a nu1ber o8 balan(e "5ee3 i3e1" individually in order 3o ad;u"3 35e1 3o 35eir appro0i1a3e 1arke3 value. For e0a1ple, i8 9e (on"ider 35a3+ - !((oun3" re(eivable in(lude" 2 1illion dollar" o8 bad deb3, 35i" i3e1 "5ould 5ave a value o8 % 1illion dollar". - )3o(k, a83er di"(oun3ing ob"ole3e, 9or35le"" i3e1" and revaluing 35e re1aining i3e1" a3 35eir 1arke3 value, 5a" a value o8 /2 1illion dollar". - Fi0ed a""e3" ,land, building", and 1a(5inery. 5ave a value o8 #/0 1illion dollar", a((ording 3o an e0per3. - *5e book value o8 a((oun3" payable, bank deb3 and longE3er1 deb3 i" e=ual 3o 35eir 1arke3 value. *5e ad;u"3ed balan(e "5ee3 9ould be 35a3 "5o9n in *able 2.

7 - IESE Business School-University of Navarra

!a'le /
!l8a In(. !d;u"3ed 'alan(e )5ee3 ,4illion >ollar".
ASSETS "ash A##ounts e#eivable Invento ies )i'ed assets Total assets , 2 ,4 +,. 4+, LIABILITIES A##ounts pa*able Bank debt Lon&/te ! debt "apital and ese ves Total liabilities -. +. 0. +0, 4+,

*5e ad;u"3ed book value i" #&/ 1illion dollar"+ 3o3al a""e3" ,2#/. le"" liabili3ie" ,%0.. In 35i" (a"e, 35e ad;u"3ed book value e0(eed" 35e book value by // 1illion dollar".

/$4$ i2ui*ation Value

*5i" i" 35e (o1pany:" value i8 i3 i" li=uida3ed, 35a3 i", i3" a""e3" are "old and i3" deb3" are paid o88. *5i" value i" (al(ula3ed by dedu(3ing 35e bu"ine"":" li=uida3ion e0pen"e" ,redundan(y pay1en3" 3o e1ployee", 3a0 e0pen"e" and o35er 3ypi(al li=uida3ion e0pen"e". 8ro1 35e ad;u"3ed ne3 9or35. *aking 35e e0a1ple given in *able 2, i8 35e redundan(y pay1en3" and o35er e0pen"e" a""o(ia3ed 9i35 35e li=uida3ion o8 35e (o1pany !l8a In(. 9ere 3o a1oun3 3o L0 1illion dollar", 35e "5are": li=uida3ion value 9ould be 7/ 1illion dollar" ,#&/EL0.. Obviou"ly, 35i" 1e35od:" u"e8ulne"" i" li1i3ed 3o a 5ig5ly "pe(i8i( "i3ua3ion, na1ely, 95en 35e (o1pany i" boug53 9i35 35e purpo"e o8 li=uida3ing i3 a3 a la3er da3e. Ko9ever, i3 al9ay" repre"en3" 35e (o1pany:" 1ini1u1 value a" a (o1pany:" value, a""u1ing i3 (on3inue" 3o opera3e, i" grea3er 35an i3" li=uida3ion value.

/$7$ Value

Su'stantial

*5e "ub"3an3ial value repre"en3" 35e inve"31en3 35a3 1u"3 be 1ade 3o 8or1 a (o1pany 5aving iden3i(al (ondi3ion" a" 35o"e o8 35e (o1pany being valued. I3 (an al"o be de8ined a" 35e a""e3": repla(e1en3 value, a""u1ing 35e (o1pany (on3inue" 3o opera3e, a" oppo"ed 3o 35eir li=uida3ion value. Nor1ally, 35e "ub"3an3ial value doe" no3 in(lude 35o"e a""e3" 35a3 are no3 u"ed 8or 35e (o1pany:" opera3ion" ,unu"ed land, 5olding" in o35er (o1panie", e3(... *5ree 3ype" o8 "ub"3an3ial value are u"ually de8ined+ - Aro"" "ub"3an3ial value+ 35i" i" 35e a""e3": value a3 1arke3 pri(e ,in 35e e0a1ple o8 *able 2+ 2#/.. - Ne3 "ub"3an3ial value or (orre(3ed ne3 a""e3"+ 35i" i" 35e gro"" "ub"3an3ial value le"" liabili3ie". I3 i" al"o kno9n a" ad;u"3ed ne3 9or35, 95i(5 9e 5ave already "een in 35e previou" "e(3ion ,in 35e e0a1ple o8 *able 2+ #&/..

IESE Business School-University of Navarra - 8

- Redu(ed gro"" "ub"3an3ial value+ 35i" i" 35e gro"" "ub"3an3ial value redu(ed only by 35e value o8 35e (o"3E8ree deb3 ,in 35e e0a1ple o8 *able 2+ #7/ P 2#/ E 40.. *5e re1aining 40 1illion dollar" (orre"pond 3o a((oun3" payable.

/$8$ Boo5 Value an* Mar5et Value

In general, 35e e=ui3y:" book value 5a" li33le bearing 3o i3" 1arke3 value. *5i" (an be "een in *able &, 95i(5 "5o9" 35e pri(eCbook value ,PC'I. ra3io o8 "everal in3erna3ional "3o(k 1arke3" in )ep3e1ber #992, !ugu"3 2000 and February 2007.

!a'le 4
4arke3 IalueC'ook Ialue ,PC'I., P7R and >ividend Qield ,>iv.CP. o8 >i88eren3 Na3ional )3o(k 4arke3"
S(+t(42(* 566P/BV PER Di&0/P (1) .527 65, 350 +50, ,65+ 054 +5-. +-5. 056 +5,6 +057 -5+ +537 +-5+ 057 +5+0 +.5. 054 .562 +354 -5+ +524 0354 +5. +5,4 +,5. 454 +522 +350 ,54 4543 4050 05+ Au,u t -... P/BV PER 0502 4456 0547 0+56 -53. 0657 05,6 425. +573 2545,, +,54 0524052 4544 2653 -5-. 445+ 457. 4-5,547 475Di&0/P (1) +5, .57 +56 45. 450 45+ 45. .53 +545+ +5+ F(2*ua*y -..3 P/BV PER 052 4.5. 054 +,52 453 +3545+-5. 45, +,54 454 +6545+657 450 4254 050 +65, 05. +-5054 +25. Di&0/P (1) 457 454 45, +57 45+53 054 +5+ +5, 457 +56

Spain "anada ) an#e 8e !an* 9on& :on& I eland Ital* ;apan S<it=e land $: $S

PC'I i" 35e "5are:" pri(e ,P. divided by i3" book value ,'I.. P7R i" 35e "5are:" pri(e divided by 35e earning" per "5are. >ivCP i" 35e dividend per "5are divided by 35e pri(e. )our(e+ 4organ >a3a"3rea1. )3anley Capi3al In3erna3ional Per"pe(3ive and

Figure # "5o9" 35e evolu3ion o8 35e pri(eCbook value ra3io o8 35e 'ri3i"5, Aer1an and Bni3ed )3a3e" "3o(k 1arke3". I3 (an be "een 35a3 35e book value, in 35e 90:", 5a" lagged (on"iderably belo9 35e "5are": 1arke3 pri(e.

9i:ure 1
7volu3ion o8 35e Pri(eC'ook Ialue Ra3io on 35e 'ri3i"5, Aer1an and Bni3ed )3a3e" )3o(k 41arke3"
L / 4 & 2 # 0
1;<8 1;<< 1;<= 1;>1 1;>4 1;>8 1;>< 1;>= 1;=1 1;=4 1;=8 1;=< 1;== 1;?1 1;?4 1;?8 1;?<

Price ; Boo5 value

Aer1any B? B)

)our(e+ 4organ )3anley and >a3a"3rea1.

@ - IESE Business School-University of Navarra

4$ IncoAe Metho*s

StateAent-Base*

Bnlike 35e balan(e "5ee3Eba"ed 1e35od", 35e"e 1e35od" are ba"ed on 35e (o1pany:" in(o1e "3a3e1en3. *5ey "eek 3o de3er1ine 35e (o1pany:" value 35roug5 35e "i e o8 i3" earning", "ale" or o35er indi(a3or". *5u", 8or e0a1ple, i3 i" a (o11on pra(3i(e 3o per8or1 =ui(k valua3ion" o8 (e1en3 (o1panie" by 1ul3iplying 35eir annual produ(3ion (apa(i3y ,or "ale". in 1e3ri( 3on" by a ra3io ,1ul3iple.. I3 i" al"o (o11on 3o value (ar parking lo3" by 1ul3iplying 35e nu1ber o8 parking "pa(e" by a 1ul3iple and 3o value in"uran(e (o1panie" by 1ul3iplying annual pre1iu1" by a 1ul3iple. *5i" (a3egory in(lude" 35e 1e35od" ba"ed on 35e P7R+ a((ording 3o 35i" 1e35od, 35e "5are": pri(e i" a 1ul3iple o8 35e earning". *5e in(o1e "3a3e1en3 8or 35e (o1pany !l8a In(. i" "5o9n in *able 4+

!a'le 7
!l8a In(. In(o1e )3a3e1en3 ,4illion >ollar".
Sales "ost o% sales 8ene al e'penses Inte est e'pense Ea nin&s be%o e ta' Ta' >0,?@ Aet in#o!e 0.. +03 +4. -. +43

4$1$ Value of Earnin:s$ PE%4

!((ording 3o 35i" 1e35od, 35e e=ui3y:" value i" ob3ained by 1ul3iplying 35e annual ne3 in(o1e by a ra3io (alled P7R ,price earnings ratio., 35a3 i"+ 7=ui3y value P P7R 0 earning" *able & "5o9" 35e 1ean P7R o8 a nu1ber o8 di88eren3 na3ional "3o(k 1arke3" in )ep3e1ber #992 and !ugu"3 2000. Figure 2 "5o9" 35e evolu3ion o8 35e P7R 8or 35e Aer1an, 7ngli"5 and Bni3ed )3a3e" "3o(k 1arke3".

&

*5e P7R ,pri(e earning" ra3io. o8 a "5are indi(a3e" 35e 1ul3iple o8 35e earning" per "5are 35a3 i" paid on 35e "3o(k 1arke3. *5u", i8 35e earning" per "5are in 35e la"3 year 5a" been R& and 35e "5are:" pri(e i" R2L, i3" P7R 9ill be %.LL ,2LC&.. On o35er o((a"ion", 35e P7R 3ake" a" i3" re8eren(e 35e 8ore(a"3 earning" per "5are 8or 35e ne03 year, or 35e 1ean earning" per "5are 8or 35e la"3 8e9 year". *5e P7R i" 35e ben(51ark u"ed predo1inan3ly by 35e "3o(k 1arke3". No3e 35a3 35e P7R i" a para1e3er 35a3 rela3e" a 1arke3 i3e1 ,"5are pri(e. 9i35 a purely a((oun3ing i3e1 ,earning"..

IESE Business School-University of Navarra - <

9i:ure /
7volu3ion o8 35e P7R o8 35e Aer1an, 7ngli"5 and Bni3ed )3a3e" )3o(k 4arke3"
0, 0. 4, 4. +, +. , . +/6+ +/60 +/6, +/66 +/67 +/2+ +/20 +/2, +/26 +/27 +/7+ +/70 +/7, +/76 +/77 +/.+ +/.0 +/., +/.6
)our(e+ 4organ )3anley and >a3a"3rea1.

PER

8e !an*

$:

$S

)o1e3i1e", 35e relative PE% i" al"o u"ed, 95i(5 i" "i1ply 35e (o1pany:" P7R divided by 35e (oun3ry:" P7R.

4$/$ Value of the #ivi*en*s

>ividend" are 35e par3 o8 35e earning" e88e(3ively paid ou3 3o 35e "5are5older and, in 1o"3 (a"e", 4 are 35e only regular 8lo9 re(eived by "5are5older". !((ording 3o 35i" 1e35od, a "5are:" value i" 35e ne3 pre"en3 value o8 35e dividend" 35a3 9e e0pe(3 3o ob3ain 8ro1 i3. In 35e perpe3ui3y (a"e, 35a3 i", a (o1pany 8ro1 95i(5 9e e0pe(3 (on"3an3 dividend" every year, 35i" value (an be e0pre""ed a" 8ollo9"+ 7=ui3y value P >P) C ?e W5ere+ >P) P dividend per "5are di"3ribu3ed by 35e (o1pany in 35e la"3 yearS ?e P re=uired re3urn 3o e=ui3y. I8, on 35e o35er 5and, 35e dividend i" e0pe(3ed 3o gro9 inde8ini3ely a3 a (on"3an3 annual ra3e g, 35e above 8or1ula be(o1e" 35e 8ollo9ing+ 7=ui3y value P >P)# C ,?e E g. W5ere >P)# i" 35e dividend" per "5are 8or 35e ne03 year. 71piri(al eviden(e "5o9" 35a3 35e (o1panie" 35a3 pay 1ore dividend" ,a" a per(en3age o8 35eir earning". do no3 ob3ain a gro935 in 35eir "5are pri(e a" a re"ul3. *5i" i" be(au"e 95en a (o1pany di"3ribu3e" 1ore dividend", nor1ally i3 redu(e" i3" gro935 be(au"e i3 di"3ribu3e" 35e 1oney 3o i3" "5are5older" in"3ead o8 plo9ing i3 ba(k in3o ne9 inve"31en3".
/

O35er 8lo9" are "5are buyEba(k" and "ub"(rip3ion rig53". Ko9ever, 95en (api3al in(rea"e" 3ake pla(e 35a3 give ri"e 3o "ub"(rip3ion rig53", 35e "5are": pri(e 8all" by an a1oun3 appro0i1a3ely e=ual 3o 35e rig53": value.
/

*5ere i" an enor1ou" and 5ig5ly varied li3era3ure abou3 35e i1pa(3 o8 dividend poli(ie" on e=ui3y value. )o1e re(o11endable 3e03" are 3o be 8ound in )oren"en and Willia1"on ,#9%/. and 4iller ,#9%L..

> - IESE Business School-University of Navarra

Figure & "5o9" 35e evolu3ion o8 35e dividend yield o8 35e Aer1an, Japane"e and Bni3ed )3a3e" "3o(k 1arke3".

9i:ure 4
7volu3ion o8 35e >ividend Qield o8 35e Aer1an, Japane"e and Bni3ed )3a3e" )3o(k 4arke3"
6 (1) 3 , 0 4 + . +/6+ +/60 +/6, +/66 +/67 +/2+ +/20 +/2, +/26 +/27 +/7+ +/70 +/7, +/76 +/77 +/.+ +/.0 +/., +/.6
)our(e+ 4organ )3anley and >a3a"3rea1.

Di&i'()' yi(#'

8e !an* ;apan $SA

*able & "5o9" 35e dividend yield o8 "everal in3erna3ional "3o(k 1arke3" in )ep3e1ber #992, !ugu"3 2000 and February 2007. In 2000, Japan 9a" 35e (oun3ry 9i35 35e lo9e"3 dividend yield ,0.LT. and )pain 5ad a dividend yield o8 #./T.

4$4$ Sales Multi-les

*5i" valua3ion 1e35od, 95i(5 i" u"ed in "o1e indu"3rie" 9i35 a (er3ain 8re=uen(y, (on"i"3" o8 (al(ula3ing a (o1pany:" value by 1ul3iplying i3" "ale" by a nu1ber. For e0a1ple, a p5ar1a(y i" o83en valued by 1ul3iplying i3" annual "ale" ,in dollar". by 2 or ano35er nu1ber, depending on 35e 1arke3 "i3ua3ion. I3 i" al"o a (o11on pra(3i(e 3o value a "o83 drink bo33ling plan3 by 1ul3iplying i3" annual "ale" in li3er" by /00 or ano35er nu1ber, depending on 35e 1arke3 "i3ua3ion. In order 3o analy e 35i" 1e35od:" (on"i"3en(y, )1i35 'arney analy ed 35e rela3ion"5ip be39een 35e pri(eC"ale" ra3io and 35e re3urn on e=ui3y. *5e "3udy 9a" (arried ou3 in large (orpora3ion" ,(api3ali a3ion in e0(e"" o8 #/0 1illion dollar". in 22 (oun3rie". Ke divided 35e (o1panie" in3o 8ive group" depending on 35eir pri(eC"ale" ra3io+ group # (on"i"3ed o8 35e (o1panie" 9i35 35e lo9e"3 ra3io, and group / (on3ained 35e (o1panie" 9i35 35e 5ig5e"3 pri(eC"ale" ra3io. *5e 1ean re3urn o8 ea(5 group o8 (o1panie" i" "5o9n in 35e 8ollo9ing 3able+

!a'le 8
Rela3ion"5ip 'e39een Re3urn and 35e Pri(eC)ale" Ra3io
G*$u+ 5 G*$u+ - G*$u+ 7 G*$u+ 8 G*$u+ 9 De#e!be 2-/De#e!be 27 De#e!be 27/Septe!be 76
)our(e+ )1i35 'arney.

02B4? +.B0?

03B0? +4B-?

00B2? +-B0?

40B2? +4B4?

+4B0? 7B,?

IESE Business School-University of Navarra - =

I3 (an be "een 8ro1 35i" 3able 35a3, during 35e period >e(e1ber %4E>e(e1ber %9, 35e e=ui3y o8 35e (o1panie" 9i35 35e lo9e"3 pri(eC"ale" ra3io in >e(e1ber #9%4 on average provided a 5ig5er re3urn 35an 35a3 o8 35e (o1panie" 9i35 a 5ig5er ra3io. Ko9ever, 35i" (ea"ed 3o apply during 35e period >e(e1ber %9E)ep3e1ber 97+ 35ere 9a" no rela3ion"5ip be39een 35e pri(eC"ale" ra3io in >e(e1ber #9%9 and 35e re3urn on e=ui3y during 35o"e year". *5e pri(eC"ale" ra3io (an be broken do9n in3o a 8ur35er 39o ra3io"+ Price;sales B 0-rice;earnin:s3 C 0earnin:s;sales3 *5e 8ir"3 ra3io ,pri(eCearning". i" 35e P7R and 35e "e(ond ,earning"C"ale". i" nor1ally kno9n a" re3urn on "ale".

4$7$ Other Multi-les

In addi3ion 3o 35e P7R and 35e pri(eC"ale" ra3io, "o1e o8 35e 8re=uen3ly u"ed 1ul3iple" are+ - Ialue o8 35e (o1pany C earning" be8ore in3ere"3 and 3a0e" ,7'I*.. - Ialue o8 35e (o1pany C earning" be8ore in3ere"3, 3a0e", depre(ia3ion and a1or3i a3ion ,7'I*>!.. - Ialue o8 35e (o1pany C opera3ing (a"5 8lo9. - Ialue o8 35e e=ui3y C book value.
L

Obviou"ly, in order 3o value a (o1pany u"ing 1ul3iple", 1ul3iple" o8 (o1parable (o1panie" 7 1u"3 be u"ed.

4$8$ Multi-les CoA-anies

Use*

to

Value

Internet
are Pri(eC"ale",

*5e 1ul3iple" 1o"3 (o11only u"ed 3o value In3erne3 (o1panie" % Pri(eC"ub"(riber, Pri(eCpage" vi"i3ed and Pri(eCin5abi3an3.

In 4ar(5 2000, a Fren(5 bank publi"5ed i3" valua3ion o8 *erra ba"ed on 35e pri(eC"ale" ra3io o8 (o1parable (o1panie"+
P i#e/Sales F*(( (*&( ++.BTi ca#i ,,B3 F*(()(t0'( +.7B+ I)"$ $u*c( 4+B. A&(*a,( 6-B.

!pplying 35e 1ean ra3io ,74. 3o *erra:" e0pe(3ed "ale" 8or 200# ,&#0 1illion dollar"., 35ey e"3i1a3ed 35e value o8 *erra:" en3ire e=ui3y 3o be #9.#0/ billion dollar" ,L%.2 dollar" per "5are..

We (ould al"o li"3 a nu1ber o8 o35er ra3io" 95i(5 9e (ould (all F"uiEgeneri"G. One e0a1ple o8 "u(5 ra3io" i" 35e valueCo9ner. In 35e ini3ial "3age" o8 a valua3ion 35a3 I 9a" (o11i""ioned 3o per8or1 by a 8a1ily bu"ine"" 35a3 9a" on "ale, one o8 35e bro35er" 3old 1e 35a3 5e re(koned 35a3 35e "5are" 9ere 9or35 abou3 &0 1illion euro". W5en I a"ked 5i1 5o9 5e 5ad arrived a3 35a3 8igure, 5e an"9ered, FWe are 35ree "5are5older "ibling" and I 9an3 ea(5 one o8 u" 3o ge3 #0 1illionG.
6

For a 1ore de3ailed di"(u""ion o8 35e 1ul3iple" 1e35od, "ee Fernnde ,200#b.. )ee Fernnde ,200#a..

1? - IESE Business School-University of Navarra

7$ Doo*)ill-Base* Metho*s=
Aenerally "peaking, good9ill i" 35e value 35a3 a (o1pany 5a" above i3" book value or above 35e ad;u"3ed book value. Aood9ill "eek" 3o repre"en3 35e value o8 35e (o1pany:" in3angible a""e3", 95i(5 o83en do no3 appear on 35e balan(e "5ee3 bu3 95i(5, 5o9ever, (on3ribu3e an advan3age 9i35 re"pe(3 3o o35er (o1panie" opera3ing in 35e indu"3ry ,=uali3y o8 35e (u"3o1er por38olio, indu"3ry leader"5ip, brand", "3ra3egi( allian(e", e3(... *5e proble1 ari"e" 95en one 3rie" 3o de3er1ine i3" value, a" 35ere i" no (on"en"u" regarding 35e 1e35odology u"ed 3o (al(ula3e i3. )o1e o8 35e 1e35od" u"ed 3o value 35e good9ill give ri"e 3o 35e variou" valua3ion pro(edure" de"(ribed in 35i" "e(3ion. *5e"e 1e35od" apply a 1i0ed approa(5+ on 35e one 5and, 35ey per8or1 a "3a3i( valua3ion o8 35e (o1pany:" a""e3" and, on 35e o35er 5and, 35ey 3ry 3o =uan3i8y 35e value 35a3 35e (o1pany 9ill genera3e in 35e 8u3ure. 'a"i(ally, 35e"e 1e35od" "eek 3o de3er1ine 35e (o1pany:" value by e"3i1a3ing 35e (o1bined value o8 i3" a""e3" plu" a (api3al gain re"ul3ing 8ro1 35e value o8 i3" 8u3ure earning"+ 35ey "3ar3 by valuing 35e (o1pany:" a""e3" and 35en add a =uan3i3y rela3ed 9i35 8u3ure earning".

7$1$ !he EClassicF Valuation Metho*

*5i" 1e35od "3a3e" 35a3 a (o1pany:" value i" e=ual 3o 35e value o8 i3" ne3 a""e3" ,ne3 "ub"3an3ial value. plu" 35e value o8 i3" good9ill. In 3urn, 35e good9ill i" valued a" n 3i1e" 35e (o1pany:" ne3 in(o1e, or a" a (er3ain per(en3age o8 35e 3urnover. !((ording 3o 35i" 1e35od, 35e 8or1ula 35a3 e0pre""e" a (o1pany:" value i"+ I P ! - ,n 0 '., or I P ! - , 0 F. P per(en3age

W5ere+ ! P ne3 a""e3 valueS n P (oe88i(ien3 be39een #./ and &S ' P ne3 in(o1eS o8 "ale" revenueS and F P 3urnover.

*5e 8ir"3 8or1ula i" 1ainly u"ed 8or indu"3rial (o1panie", 95ile 35e "e(ond i" (o11only u"ed 8or 35e re3ail 3rade. W5en 35e 8ir"3 1e35od i" applied 3o 35e 5ypo35e3i(al (o1pany !l8a In(., a""u1ing 35a3 35e good9ill i" e"3i1a3ed a3 35ree 3i1e" 35e annual earning", i3 9ould give a value 8or 35e (o1pany:" e=ui3y a1oun3ing 3o 2#& 1illion dollar" ,#&/ - & 0 2L.. ! varian3 o8 35i" 1e35od (on"i"3" o8 u"ing 35e (a"5 8lo9 in"3ead o8 35e ne3 in(o1e.

*5e au35or 8eel" du3y bound 3o 3ell 35e reader 35a3 5e doe" no3 like 35e"e 1e35od" a3 all bu3 a" 35ey 5ave been u"ed a lo3 in 35e pa"3, and 35ey are "3ill u"ed 8ro1 3i1e 3o 3i1e, a brie8 de"(rip3ion o8 "o1e o8 35e1 i" in(luded. Ko9ever, 9e 9ill no3 1en3ion 35e1 again in 35e re"3 o8 35e book. *5e reader (an "kip dire(3ly 3o )e(3ion /. Ko9ever, i8 5e (on3inue" 3o read 35i" "e(3ion, 5e "5ould no3 look 8or 1u(5 F"(ien(eG in 35e 1e35od" 35a3 8ollo9 be(au"e 35ey are very arbi3rary.

IESE Business School-University of Navarra - 11

7$/$ !he SiA-lifie* GA''reviate* Doo*)ill IncoAeG Metho* or the SiA-lifie* UEC1? Metho*
!((ording 3o 35i" 1e35od, a (o1pany:" value i" e0pre""ed by 35e 8ollo9ing 8or1ula+ I P ! - an ,' E i!. W5ere+ ! P (orre(3ed ne3 a""e3" or ne3 "ub"3an3ial value. an P pre"en3 value, a3 a ra3e 3, o8 n annui3ie", 9i35 n be39een / and % year". ' P ne3 in(o1e 8or 35e previou" year or 35a3 8ore(a"3 8or 35e (o1ing year. i P in3ere"3 ra3e ob3ained by an al3erna3ive pla(e1en3, 95i(5 (ould be deben3ure", 35e re3urn on e=ui3ie", or 35e re3urn on real e"3a3e inve"31en3" ,a83er 3a0.. an ,' good9ill. E i!. P

*5i" 8or1ula (ould be e0plained in 35e 8ollo9ing 1anner+ 35e (o1pany:" value i" 35e value o8 i3" ad;u"3ed ne3 9or35 plu" 35e value o8 35e good9ill. *5e value o8 35e good9ill i" ob3ained by (api3ali ing, by appli(a3ion o8 a (oe88i(ien3 an, a U"uperpro8i3U 35a3 i" e=ual 3o 35e di88eren(e be39een 35e ne3 in(o1e and 35e inve"31en3 o8 35e ne3 a""e3" F!G a3 an in3ere"3 ra3e FiG (orre"ponding 3o 35e ri"kE8ree ra3e. In 35e (a"e o8 35e (o1pany !l8a In(., ' P 2LS ! P #&/. He3 u" a""u1e 35a3 / year" and #/T are u"ed in 35e (al(ula3ion o8 an, 95i(5 9ould give an P &.&/2. He3 u" al"o a""u1e 35a3 i P #0T. Wi35 35i" 5ypo35e"i", 35e e=ui3y:" value 9ould be+ #&/ - &.&/2 ,2L E 0.# 0 #&/. P #&/ - 4#.9 P #7L.9 1illion dollar".

7$4$ Union of Euro-ean Accountin: EC-erts 0UEC3 Metho*

*5e (o1pany:" value a((ording 3o 35i" 1e35od i" ob3ained 8ro1 35e 8ollo9ing e=ua3ion+ I P ! - an ,' E iI. giving+ I P V! - ,an 0 '.W C ,# - ian.

For 35e B7C, a (o1pany:" 3o3al value i" e=ual 3o 35e "ub"3an3ial value ,or revalued ne3 a""e3". plu" 35e good9ill. *5i" (al(ula3ed by (api3ali ing a3 (o1pound in3ere"3 ,u"ing 35e 8a(3or an. a "uperpro8i3 95i(5 i" 35e pro8i3 le"" 35e 8lo9 ob3ained by inve"3ing a3 a ri"kE8ree ra3e i a (api3al e=ual 3o 35e (o1pany:" value I. *5e di88eren(e be39een 35i" 1e35od and 35e previou" 1e35od lie" in 35e value o8 35e good9ill, 95i(5, in 35i" (a"e, i" (al(ula3ed 8ro1 35e value I 9e are looking 8or, 95ile in 35e "i1pli8ied 1e35od, i3 9a" (al(ula3ed 8ro1 35e ne3 a""e3" !. In 35e (a"e o8 35e (o1pany !l8a In(., ' P 2LS ! P #&/, an P &.&/2, i P #0T. Wi35 35e"e a""u1p3ion", 35e e=ui3y:" value 9ould be+ ,#&/ - &.&/2 0 2L. C ,# - 0.# 0 &.&/2. P 222.# C #.&&/2 P #LL.% 1illion dollar".

+.

B7C+ *5i" i" 35e a(rony1 o8 FBnion o8 7uropean !((oun3ing 70per3"G.

1/ - IESE Business School-University of Navarra

7$7$ In*irect Metho*

*5e 8or1ula 8or 8inding a (o1pany:" value a((ording 3o 35i" 1e35od i" 35e 8ollo9ing+ I P ,! - 'Ci.C2, 95i(5 (an al"o be e0pre""ed a" I P ! - ,' E i!.C2i *5e ra3e i u"ed i" nor1ally 35e in3ere"3 ra3e paid on longE3er1 *rea"ury bond". !" (an be "een in 35e 8ir"3 e0pre""ion, 35i" 1e35od give" e=ual 9eig53 3o 35e value o8 35e ne3 a""e3" ,"ub"3an3ial value. and 35e value o8 35e re3urn. *5i" 1e35od 5a" a large nu1ber o8 varian3" 35a3 are ob3ained by giving di88eren3 9eig53" 3o 35e "ub"3an3ial value and 35e earning": (api3ali a3ion value. In 35e (a"e o8 35e (o1pany !l8a In(., ' P 2LS ! P #&/, i P #0T. Wi35 35e"e a""u1p3ion", 35e e=ui3y:" value 9ould be #97./ 1illion dollar".

7$8$ An:lo-SaCon Metho*

or

#irect
I P ! - ,' E i!. C 31

*5i" 1e35od:" 8or1ula i" 35e 8ollo9ing+

In 35i" (a"e, 35e value o8 35e good9ill i" ob3ained by re"3a3ing 8or an inde8ini3e dura3ion 35e value o8 35e "uperpro8i3 ob3ained by 35e (o1pany. *5i" "uperpro8i3 i" 35e di88eren(e be39een 35e ne3 in(o1e and 95a3 9ould be ob3ained 8ro1 pla(ing a3 35e in3ere"3 ra3e i, a (api3al e=ual 3o 35e value o8 35e (o1pany:" a""e3". *5e ra3e 31 i" 35e in3ere"3 ra3e earned on 8i0edEin(o1e "e(uri3ie" 1ul3iplied by a (oe88i(ien3 be39een #.2/ and #./ 3o ad;u"3 8or 35e ri"k. In 35e (a"e o8 35e (o1pany !l8a In(., ' P 2LS ! P #&/, i P #0T. He3 u" a""u1e 35a3 31 P #/T. Wi35 35e"e a""u1p3ion", 35e e=ui3y:" value 9ould be 2#%.& 1illion dollar".

7$@$ Annual Profit Purchase Metho*

Wi35 35i" 1e35od, 35e 8ollo9ing valua3ion 8or1ula i" u"ed+ I P ! - 1 ,' E i!.. Kere, 35e value o8 35e good9ill i" e=ual 3o a (er3ain nu1ber o8 year" o8 "uperpro8i3". *5e buyer i" prepared 3o pay 35e "eller 35e value o8 35e ne3 a""e3" plu" 1 year" o8 "uperpro8i3". *5e nu1ber o8 year" ,1. nor1ally u"ed range" be39een & and /, and 35e in3ere"3 ra3e ,i. i" 35e in3ere"3 ra3e 8or longE3er1 loan". In 35e (a"e o8 35e (o1pany !l8a In(., ' P 2LS ! P #&/, i P #0T. Wi35 35e"e a""u1p3ion", and i8 1 i" / year", 35e e=ui3y:" value 9ould be #97./ 1illion dollar".

7$<$ %is5-Bearin: an* %is5-9ree %ate Metho*

*5i" 1e35od de3er1ine" a (o1pany:" value u"ing 35e 8ollo9ing e0pre""ion+ I P ! - ,' E iI. C 3 giving I P ,! - 'C3. C ,# - iC3.

*5e ra3e i i" 35e ra3e o8 an al3erna3ive, ri"kE8ree pla(e1en3S 35e ra3e 3 i" 35e ri"kEbearing ra3e u"ed 3o re"3a3e 35e "uperpro8i3 and i" e=ual 3o 35e ra3e i in(rea"ed by a ri"k ra3io. !((ording 3o 35i" 1e35od, a (o1pany:" value i" e=ual 3o 35e ne3 a""e3" in(rea"ed by 35e re"3a3ed "uperpro8i3. !" (an be "een, 35e 8or1ula i" a varian3 o8 35e B7C:" 1e35od 95en 35e nu1ber o8 year" 3end" 3o9ard" in8ini3y.

IESE Business School-University of Navarra - 14

In 35e (a"e o8 35e (o1pany !l8a In(., ' P 2LS ! P #&/, i P #0T. Wi35 35e"e a""u1p3ion", i8 3 P #/T, 35e e=ui3y:" value 9ould be #%/ 1illion dollar".

8$ Cash 9lo) #iscountin:-Base* Metho*s

*5e"e 1e35od" "eek 3o de3er1ine 35e (o1pany:" value by e"3i1a3ing 35e (a"5 8lo9" i3 9ill genera3e in 35e 8u3ure and 35en di"(oun3ing 35e1 a3 a di"(oun3 ra3e 1a3(5ed 3o 35e 8lo9": ri"k. *5e 1i0ed 1e35od" de"(ribed previou"ly 5ave been u"ed e03en"ively in 35e pa"3. Ko9ever, 35ey are (urren3ly u"ed in(rea"ingly le"" and i3 (an be "aid 35a3, no9aday", 35e (a"5 8lo9 di"(oun3ing 1e35od i" generally u"ed be(au"e i3 i" 35e only (on(ep3ually (orre(3 valua3ion 1e35od. In 35e"e 1e35od", 35e (o1pany i" vie9ed a" a (a"5 8lo9 genera3or and 35e (o1pany:" value i" ob3ained by (al(ula3ing 35e"e 8lo9": pre"en3 value u"ing a "ui3able di"(oun3 ra3e. Ca"5 8lo9 di"(oun3ing 1e35od" are ba"ed on 35e de3ailed, (are8ul 8ore(a"3, 8or ea(5 period, o8 ea(5 o8 35e 8inan(ial i3e1" rela3ed 9i35 35e genera3ion o8 35e (a"5 8lo9" (orre"ponding 3o 35e (o1pany:" opera3ion", "u(5 a", 8or e0a1ple, (olle(3ion o8 "ale", per"onnel, ra9 1a3erial", ad1ini"3ra3ive and "ale" e0pen"e", loan repay1en3". Con"e=uen3ly, 35e (on(ep3ual approa(5 i" "i1ilar 3o 35a3 o8 35e (a"5 budge3. In (a"5 8lo9 di"(oun3ingEba"ed valua3ion", a "ui3able di"(oun3 ra3e i" de3er1ined 8or ea(5 3ype o8 (a"5 8lo9. >e3er1ining 35e di"(oun3 ra3e i" one o8 35e 1o"3 i1por3an3 3a"k" and 3ake" in3o a((oun3 35e ri"k, 5i"3ori( vola3ili3ie"S in pra(3i(e, 35e 1ini1u1 di"(oun3 ra3e i" o83en "e3 by 35e in3ere"3ed par3ie" ,35e buyer" or "eller" are no3 prepared 3o inve"3 or "ell 8or le"" 35an a (er3ain re3urn, e3(...

8$1$ Deneral Metho* for Cash 9lo) #iscountin:

*5e di88eren3 (a"5 8lo9 di"(oun3ingEba"ed 1e35od" "3ar3 9i35 35e 8ollo9ing e0pre""ion+
IP CF# CF& CFn + IR n CF2 + # - k ,# - k. + ,# - k. & + ... + ,# - k. n
2

W5ere+

CFi P (a"5 8lo9 genera3ed by 35e (o1pany in 35e period i. In P re"idual value o8 35e (o1pany in 35e year n. k P appropria3e di"(oun3 ra3e 8or 35e (a"5 8lo9": ri"k.

!l35oug5 a3 8ir"3 "ig53 i3 1ay appear 35a3 35e above 8or1ula i" (on"idering a 3e1porary dura3ion o8 35e 8lo9", 35i" i" no3 ne(e""arily "o a" 35e (o1pany:" re"idual value in 35e year n ,In. (an be (al(ula3ed by di"(oun3ing 35e 8u3ure 8lo9" a83er 35a3 period. ! "i1pli8ied pro(edure 8or (on"idering an inde8ini3e dura3ion o8 8u3ure 8lo9" a83er 35e year n i" 3o a""u1e a (on"3an3 gro935 ra3e ,g. o8 8lo9" a83er 35a3 period. *5en 35e re"idual value in year n i" IRn P CFn ,# - g. C ,k E g.. !l35oug5 35e 8lo9" 1ay 5ave an inde8ini3e dura3ion, i3 1ay be a((ep3able 3o ignore 35eir value a83er a (er3ain period, a" 35eir pre"en3 value de(rea"e" progre""ively 9i35 longer 3i1e 5ori on". Fur35er1ore, 35e (o1pe3i3ive advan3age o8 1any bu"ine""e" 3end" 3o di"appear a83er a 8e9 year".

17 - IESE Business School-University of Navarra

'e8ore looking in 1ore de3ail a3 35e di88eren3 (a"5 8lo9 di"(oun3ingEba"ed valua3ion 1e35od", 9e 1u"3 8ir"3 de8ine 35e di88eren3 3ype" o8 (a"5 8lo9 35a3 (an be u"ed in a valua3ion.

8$/$ #eci*in: the A--ro-riate Cash 9lo) CoA-any1s EconoAic Balance Sheet

for #iscountin: an* the

In order 3o under"3and 95a3 are 35e ba"i( (a"5 8lo9" 35a3 (an be (on"idered in a valua3ion, 35e 8ollo9ing (5ar3 "5o9" 35e di88eren3 (a"5 "3rea1" genera3ed by a (o1pany and 35e appropria3e di"(oun3 ra3e" 8or ea(5 8lo9.
CASH FLOWS FCF0 ) ee #ash %lo< ECF0 Equit* #ash %lo< CF'0 Debt #ash %lo< APPROPRIATE DISCOUNT RATE WACC0 Cei&hted ave a&e #ost o% #apital :(0 Requi ed etu n to equit* :'0 Requi ed etu n to debt

*5ere are 35ree ba"i( (a"5 8lo9"+ 35e 8ree (a"5 8lo9, 35e e=ui3y (a"5 8lo9, and 35e deb3 (a"5 8lo9. *5e ea"ie"3 one 3o under"3and i" 35e deb3 (a"5 8lo9, 95i(5 i" 35e "u1 o8 35e in3ere"3 3o be paid on 35e deb3 plu" prin(ipal repay1en3". In order 3o de3er1ine 35e pre"en3 1arke3 value o8 35e e0i"3ing deb3, 35i" 8lo9 1u"3 be di"(oun3ed a3 35e re=uired ra3e o8 re3urn 3o deb3 ,(o"3 o8 35e deb3.. In 1any (a"e", 35e deb3:" 1arke3 value "5all be e=uivalen3 3o i3" book value, 95i(5 i" ## 95y i3" book value i" o83en 3aken a" a "u88i(ien3 appro0i1a3ion 3o 35e 1arke3 value. *5e 8ree (a"5 8lo9 09C93 enable" 35e (o1pany:" 3o3al value ,deb3 and e=ui3y+ > - 7. 3o be ob3ained. *5e e=ui3y (a"5 8lo9 0EC93 enable" 35e value o8 35e e=ui3y 3o be ob3ained, 95i(5, (o1bined 9i35 35e value o8 35e deb3, 9ill al"o enable 35e (o1pany:" 3o3al value 3o be de3er1ined. *5e di"(oun3 ra3e" 35a3 1u"3 be u"ed 8or 35e FCF and 35e 7CF are e0plained in 35e 8ollo9ing "e(3ion". Figure 4 "5o9" in "i1pli8ied 8or1 35e di88eren(e be39een 35e (o1pany:" 8ull balan(e "5ee3 and i3" e(ono1i( balan(e "5ee3. W5en 9e re8er 3o 35e (o1pany:" ,8inan(ial. a""e3", 9e are no3 3alking abou3 i3" en3ire a""e3" bu3 abou3 3o3al a""e3" le"" "pon3aneou" 8inan(ing ,"upplier", (redi3or"..... *o pu3 i3 ano35er 9ay, 35e (o1pany:" ,8inan(ial. a""e3" (on"i"3 o8 35e ne3 8i0ed #& a""e3" plu" 35e 9orking (api3al re=uire1en3". *5e (o1pany:" ,8inan(ial. liabili3ie" (on"i"3 o8 #4 35e "5are5older": e=ui3y ,35e "5are". and i3" deb3 ,"5or3 and longE3er1 8inan(ial deb3.. In 35e re"3 o8 35e paper, 95en 9e 3alk abou3 35e (o1pany:" value, 9e 9ill be re8erring 3o 35e value o8 35e deb3 plu" 35e value o8 35e "5are5older": e=ui3y ,"5are"..
#2

++ +4

*5i" i" only valid i8 35e re=uired re3urn 3o deb3 i" e=ual 3o 35e deb3:" (o"3.

*5e F(o1pany:" valueG i" u"ually (on"idered 3o be 35e "u1 o8 35e value o8 35e e=ui3y plu" 35e value o8 35e 8inan(ial deb3.
+0 +-

For an e0(ellen3 di"(u""ion o8 9orking (api3al re=uire1en3" ,WCR., "ee Fau" ,#99L..

*5e "5are5older": e=ui3y or (api3al (an in(lude, a1ong o35er", (o11on "3o(k, pre8erred "3o(k and (onver3ible pre8erred "3o(kS and 35e di88eren3 3ype" o8 deb3 (an in(lude, a1ong o35er", "enior deb3, "ubordina3ed deb3, (onver3ible deb3, 8i0ed or variable in3ere"3 deb3, ero or regular (oupon deb3, "5or3 or longE3er1 deb3, e3(.

IESE Business School-University of Navarra - 18

9i:ure 7
Full and 7(ono1i( 'alan(e )5ee3 o8 a Co1pany
9U Assets Ca"5 !((oun3" re(eivable !((oun3" payable )5or3E3er1 8inan(ial deb3 HongE3er1 8inan(ial deb3 )5are5older"J e=ui3y Working Capi3al Re=uire1en3" ,WCR. Ne3 Fi0ed !""e3" BA ANCE S"EE! ia'ilities ECONOMIC BA ANCE S"EE! Assets ia'ilities

>eb3

,C% Inven3orie" Ne3 Fi0ed !""e3"

)5are5older"J e=ui3y

WCR P Ca"5 - !((oun3" Re(eivable - Inven3orie" E !((oun3" Payable

5.2.1. The Flow

Free

Cash

*5e 8ree (a"5 8lo9 ,FCF. i" 35e opera3ing (a"5 8lo9, 35a3 i", 35e (a"5 8lo9 genera3ed by opera3ion", 9i35ou3 3aking in3o a((oun3 borro9ing ,8inan(ial deb3., a83er 3a0. I3 i" 35e 1oney 35a3 9ould be available in 35e (o1pany a83er (overing 8i0ed a""e3 inve"31en3" and 9orking (api3al re=uire1en3", a""u1ing 35a3 35ere i" no deb3 and, 35ere8ore, 35ere are no 8inan(ial e0pen"e". In order 3o (al(ula3e 8u3ure 8ree (a"5 8lo9", 9e 1u"3 8ore(a"3 35e (a"5 9e 9ill re(eive and 1u"3 pay in ea(5 period. *5i" i" ba"i(ally 35e approa(5 u"ed 3o dra9 up a (a"5 budge3. Ko9ever, in (o1pany valua3ion, 35i" 3a"k re=uire" 8ore(a"3ing (a"5 8lo9" 8ur35er a5ead in 3i1e 35an i" nor1ally done in any (a"5 budge3. !((oun3ing (anno3 give u" 35i" in8or1a3ion dire(3ly a", on one 5and, i3 u"e" 35e a((rual approa(5 and, on 35e o35er 5and, i3 allo(a3e" i3" revenue", (o"3" and e0pen"e" u"ing ba"i(ally arbi3rary 1e(5ani"1". *5e"e 39o 8ea3ure" o8 a((oun3ing di"3or3 our per(ep3ion o8 35e appropria3e approa(5 95en (al(ula3ing (a"5 8lo9", 95i(5 1u"3 be 35e F(a"5G approa(5, 35a3 i", (a"5 a(3ually re(eived or paid ,(olle(3ion" and pay1en3".. Ko9ever, 95en 35e a((oun3ing i" ad;u"3ed 3o 35i" approa(5, 9e (an (al(ula3e 95a3ever (a"5 8lo9 9e are in3ere"3ed in. We 9ill no9 3ry 3o iden3i8y 35e ba"i( (o1ponen3" o8 a 8ree (a"5 8lo9 in 35e 5ypo35e3i(al e0a1ple o8 35e (o1pany XQY. *5e in8or1a3ion given in 35e a((oun3ing "3a3e1en3" "5o9n in *able L 1u"3 be ad;u"3ed 3o give 35e (a"5 8lo9" 8or ea(5 period, 35a3 i", 35e "u1" o8 1oney a(3ually re(eived and paid in ea(5 period. *able L give" 35e in(o1e "3a3e1en3 8or 35e (o1pany XQY, )!. B"ing 35i" da3a, 9e "5all de3er1ine 35e (o1pany:" 8ree (a"5 8lo9, 95i(5 9e kno9 by de8ini3ion 1u"3 no3 in(lude any

1@ - IESE Business School-University of Navarra

pay1en3" 3o 8und provider". *5ere8ore, dividend" and in3ere"3 e0pen"e" 1u"3 no3 be in(luded in 35e 8ree (a"5 8lo9. *able 7 "5o9" 5o9 35e 8ree (a"5 8lo9 i" ob3ained 8ro1 earning" be8ore in3ere"3 and 3a0 ,7'I*.. *5e 3a0 payable on 35e 7'I* 1u"3 be (al(ula3ed dire(3lyS 35i" give" u" 35e ne3 in(o1e 9i35ou3 "ub3ra(3ing in3ere"3 pay1en3", 3o 95i(5 9e 1u"3 add 35e depre(ia3ion 8or 35e period be(au"e i3 i" no3 a pay1en3 bu3 1erely an a((oun3ing en3ry. We 1u"3 al"o (on"ider 35e "u1" o8 1oney 3o be allo(a3ed 3o ne9 inve"31en3" in 8i0ed a""e3" and ne9 9orking (api3al re=uire1en3" ,WCR., a" 35e"e "u1" 1u"3 be dedu(3ed in order 3o (al(ula3e 35e 8ree (a"5 8lo9.

!a'le @
In(o1e )3a3e1en3 8or XQY
5666 Sa#( /"ost o% &oods sold /8ene al e'penses /Dep e#iation Ea*)i), 2("$*( i)t(*( t a)' ta; (EBIT) /Inte est e'penses Ea*)i), 2("$*( ta; (EBT) /Ta' N(t i)c$4( (EAT) /Dividends R(tai)(' (a*)i), -... -..5

+5...B.. +5+..B.. +54+.B.. /3,.B.. /6+,B.. / 623B,. /+27B.. / 4.6B7. /442B6. /4.B.. /4.B.. /4.B.. +-+B.. +,6B+. +6-B2. / +.B.. / +.B.. / +.B.. +0+B.. +-6B+. +3-B2. / -,B2, / ,+B-7 / ,6B32 2,B+, 7,B34 +.6B+. / 0-B.3 / 02B4, / -4B2, ,+B.7 ,6B06 3-B42

!a'le <
Free Ca"5 Flo9 o8 XQY, )!
5666 Ea*)i), 2("$*( i)t(*( t a)' ta; (EBIT) /Ta' paid on EBIT N(t i)c$4( %it!$ut '(2t DDep e#iation / In# ease in %i'ed assets / In# ease in C"R F*(( ca ! "#$% +-+B.. /-7B-. 7+B3, 4.B.. /3+B.. /++B.. 760<9 -... +,6B+. /,,B.. +.4B+. 4.B.. /36B+. /+4B+. 8-06-..5 +6-B2. /3+B4. ++0B3. 4.B.. /60B2. /+0B0. 8<095

In order 3o (al(ula3e 35e 8ree (a"5 8lo9, 9e 1u"3 ignore 8inan(ing 8or 35e (o1pany:" opera3ion" and (on(en3ra3e on 35e 8inan(ial re3urn on 35e (o1pany:" a""e3" a83er 3a0, vie9ed 8ro1 35e per"pe(3ive o8 a going (on(ern, 3aking in3o a((oun3 in ea(5 period 35e inve"31en3" re=uired 8or 35e bu"ine"":" (on3inued e0i"3en(e. Finally, i8 35e (o1pany 5ad no deb3, 35e 8ree (a"5 8lo9 9ould be iden3i(al 3o 35e e=ui3y (a"5 8lo9, 95i(5 i" ano35er (a"5 8lo9 varian3 u"ed in valua3ion" and 9ill be analy ed belo9.
IESE Business School-University of Navarra - 1<

5.2.2. The Equity Cash Flow *5e e=ui3y (a"5 8lo9 ,7CF. i" (al(ula3ed by "ub3ra(3ing 8ro1 35e 8ree (a"5 8lo9 35e in3ere"3 and prin(ipal pay1en3" ,a83er 3a0. 1ade in ea(5 period 3o 35e deb3 5older" and adding 35e ne9 deb3 provided. In "5or3, i3 i" 35e (a"5 8lo9 re1aining available in 35e (o1pany a83er (overing 8i0ed a""e3 inve"31en3" and 9orking (api3al re=uire1en3" and a83er paying 35e 8inan(ial (5arge" and repaying 35e (orre"ponding par3 o8 35e deb3:" prin(ipal ,in 35e even3 35a3 35ere e0i"3" deb3.. *5i" (an be repre"en3ed in 35e 8ollo9ing e0pre""ion+ EC9 B 9C9 - Hinterest -ayAents C 01- !3I - -rinci-al re-ayAents J ne) *e't W5en 1aking pro;e(3ion", 35e dividend" and o35er e0pe(3ed pay1en3" 3o "5are5older" 1u"3 1a3(5 35e e=ui3y (a"5 8lo9". *5i" (a"5 8lo9 a""u1e" 35e e0i"3en(e o8 a (er3ain 8inan(ing "3ru(3ure in ea(5 period, by 95i(5 35e in3ere"3 (orre"ponding 3o 35e e0i"3ing deb3" i" paid, 35e in"3all1en3" o8 35e prin(ipal are paid a3 35e (orre"ponding 1a3uri3y da3e" and 8und" 8ro1 ne9 deb3 are re(eived. !83er 35a3 35ere re1ain" a (er3ain "u1 95i(5 i" 35e (a"5 available 3o 35e "5are5older", 95i(5 9ill be allo(a3ed 3o paying dividend" or buying ba(k "5are". W5en 9e re"3a3e 35e e=ui3y (a"5 8lo9, 9e are valuing 35e (o1pany:" e=ui3y ,7., and, 35ere8ore, 35e appropria3e di"(oun3 ra3e 9ill be 35e re=uired re3urn 3o e=ui3y ,?e.. *o 8ind 35e (o1pany:" 3o3al value ,> - 7., 9e 1u"3 add 35e value o8 35e e0i"3ing deb3 ,>. 3o 35e value o8 35e e=ui3y ,7.. 5.2.3. Flow Capital Cash

Capi3al (a"5 8lo9 ,CCF. i" 35e 3er1 given 3o 35e "u1 o8 35e deb3 (a"5 8lo9 plu" 35e e=ui3y (a"5 8lo9. *5e deb3 (a"5 8lo9 i" (o1po"ed by 35e "u1 o8 in3ere"3 pay1en3" plu" prin(ipal repay1en3". *5ere8ore+ CC9 B EC9 J #C9 B EC9 J I - K# I B # (*

I3 i" i1por3an3 3o no3 (on8u"e 35e (api3al (a"5 8lo9 9i35 35e 8ree (a"5 8lo9.

8$4$ Calculatin: the Value of the CoA-any Usin: the 9ree Cash 9lo)
In order 3o (al(ula3e 35e value o8 35e (o1pany u"ing 35i" 1e35od, 35e 8ree (a"5 8lo9" are di"(oun3ed ,re"3a3ed. u"ing 35e 9eig53ed average (o"3 o8 deb3 and e=ui3y or 9eig53ed average (o"3 o8 (api3al ,W!CC.+ E J # B -resent value H9C9L ,ACCI 95ere W!CC P 7 ?e - > ?d ,# E * . 7- > > P 1arke3 value o8 35e deb3. 7 P 1arke3 value o8 35e e=ui3y. ?d P (o"3 o8 35e deb3 be8ore 3a0 P re=uired re3urn 3o deb3. * P 3a0 ra3e.

?e P re=uired re3urn 3o e=ui3y, 95i(5 re8le(3" 35e e=ui3y:" ri"k. *5e W!CC i" (al(ula3ed by 9eig53ing 35e (o"3 o8 35e deb3 ,?d. and 35e (o"3 o8 35e e=ui3y ,?e. 9i35 re"pe(3 3o 35e (o1pany:" 8inan(ial "3ru(3ure. *5i" i" 35e appropria3e ra3e 8or 35i" (a"e a", "in(e 9e are valuing 35e (o1pany a" a 95ole ,deb3 plu" e=ui3y., 9e 1u"3 (on"ider 35e re=uired re3urn 3o deb3 and 35e re=uired re3urn 3o e=ui3y in 35e propor3ion 3o 95i(5 35ey 8inan(e 35e (o1pany.

1> - IESE Business School-University of Navarra

8$7$ Calculatin: the Value of the CoA-any as the Unlevere* Value Plus the #iscounte* Value of the !aC Shiel*
In 35i" 1e35od, 35e (o1pany:" value i" (al(ula3ed by adding 39o value"+ on 35e one 5and, 35e value o8 35e (o1pany a""u1ing 35a3 35e (o1pany 5a" no deb3 and, on 35e o35er 5and, 35e value o8 35e 3a0 "5ield ob3ained by 35e 8a(3 35a3 35e (o1pany i" 8inan(ed 9i35 deb3. *5e value o8 35e (o1pany 9i35ou3 deb3 i" ob3ained by di"(oun3ing 35e 8ree (a"5 8lo9, u"ing 35e ra3e o8 re=uired re3urn 3o e=ui3y 35a3 9ould be appli(able 3o 35e (o1pany i8 i3 9ere 3o be (on"idered a" 5aving no deb3. *5i" ra3e ,?u. i" kno9n a" 35e unlevered ra3e or re=uired re3urn 3o a""e3". *5e re=uired re3urn 3o a""e3" i" "1aller 35an 35e re=uired re3urn 3o e=ui3y i8 35e (o1pany 5a" deb3 in i3" (api3al "3ru(3ure a", in 35i" (a"e, 35e "5are5older" 9ould bear 35e 8inan(ial ri"k i1plied by 35e e0i"3en(e o8 deb3 and 9ould de1and a 5ig5er e=ui3y ri"k pre1iu1. In 35o"e (a"e" 95ere 35ere i" no deb3, 35e re=uired re3urn 3o e=ui3y ,?e P ?u. i" e=uivalen3 3o 35e 9eig53ed average (o"3 o8 (api3al ,W!CC., a" 35e only "our(e o8 8inan(ing being u"ed i" (api3al. *5e pre"en3 value o8 35e 3a0 "5ield ari"e" 8ro1 35e 8a(3 35a3 35e (o1pany i" being 8inan(ed 9i35 deb3, and i3 i" 35e "pe(i8i( (on"e=uen(e o8 35e lo9er 3a0 paid by 35e (o1pany a" a (on"e=uen(e o8 35e in3ere"3 paid on 35e deb3 in ea(5 period. In order 3o 8ind 35e pre"en3 value o8 35e 3a0 "5ield, 9e 9ould 8ir"3 5ave 3o (al(ula3e 35e "aving ob3ained by 35i" 1ean" 8or ea(5 o8 35e year", 1ul3iplying 35e in3ere"3 payable on 35e deb3 by 35e 3a0 ra3e. On(e 9e 5ave ob3ained 35e"e 8lo9", 9e 9ill 5ave 3o di"(oun3 35e1 a3 35e ra3e (on"idered appropria3e. !l35oug5 35e di"(oun3 ra3e 3o be u"ed in 35i" (a"e i" "o1e95a3 (on3rover"ial, 1any au35or" "ugge"3 u"ing 35e deb3:" 1arke3 (o"3, 95i(5 need no3 ne(e""arily be 35e in3ere"3 ra3e a3 95i(5 35e (o1pany 5a" (on3ra(3ed i3" deb3. Con"e=uen3ly, 35e !PI (onden"e" in3o 35e 8ollo9ing 8or1ula+ # J E B NPV09C9L (u3 J value of the *e't1s taC shiel*
#/

8$8$ Calculatin: the Value of the CoA-any1s E2uity 'y #iscountin: the E2uity Cash 9lo)
*5e 1arke3 value o8 35e (o1pany:" e=ui3y i" ob3ained by di"(oun3ing 35e e=ui3y (a"5 8lo9 a3 35e ra3e o8 re=uired re3urn 3o e=ui3y 8or 35e (o1pany ,?e.. W5en 35i" value i" added 3o 35e 1arke3 value o8 35e deb3, i3 i" po""ible 3o de3er1ine 35e (o1pany:" 3o3al value. *5e re=uired re3urn 3o e=ui3y (an be e"3i1a3ed u"ing any o8 35e 8ollo9ing 1e35od"+ #. Aordon and )5apiro:" (on"3an3 gro935 valua3ion 1odel+ ?e P V>iv# C P0W - g. >iv# P dividend" 3o be re(eived in 35e 8ollo9ing period P >iv0,# - g..

P0 P "5are:" (urren3 pri(e. g P (on"3an3, "u"3ainable dividend gro935 ra3e.

+,

*5i" 1e35od i" (alled !PI ,ad;u"3ed pre"en3 value.. For a 1ore de3ailed di"(u""ion, 35e reader (an "ee Fernnde ,2002, (5ap3er" #9 and 2#. and Fernnde ,2004..

IESE Business School-University of Navarra - 1=

For e0a1ple, i8 a "5are:" pri(e i" 200 dollar", i3 i" e0pe(3ed 3o pay a dividend o8 #0 dollar" and 35e dividend:" e0pe(3ed annual gro935 ra3e i" ##T+ ?e P ,#0C200. - 0.## P 0.#L P #LT 2. *5e (api3al a""e3 pri(ing 1odel ,C!P4., 95i(5 de8ine" 35e re=uired re3urn 3o e=ui3y in 35e 8ollo9ing 3er1"+ ?e P RF - Z ,R4 E RF. RF P ra3e o8 re3urn 8or ri"kE8ree inve"31en3" ,*rea"ury bond".. Z P "5are:" be3a . R4 P e0pe(3ed 1arke3 re3urn. R4 $ RF P 1arke3 ri"k pre1iu1 or e=ui3y pre1iu1. *5u", given (er3ain value" 8or 35e e=ui3y:" be3a, 35e ri"kE8ree ra3e and 35e 1arke3 ri"k pre1iu1, #7 i3 i" po""ible 3o (al(ula3e 35e re=uired re3urn 3o e=ui3y.
#L

8$@$ Calculatin: the CoA-any1s Value 'y #iscountin: the Ca-ital Cash 9lo)
!((ording 3o 35i" 1odel, 35e value o8 a (o1pany ,1arke3 value o8 i3" e=ui3y plu" 1arke3 value o8 i3" deb3. i" e=ual 3o 35e pre"en3 value o8 35e (api3al (a"5 8lo9" ,CCF. di"(oun3ed a3 35e 9eig53ed average (o"3 o8 (api3al be8ore 3a0 ,W!CC'*.+ 7 - > P pre"en3 value VCCFS W!CC'*W W!CC '* P 7 ?e - > ?d 7 - > CCF P ,7CF - >CF.

*5ere are 1ore 1e35od" 8or valuing (o1panie" by di"(oun3ing 35e e0pe(3ed (a"5 8lo9". Fernnde ,2004b. e0plain" 3en di88eren3 1e35od" 8or Ialuing Co1panie" by Ca"5 Flo9 >i"(oun3ing and "5o9" 35a3 all 3en 1e35od" al9ay" give 35e "a1e value. *5i" re"ul3 i" logi(al, a" all 35e 1e35od" analy e 35e "a1e reali3y under 35e "a1e 5ypo35e"e"S 35ey di88er only in 35e (a"5 8lo9" 3aken a" 35e "3ar3ing poin3 8or 35e valua3ion.

8$<$ Basic Sta:es in the PerforAance of a Valuation 'y Cash 9lo) #iscountin:
*5e ba"i( "3age" in per8or1ing an a((ura3e valua3ion by (a"5 8lo9 di"(oun3ing are+

#L

*5e be3a 1ea"ure" 35e "y"3e1a3i( or 1arke3 ri"k o8 a "5are. I3 indi(a3e" 35e "en"i3ivi3y o8 35e re3urn on a "5are 5eld in 35e (o1pany 3o 1arke3 1ove1en3". I8 35e (o1pany 5a" deb3, 35e in(re1en3al ri"k ari"ing 8ro1 35e leverage 1u"3 be added 3o 35e in3rin"i( "y"3e1a3i( ri"k o8 35e (o1pany:" bu"ine"", 35u" ob3aining 35e levered be3a.
#7

*5e (la""i( 8inan(e 3e03book" provide a 8ull di"(u""ion o8 35e (on(ep3" analy ed 5ere. For e0a1ple, 'realey and 4yer" ,#99L., and Copeland and We"3on ,#9%%..

/? - IESE Business School-University of Navarra

1$ "istoric an* strate:ic analysis of the coA-any an* the in*ustry

Evolution o% in#o!e state!ents and balan#e sheets Evolution o% #ash %lo<s &ene ated b* the #o!pan* Evolution o% the #o!pan*1s invest!ents Evolution o% the #o!pan*1s %inan#in& Anal*sis o% the %inan#ial health Anal*sis o% the business1s isk

A0 Fi)a)cia# a)a#y i

Evolution o% the indust * Evolution o% the #o!pan*1s #o!petitive position Identi%i#ation o% the value #hain "o!petitive position o% the !ain #o!petito s Identi%i#ation o% the value d ive s

B0 St*at(,ic a)' c$4+(titi&( a)a#y i

/$ Pro6ections of future flo)s

A0 Fi)a)cia# "$*(ca t
In#o!e state!ents and balan#e sheets "ash %lo<s &ene ated b* the #o!pan* Invest!ents )inan#in& Te !inal value )o e#ast o% va ious s#ena ios

B0 St*at(,ic a)' c$4+(titi&( "$*(ca t

)o e#ast o% the indust *1s evolution )o e#ast o% the #o!pan*1s #o!petitive position "o!petitive position o% the !ain #o!petito s

C0 C$) i t()cy $" t!( ca ! "#$% "$*(ca t

)inan#ial #onsisten#* bet<een %o e#asts "o!pa ison o% %o e#asts <ith histo i# %i&u es "onsisten#* o% #ash %lo<s <ith the st ate&i# anal*sis

4$ #eterAination of the cost 0re2uire* return3 of ca-ital

)o ea#h business unit and %o the #o!pan* as a <hole "ost o% the debt5 equi ed etu n to equit* and <ei&hted #ost o% #apital

7$ Net -resent value of future flo)s

Aet p esent value o% the %lo<s at thei #o espondin& ateB P esent value o% the te !inal valueB (alue o% the equit*B

8$ Inter-retation of the results

Ben#h!a kin& o% the value obtainedE #o!pa ison <ith si!ila #o!panies Identi%i#ation o% the value # eationB Sustainabilit* o% the value # eation >ti!e ho i=on@ Anal*sis o% the value1s sensitivit* to #han&es in the %unda!ental pa a!ete s St ate&i# and #o!petitive justi%i#ation o% the value # eation

*5e (ri3i(al a"pe(3" in per8or1ing a (o1pany valua3ion are+ C%I!ICA ASPEC!S O9 A VA UA!ION #ynaAic$ !he valuation is a -rocess$ InvolveAent of the coA-any$ Multifunctional$ Strate:ic$
*5e pro(e"" 8or e"3i1a3ing e0pe(3ed ri"k" and (alibra3ing 35e ri"k o8 35e di88eren3 bu"ine""e" and bu"ine"" uni3" i" (ru(ial. *5e (o1pany:" 1anager" 1u"3 be involved in 35e analy"i" o8 35e (o1pany, o8 35e indu"3ry and in 35e (a"5 8lo9 pro;e(3ion".

*5e valua3ion i" no3 a 3a"k 3o be per8or1ed "olely by 8inan(ial 1anage1en3. In order 3o ob3ain a good valua3ion, i3 i" vi3al 35a3 1anager" 8ro1 o35er depar31en3" 3ake par3 in e"3i1a3ing 8u3ure (a"5 8lo9" and 35eir ri"k. *5e (a"5 8lo9 re"3a3e1en3 3e(5ni=ue i" "i1ilar in all valua3ion", bu3 e"3i1a3ing 35e (a"5 8lo9" and (alibra3ing 35e ri"k 1u"3 3ake in3o a((oun3 ea(5 bu"ine"" uni3:" "3ra3egy. *5e valua3ion:" =uali3y i" in(rea"ed 95en i3 in(lude" goal" ,"ale", gro935, 1arke3 "5are, pro8i3", inve"31en3", .... on 95i(5 35e 1anager": 8u3ure (o1pen"a3ion 9ill depend.

CoA-ensation$ %eal o-tions$

I8 35e (o1pany 5a" real op3ion", 35e"e 1u"3 be valued appropria3ely. Real op3ion" re=uire a 3o3ally di88eren3 ri"k 3rea31en3 8ro1 35e (a"5 8lo9 re"3a3e1en3".

"istoric analysis$ !l35oug5 35e value depend" on 8u3ure e0pe(3a3ion", a 35oroug5 5i"3ori( analy"i" o8 35e 8inan(ial,
"3ra3egi( and (o1pe3i3ive evolu3ion o8 35e di88eren3 bu"ine"" uni3" 5elp" a""e"" 35e 8ore(a"3": (on"i"3en(y.

!echnically correct$ *e(5ni(al (orre(3ion re8er" ba"i(ally 3o+ a. (al(ula3ion o8 35e (a"5 8lo9"S b. ade=ua3e 3rea31en3 o8 35e ri"k, 95i(5 3ran"la3e" in3o 35e di"(oun3 ra3e"S (. (on"i"3en(y o8 35e (a"5 8lo9" u"ed 9i35 35e ra3e" appliedS d. 3rea31en3 o8 35e re"idual valueS e. 3rea31en3 o8 in8la3ion.

IESE Business School-University of Navarra - /1

@$ ,hich is the Best Metho* to Use.

*able % "5o9" 35e value o8 35e e=ui3y o8 35e (o1pany !l8a In(. ob3ained by di88eren3 1e35od" ba"ed on "5are5older": e=ui3y, earning" and good9ill. *5e 8unda1en3al proble1 9i35 35e"e 1e35od" i" 35a3 "o1e are ba"ed "olely on 35e balan(e "5ee3, o35er" are ba"ed on 35e in(o1e "3a3e1en3, bu3 none o8 35e1 (on"ider any35ing bu3 5i"3ori( da3a. We (ould i1agine 39o (o1panie" 9i35 iden3i(al balan(e "5ee3" and in(o1e "3a3e1en3" bu3 di88eren3 pro"pe(3"+ one 9i35 5ig5 "ale", earning" and 1argin po3en3ial, and 35e o35er in a "3abili ed "i3ua3ion 9i35 8ier(e (o1pe3i3ion. We 9ould all (on(ur in giving a 5ig5er value 3o 35e 8or1er (o1pany 35an 3o 35e la33er, in "pi3e o8 35eir 5i"3ori( balan(e "5ee3" and in(o1e "3a3e1en3" being e=ual. *5e 1o"3 "ui3able 1e35od 8or valuing a (o1pany i" 3o di"(oun3 35e e0pe(3ed 8u3ure (a"5 8lo9", a" 35e value o8 a (o1pany:" e=ui3y E a""u1ing i3 (on3inue" 3o opera3e E ari"e" 8ro1 35e (o1pany:" (apa(i3y 3o genera3e (a"5 ,8lo9". 8or 35e e=ui3y:" o9ner".

!a'le >
!l8a In(. Ialue o8 35e 7=ui3y !((ording 3o >i88eren3 4e35od" ,4illion >ollar".
Book value Adjusted book value Liquidation value PER "lassi# valuation !ethod Si!pli%ied $E" !ethod $E" !ethod Indi e#t !ethod Di e#t o An&lo/Sa'on !ethod Annual p o%it pu #hase !ethod Risk/bea in& and isk/% ee ate !ethod 2. +0, 6, +60 4+0 +66 +36 +76 4+2 +76 +2,

<$ !he CoA-any as the SuA of the values of #ifferent #ivisions$ Brea5-u- Value
On 1any o((a"ion", 35e (o1pany:" value i" (al(ula3ed a" 35e "u1 o8 35e value" o8 i3" di88eren3 #% divi"ion" or bu"ine"" uni3". *5e be"3 9ay 3o e0plain 35i" 1e35od i" 9i35 an e0a1ple. *able 9 "5o9" 35e valua3ion o8 a Nor35 !1eri(an (o1pany per8or1ed in early #9%0. *5e (o1pany in =ue"3ion 5ad 35ree "epara3e divi"ion"+ 5ou"e5old produ(3", "5ipbuilding, and (ar a((e""orie".

+2

For a 1ore de3ailed di"(u""ion o8 35i" 3ype o8 valua3ion, 9e re(o11end C5ap3er #4 o8 35e book FIalua3ion+ 1ea"uring and 1anaging 35e value o8 (o1panie"G, by Copeland e3 al., edi3ed by Wiley, 2000.

// - IESE Business School-University of Navarra

! 8inan(ial group laun(5ed a 3akeover bid on 35i" (o1pany a3 &% dollar" per "5are and a 9ellE kno9n inve"31en3 bank 9a" (o11i""ioned 3o value 35e (o1pany. *5i" valua3ion, 95i(5 i" in(luded in *able 9, 9ould "erve a" a ba"i" 8or a""e""ing 35e o88er. *able 9 "5o9" 35a3 35e inve"31en3 bank valued 35e (o1pany:" e=ui3y be39een 4&0 and 479 1illion dollar" ,or, 3o pu3 i3 ano35er 9ay, be39een &/ and &9 dollar" per "5are.. 'u3 le3 u" "ee 5o9 i3 arrived a3 35a3 value. Fir"3 o8 all, i3 pro;e(3ed ea(5 divi"ion:" ne3 in(o1e and 35en allo(a3ed a ,1a0i1u1 and 1ini1u1. P7R 3o ea(5 one. B"ing a "i1ple 1ul3ipli(a3ion ,earning" 0 P7R., i3 (al(ula3ed 35e value o8 ea(5 divi"ion. *5e (o1pany:" value i" "i1ply 35e "u1 o8 35e 35ree divi"ion": value". We (an (all 35i" value ,be39een &%7 and 4&L 1illion dollar". 35e value o8 35e earning" genera3ed by 35e (o1pany. We 1u"3 no9 add 3o 35i" 8igure 35e (o1pany:" (a"5 "urplu", 95i(5 35e inve"31en3 bank e"3i1a3ed a3 77./ 1illion dollar". Ko9ever, 35e (o1pany:" pen"ion plan 9a" no3 8ully 8unded ,i3 9a" "5or3 by &4./ 1illion dollar"., and (on"e=uen3ly, 35i" =uan3i3y 5ad 3o be "ub3ra(3ed 8ro1 35e (o1pany:" value. !83er per8or1ing 35e"e opera3ion", 35e (on(lu"ion rea(5ed i" 35a3 ea(5 "5are i" 9or35 be39een &/ and &9 dollar", 95i(5 i" very (lo"e 3o 35e o88er 1ade o8 &% dollar" per "5are.

!a'le =
Ialua3ion o8 a Co1pany a" 35e )u1 o8 35e Ialue o8 i3" >ivi"ion" Individual Ialua3ion o8 7a(5 'u"ine"" B"ing 35e P7R Cri3erion
9ousehold "a TOTAL >Million dolla s@ p odu#ts Shipbuildin& a##esso ies "OMPAAF E'pe#ted net -=0< 5808 90= 8=0= !ini!u! !a'i!u! !ini!u! !a'i!u! !ini!u! !a'i!u! !ini!u! !a'i!u! in#o!e , 3 PER %o ea#h business >!ini!u! and !a'i!u!@ 7 +. +. ++ (alue >!illion dolla s@ 4,6B423B. 64B. 23B,2B. 30B2 026B-03B4 PlusE esti!ated net #ash su plus at *ea /endG 66B, 66B, LessE non/%unded eti e!ent pensions at *ea /end 0-B, 0-B, (alue o% equit* >!illion dolla s@ -0.B-67B4 7907 7607 (alue pe sha e >based on +454.+5... sha es@ DCa"5 "urplu"+ #0&.# 1illion dollar" in (a"5, le"" #0 1illion dolar" 8or opera3ion" and le"" #/.L 1illion dollar" o8 8inan(ial deb3.

>$ Valuation Metho*s Use* #e-en*in: on the Nature of the CoA-any

Kolding (o1panie" are ba"i(ally valued by 35eir li=uida3ion value, 95i(5 i" (orre(3ed 3o 3ake in3o a((oun3 3a0e" payable and 1anagerial =uali3y. *5e gro935 o8 u3ili3y (o1panie" i" u"ually 8airly "3able. In developed (oun3rie", 35e ra3e" (5arged 8or 35eir "ervi(e" are u"ually inde0ed 3o 35e CPI, or 35ey are (al(ula3ed in a((ordan(e 9i35 a legal 8ra1e9ork. *5ere8ore, i3 i" "i1pler 3o e03rapola3e 35eir opera3ing "3a3e1en3 and 35en di"(oun3 35e (a"5 8lo9". In 35e"e (a"e", par3i(ular a33en3ion 1u"3 be paid 3o regula3ory (5ange", 95i(5 1ay in3rodu(e un(er3ain3ie".

IESE Business School-University of Navarra - /4

In 35e (a"e o8 bank", 35e 8o(u" o8 a33en3ion i" 35e opera3ing pro8i3 ,8inan(ial 1argin le"" (o11i""ion" le"" opera3ing e0pen"e"., ad;u"3ing ba"i(ally 8or bad deb3". *5eir indu"3ry por38olio i" al"o analy ed. Ialua3ion" "u(5 a" 35e P7R are u"ed, or 35e ne3 9or35 1e35od ,"5are5older": e=ui3y ad;u"3ed 8or provi"ion "urplu"e"Cde8i(i3", and (api3al gain" or lo""e" on a""e3" "u(5 a" 35e indu"3ry por38olio.. Indu"3rial and (o11er(ial (o1panie". In 35e"e (a"e", 35e 1o"3 (o11only u"ed valua3ion" E apar3 8ro1 re"3a3ed (a"5 8lo9" E are 35o"e ba"ed on 8inan(ial ra3io" ,P7R, pri(eC"ale", pri(eC(a"5 8lo9.. *5e"e i""ue" are di"(u""ed in grea3er de3ail in Fernnde ,2002, (5ap3er" & and 4..

=$ (ey 9actors Affectin: Value+ Dro)thM Interest %ates

%eturnM %is5 an*

*5e e=ui3y:" value depend" on e0pe(3ed 8u3ure 8lo9" and 35e re=uired re3urn 3o e=ui3y. In 3urn, 35e gro935 o8 8u3ure 8lo9" depend" on 35e re3urn on inve"31en3" and 35e (o1pany:" gro935. Ko9ever, 35e re=uired re3urn 3o e=ui3y depend" on a variable over 95i(5 35e (o1pany 5a" no (on3rol, 35e ri"kE8ree in3ere"3 ra3e, and on 35e e=ui3y:" ri"k 95i(5, in 3urn, 9e (an divide in3o opera3ing ri"k and 8inan(ial ri"k.

!a'le 1?
Fa(3or" In8luen(ing 35e "rivers. 7=ui3y:" Ialue !alue

VA UE O9 ENUI!Y
Adquisitions / disposals st u#tu Indust e *B "o!petitive

E;+(ctati$) $" "utu*( ca ! "#$%

"o!petitive advanta&e pe iod A#tual businessB Ba ie s to Ae< businesses / p odu#ts Re&ulato * envi on!ent

R(qui*(' *(tu*) t$ (quity

"ont ol o% ope ations

Mana&e PeopleB "o po ate sB #ultu e

/7 - IESE Business School-University of Navarra

Risk !ana&e!ent

Assets in pla#e

P o%it !a &in

Real options

Te#hnolo&*

Ope atin& isk

Indust *5 #ount ies5 la<s

Expected *(tu*) on invest!ent

Expected #o!pan* ,*$%t!

Risk/% ee Ma ket inte est isk ate p e!iu !

Bu*e / ta &et Risk pe #eived b* the !a ket

)inan#ial isk

Ma*>(t c$44u)icati$)

*able #0 "5o9" 35a3 35e e=ui3y:" value depend" on 35ree pri1ary 8a(3or" ,value #rivers.+ - 70pe(3a3ion" o8 8u3ure 8lo9". - Re=uired re3urn 3o e=ui3y. - Co11uni(a3ion 9i35 35e 1arke3.
#9

*5e"e 8a(3or" (an be "ubdivided in 3urn in3o re3urn on 35e inve"31en3, (o1pany gro935, ri"kE 8ree in3ere"3 ra3e, 1arke3 ri"k pre1iu1, opera3ing ri"k and 8inan(ial ri"k. Ko9ever, 35e"e 8a(3or" are "3ill very general. I3 i" very i1por3an3 35a3 a (o1pany iden3i8y 35e 8unda1en3al para1e3er" 35a3 5ave 1o"3 in8luen(e on 35e value o8 i3" "5are" and on value (rea3ion. Obviou"ly, ea(5 8a(3or:" i1por3an(e 9ill vary 8or 35e di88eren3 bu"ine"" uni3".

11$ S-eculative Bu''les on the Stoc5 Mar5et

*5e advo(a3e" o8 8unda1en3al analy"i" argue 35a3 "5are pri(e" re8le(3 8u3ure e0pe(3a3ion" upda3ed by ra3ional inve"3or". *5u", a "5are:" pri(e i" e=ual 3o 35e ne3 pre"en3 value o8 all 35e e0pe(3ed 8u3ure dividend". *5i" i" 35e "oE(alled 8unda1en3al value. In o35er 9ord", 35e "5are pri(e re8le(3" (urren3 earning" genera3ion plu" gro935 e0pe(3a3ion". *5e ad;e(3ive 8unda1en3al re8er" 3o 35e para1e3er" 35a3 in8luen(e 35e "5are pri(e+ in3ere"3 ra3e", gro935 e0pe(3a3ion", inve"31en3:" ri"k... !no35er group o8 35eorie" i" ba"ed on p"y(5ologi(al or "o(iologi(al be5avior", "u(5 a" ?eyne": Uani1al "piri3"U. !((ording 3o 35e"e 35eorie", "5are pri(e 8or1a3ion doe" no3 8ollo9 any ra3ional valua3ion rule bu3 ra35er depend" on 35e "3a3e" o8 eup5oria, pe""i1i"1... predo1ina3ing a3 any given 3i1e in 35e 8inan(ial (o11uni3y and in "o(ie3y in general. I3 i" 35e"e p"y(5ologi(al p5eno1ena 35a3 give 5ope 3o 35e (5ar3i"3"+ i8 1ood" do no3 (5ange 3oo o83en and inve"3or" value e=ui3y 3aking in3o a((oun3 35e "5are pri(e": pa"3 evolu3ion, one (an e0pe(3 35a3 "u((e""ive "5are pri(e" 9ill be (orrela3ed or 9ill repea3 in "i1ilar (y(le". *5e "pe(ula3ive bubble 35eory (an be derived 8ro1 8unda1en3al analy"i" and o((upie" a 1iddle ground be39een 35e above 39o 35eorie", 95i(5 "eek 3o a((oun3 8or 35e be5avior and evolu3ion o8 "5are pri(e". *5e 4I* pro8e""or Olivier 'lan(5ard developed 35e algebrai( e0pre""ion o8 35e "pe(ula3ive bubble, and i3 (an be ob3ained 8ro1 35e "a1e e=ua3ion 35a3 give" 35e 8or1ula nor1ally u"ed by 35e 8unda1en3ali"3". I3 "i1ply 1ake" u"e o8 35e 8a(3 35a3 35e e=ua3ion 5a" "everal "olu3ion", one o8 95i(5 i" 35e 8unda1en3al "olu3ion and ano35er i" 35e 8unda1en3al "olu3ion 9i35 a "pe(ula3ive bubble 3a(ked on3o i3. 'y vir3ue o8 35e la33er "olu3ion, a "5are:" pri(e (an be grea3er 35an i3" 8unda1en3al value ,Ne3 Pre"en3 Ialue o8 all 8u3ure dividend". i8 a bubble develop" "i1ul3aneou"ly, 95i(5 a3 any given 3i1e 1ay+ a. (on3inue 3o gro9, or b. bur"3 and vani"5. *o avoid 3iring our"elve" 9i35 e=ua3ion", 9e (an i1agine 35e bubble a" an e=ui3y overvalua3ion+ an inve"3or 9ill pay 3oday 8or a "5are a =uan3i3y 35a3 i" grea3er 35an i3" 8unda1en3al value i8 5e 5ope" 3o "ell i3 3o1orro9 8or a 5ig5er pri(e, 35a3 i", i8 5e 5ope" 35a3 35e bubble 9ill (on3inue gro9ing. *5i" pro(e"" (an (on3inue "o long a" 35ere are inve"3or" 95o 3ru"3 35a3 35e "pe(ula3ive bubble 9ill (on3inue 3o gro9, 35a3 i", inve"3or" 95o e0pe(3 3o 8ind in

+7

*5e (o11uni(a3ion 9i35 35e 1arke3 8a(3or no3 only re8er" 3o (o11uni(a3ion and 3ran"paren(y 9i35 35e 1arke3" in 35e "3ri(3 "en"e bu3 al"o 3o (o11uni(a3ion 9i35+ analy"3", ra3ing (o1panie", regula3ory agen(ie", board o8 dire(3or", e1ployee", (u"3o1er", di"3ribu3ion (5annel", par3ner (o1panie", "upplier", 8inan(ial in"3i3u3ion", and "5are5older".
IESE Business School-University of Navarra - /8

35e 8u3ure o35er 3ru"3ing inve"3or" 3o 95o1 35ey (an "ell 35e bubble ,"5are. 8or a pri(e 35a3 i" grea3er 35an 35e pri(e 35ey 5ave paid. 'ubble" 3end 3o gro9 during period" o8 eup5oria, 95en i3 "ee1" 35a3 35e 1arke3:" only po""ible 3rend i" up9ard". Ko9ever, 35ere (o1e" a day 95en 35ere are no 1ore 3ru"3ing inve"3or" le83 and 35e bubble bur"3" and vani"5e"+ "5are" re3urn 3o 35eir 8unda1en3al value. *5i" 35eory i" a33ra(3ive be(au"e i3 enable" 8unda1en3al 35eory 3o be "yn35e"i ed 9i35 35e e0i"3en(e o8 ano1alou" be5avior" ,8or 35e 8unda1en3ali"3". in 35e evolu3ion o8 "5are pri(e". 4any analy"3" 5ave u"ed 35i" 35eory 3o a((oun3 8or 35e 3re1endou" drop in "5are pri(e" on 35e Ne9 Qork "3o(k 1arke3 and on 35e o35er 9orld 1arke3" on #9 O(3ober #9%7. !((ording 3o 35i" e0plana3ion, 35e bur"3ing o8 a bubble 35a3 5ad been gro9ing over 35e previou" 1on35" (au"ed 35e "3o(k 1arke3 (ra"5. ! re(en3 "3udy per8or1ed by 35e Qale pro8e""or )5iller provide" 8ur35er eviden(e in "uppor3 o8 35i" 35eory. )5iller in3ervie9ed #000 in"3i3u3ional and priva3e inve"3or". *5e inve"3or" 95o "old be8ore 35e 'la(k 4onday "aid 35a3 35ey "old be(au"e 35ey 35oug53 35a3 35e "3o(k" 9ere already overvalued. Ko9ever, 35e 1o"3 "urpri"ing 8inding i" 35a3 1ore 35an 90T o8 35e in"3i3u3ional inve"3or" 95o did no3 "ell "aid 35a3 35ey 3oo believed 35a3 35e 1arke3 9a" overvalued, bu3 5oped 35a3 35ey 9ould be able 3o "ell be8ore 35e inevi3able do9n3urn. In o35er 9ord", i3 "ee1" 35a3 1ore 35an 90T o8 35e in"3i3u3ional inve"3or" 9ere a9are 35a3 a "pe(ula3ive bubble 9a" being 8or1ed E 35e "3o(k 9a" being "old 8or 1ore 35an i3" 8unda1en3al value E, bu3 3ru"3ed 35a3 35ey 9ould be able 3o "ell be8ore 35e bubble bur"3. !1ong 35e priva3e inve"3or" 95o did no3 "ell be8ore #9 O(3ober, 1ore 35an L0T "3a3ed 35a3 35ey al"o believed 35a3 35e "3o(k" 9ere overvalued.

9i:ure 8
*5e #929 !1eri(an )3o(k 4arke3 Cri"i"
&00 2/0 200 #/0 #00 /0 0 #E2L #E27 #E2% #E29 #E&0 #E&# #E&2 #E&& #E&4 #E&/ #E&L #E&7

9i:ure @
*5e )pani"5 )3o(k 4arke3 Cri"i" o8 O(3ober #9%7
&.L00 &.400 I'7X &/ &.200 &.000 2.%00 2.L00 2.400 2.200 2.000 0#E%7 0&E%7 0/E%7 07E%7 09E%7 ##E%7 0#E%% 0&E%% 0/E%% 07E%% 09E%% ##E%%
/@ - IESE Business School-University of Navarra

*5i" bur"3ing o8 a "pe(ula3ive bubble i" no3 a ne9 p5eno1enon in 5i"3ory. We (an 8ind re(en3 e0a1ple" in )pain in #974 and in 35e B)!+ ele(3roni( and 5ig5E3e(5 (o1panie" in #9L2, Ugood (on(ep3U (o1panie" in #970, and 5ou"e5old na1e (o1panie" 35roug5ou3 35e 70:". In 35e ele(3roni( (o1panie": bubble, 1any (o1panie": "5are" in #9L2 9ere 9or35 le"" 35an 20T 95a3 35ey 9ere 9or35 in #9L#. I'4:" "5are pri(e 8ell 8ro1 RL00- in #9L# 3o R&00 in #9L2S and *e0a" In"3ru1en3": "5are pri(e 8ell 8ro1 R200- 3o R/0. 7ven larger 9a" 35e bubble 35a3 gre9 in #970 around 35e Ugood (on(ep3U (o1panie"+ "everal o8 35e1 lo"3 99T o8 35eir value in 35e "pa(e o8 ;u"3 one year. Kou"e5old na1e (o1panie" al"o "u88ered "evere drop" in 35eir "5are pri(e" during 35e 70:"+ 4(>onaldJ" P7R 8ell 8ro1 %& 3o 9, )ony:" 8ro1 92 3o #7, and Polaroid:" 8ro1 90 3o #L, 3o give ;u"3 a 8e9 e0a1ple". )pe(ula3ive bubble" (an al"o develop ou3"ide o8 35e "3o(k 1arke3. One o83enE=uo3ed e0a1ple i" 35 35a3 o8 35e >u3(5 3ulip" in 35e #7 Cen3ury. !n unu"ual "3rain o8 3ulip" began 3o be(o1e in(rea"ingly "oug53 a83er and i3" pri(e ro"e (on3inuou"ly... In 35e end, 35e 3ulip": pri(e re3urned 3o nor1al level" and 1any people 9ere ruined. *5ere 5ave al"o been 1any "pe(ula3ive bubble" in 35e real e"3a3e bu"ine"". *5e "3ory i" al9ay" 35e "a1e+ pri(e" 3e1porarily ro(ke3 up9ard" and 35en re3urn 3o Fnor1alG level". In 35e pro(e"", 1any inve"3or" 95o 3ru"3 35a3 35e pri(e 9ill (on3inue 3o ri"e lo"e a lo3 o8 1oney. *5e proble1 9i35 35i" 35eory, a" 9i35 1any o8 35e e(ono1i( in3erpre3a3ion", i" 35a3 i3 provide" an ingeniou" e0plana3ion 3o a((oun3 8or even3" a po"3eriori bu3 i3 i" no3 very u"e8ul 8or providing 8ore(a"3" abou3 35e (our"e 35a3 "5are pri(e" 9ill 8ollo9 in 35e 8u3ure. For 35i", 9e 9ould need 3o kno9 5o9 3o de3e(3 35e bubble and predi(3 i3" 8u3ure (our"e. *5i" 1ean" being able 3o "epara3e 35e "5are pri(e in3o 39o (o1ponen3" ,35e 8unda1en3al value and 35e bubble. and kno9ing 35e nu1ber o8 inve"3or" 95o 3ru"3 35a3 35e bubble 9ill (on3inue 3o gro9 ,5ere 1any (5ar3i"3" (an be in(luded.. W5a3 35e 35eory doe" re1ind u" i" 35a3 35e bubble (an bur"3 a3 any 3i1e. Ki"3ory "5o9" 35a3, "o 8ar, all 35e bubble" 5ave even3ually bur"3. *5e only "ure re(ipe 3o avoid being 3rapped in a "pe(ula3ive bubble i" 3o no3 en3er i3+ 3o never buy 95a3 "ee1" 3o be e0pen"ive, even i8 advi"ed 3o do "o by (er3ain Ue0per3"U, 95o appeal 3o e"o3eri( 3enden(ie" and 35e 8ooli"5ne"" or ra"5ne"" o8 o35er inve"3or".

1/$ Most Valuations

CoAAon

Errors

in

*5e 8ollo9ing li"3 (on3ain" 35e 1o"3 (o11on error" 35a3 35e au35or 5a" de3e(3ed in 35e 1ore 35an one 35ou"and valua3ion" 5e 5a" 5ad a((e"" 3o in 5i" (apa(i3y a" bu"ine"" (on"ul3an3 or pro8e""or ,"ee Fernnde and Carabia", 200L.+

IESE Business School-University of Navarra - /<

!he Aost coAAon errors are in italic

50 E**$* i) t!( 'i c$u)t *at( ca#cu#ati$) a)' c$)c(*)i), t!( c$4+a)y? *i >i)( AB C on& isk/% ee ate used %o the valuation +B $sin& the histo i#al ave a&e o% the isk/% ee ateB 4B $sin& the sho t/te ! 8ove n!ent ateB 0B C on& #al#ulation o% the eal isk/% ee ateB BB C on& beta used %o the valuation +. Using the historical industry beta, or the average of the betas of similar companies, when the result goes against common sense. 4B $sin& the histo i#al beta o% the #o!pan* <hen the esult &oes a&ainst #o!!on senseB 0B Assu!in& that the beta #al#ulated % o! histo i#al data #aptu es the #ount * iskB -B Using the wrong formulae for levering and unlevering the beta. ,B A &uin& that the best esti!ation o% the beta o% a #o!pan* % o! an e!e &in& !a ket is the beta o% the #o!pan* <ith espe#t to the SHP ,..B 3B When valuing an acquisition, using the beta of the acquiring company. "B C on& !a ket isk p e!iu! used %o the valuation +B The required market risk premium is equal to the historical equity premium. 4B The equi ed !a ket isk p e!iu! is equal to =e oB 0B Assu!e that the equi ed !a ket isk p e!iu! is the e'pe#ted isk p e!iu!B DB C on& #al#ulation o% CA"" +B C on& de%inition o% CA""B 4B The debt to equity ratio used to calculate the W !! is different from the debt to equity ratio resulting from the valuation. 0B $sin& dis#ount ates lo<e than the isk/% ee ateB -B $sin& the statuto * ta' ate5 instead o% the e%%e#tive ta' ate o% the leve ed #o!pan*B ,B "aluing all the different businesses of a diversified company using the same W !! #same leverage and same $e%. 3B "onside in& that CA"" / >+/T@ is a easonable etu n %o the #o!pan*1s stakeholde sB 6B Using the wrong formula for the W !! when the value of debt is not equal to its book value. 2B "al#ulatin& the CA"" assu!in& a #e tain #apital st u#tu e and dedu#tin& the outstandin& debt % o! the ente p ise valueB 7B "al#ulatin& the CA"" usin& book values o% debt and equit*B +.B "al#ulatin& the CA"" usin& st an&e %o !ulaeB EB C on& #al#ulation o% the value o% ta' shields +B &iscounting the tax shield using the cost of debt or the required return to unlevered equity. 4B Odd o ad/ho# %o !ulaeB )B C on& t eat!ent o% #ount * isk +B 'ot considering the country risk, arguing that it is diversifiable. 4B Assu!in& that a disaste in an e!e &in& !a ket <ill in# ease the beta o% the #ount *1s #o!panies #al#ulated <ith espe#t to the SHP ,..B 0B Assu!in& that an a& ee!ent <ith a &ove n!ent a&en#* eli!inates #ount * iskB -B Assu!in& that the beta p ovided b* Ma ket 8uide <ith the Bloo!be & adjust!ent in#o po ates the illiquidit* isk and the s!all #ap p e!iu!B ,B Odd #al#ulations o% the #ount * isk p e!iu!B 8B In#ludin& an illiquidit*5 s!all/#ap5 o spe#i%i# p e!iu! <hen it is not app op iate +B In#ludin& an odd s!all/#ap p e!iu!B 4B In#ludin& an odd illiquidit* p e!iu!B 0B In#ludin& a s!all/#ap p e!iu! equal %o all #o!paniesB -0 E**$* %!() ca#cu#ati), $* "$*(ca ti), t!( (;+(ct(' ca ! "#$% AB C on& de%inition o% the #ash %lo<s +B )o &ettin& the in# ease in Co kin& "apital Requi e!ents <hen #al#ulatin& #ash %lo<sB 4.!onsidering the increase in the company(s cash position or financial investments as an equity cash flow. 0B Errors in the calculation of the taxes that affect the )!). -B Expected Equity !ash )lows are not equal to expected dividends plus other payments to shareholders #share repurchases*% ,B "onside in& net in#o!e as a #ash %lo<B 3B "onside in& net in#o!e plus dep e#iation as a #ash %lo<B BB E o s <hen valuin& seasonal #o!panies +B Wrong treatment of seasonal working capital requirements. 4B Wrong treatment of stocks that are cash equivalent. 0B C on& t eat!ent o% seasonal debtB "B E o s due to not p oje#tin& the balan#e sheets +B )orgetting balance sheet accounts that affect the cash flows. 4B "onside in& an asset evaluation as a #ash %lo<B 0B Inte est e'penses not equal to D :dB DB Exaggerated optimism when forecasting cash flows

/> - IESE Business School-University of Navarra

70 E**$* i) t!( ca#cu#ati$) $" t!( *( i'ua# &a#u( AB +nconsistent cash flow used to calculate perpetuity. BB The debt to equit* atio used to #al#ulate the CA"" to dis#ount the pe petuit* is di%%e ent % o! the debt to equit* atio esultin& % o! the valuationB "B $sin& ad ho# %o !ulas that have no e#ono!i# !eanin&B DB Using arithmetic averages instead of geometric averages to assess growth. EB "al#ulatin& the esidual value usin& the < on& %o !ulaB )B Assu!e that a pe petuit* sta ts a *ea be%o e it eall* sta tsB 80 I)c$) i t()ci( a)' c$)c(+tua# (**$* AB "on#eptual e o s about the % ee #ash %lo< and the equit* #ash %lo< +B !onsidering the cash in the company as an equity cash flow when the company has no plans to distribute it. 4B Using real cash flows and nominal discount rates, or vice,versa. 0B The % ee #ash %lo< and the equit* #ash %lo< do not satis%* E") I )") D JD K Int >+/T@B BB E o s <hen usin& !ultiples +B Using the average of multiples extracted from transactions executed over a very long period of time. 4B Using the average of transactions multiples that have a wide scatterB 0B $sin& !ultiples in a <a* that is di%%e ent to thei de%initionB -B $sin& a !ultiple % o! an e't ao dina * t ansa#tionB ,B $sin& ad ho# valuation !ultiples that #on%li#t <ith #o!!on senseB 3B $sin& !ultiples <ithout usin& #o!!on senseB "B Ti!e in#onsisten#ies +B Assu!in& that the equit* value <ill be #onstant %o the ne't %ive *ea sB 4B The equity value or the enterprise value does not satisfy the time consistency formulae. DB Othe #on#eptual e o s Aot #onside in& #ash %lo<s esultin& % o! %utu e invest!entsB "onside in& that a #han&e in e#ono!i# #onditions invalidates si&ned #ont a#tsB !onsidering that the value of debt is equal to its book value when they are different. Aot usin& the #o e#t %o !ulae <hen the value o% debt is not equal to its book valueB +ncluding the value of real options that have no economic meaning. )o &ettin& to in#lude the value o% non/ope atin& assetsB In#onsisten#ies bet<een dis#ount ates and e'pe#ted in%lationB (aluin& a holdin& #o!pan* assu!in& pe !anent losses ><ithout ta' savin&s@ in so!e #o!panies and pe !anent p o%its in othe sB 7B Wrong concept of the optimal capital structure. +.B In !atu e #o!panies5 assu!in& p oje#ted #ash %lo<s that a e !u#h hi&he than histo i#al #ash %lo<s <ithout an* &ood easonB ++B ssumptions about future sales, margins, etc. that are inconsistent with the economic environment, the industry outlook, or competitive analysis. +4B !onsidering that the -.E is the return to the shareholders. +0B "onside in& that the ROA is the etu n o% the debt and equit*holde sB +-B $sin& di%%e ent and in#onsistent dis#ount ates %o #ash %lo<s o% di%%e ent *ea s o %o di%%e ent #o!ponents o% the % ee #ash %lo<B +,B $sin& past !a ket etu ns as a p o'* %o equi ed etu n to equit*B +3B Addin& the liquidation value and the p esent value o% #ash %lo<sB +6B $sin& ad ho# %o !ulas to value intan&iblesB +2B A &uin& that di%%e ent dis#ounted #ash %lo< !ethods p ovide di%%e ent valuationsB +7B C on& notion o% the !eanin& o% the e%%i#ient !a ketsB 4.B Appl*in& a dis#ount <hen valuin& dive si%ied #o!paniesB 4+B C on& a bit a&e a &u!entsB 44B Addin& a #ont ol p e!iu! <hen it is not app op iateB 90 E**$* %!() i)t(*+*(ti), t!( &a#uati$) AB !onfusing "alue with /rice. BB Asse tin& that Lthe valuation is a s#ienti%i# %a#t5 not an opinionMB "B A valuation is valid %o eve *bod*B DB company has the same value for all buyers. EB "on%usin& st ate&i# value %o a bu*e <ith %ai !a ket valueB )B !onsidering that the goodwill includes the brand value and the intellectual capitalB 8B )o &ettin& that a valuation is #ontin&ent on a set o% e'pe#tations about #ash %lo<s that <ill be &ene ated and about thei iskinessB 9B A%%i !in& that Na valuation is the sta tin& point o% a ne&otiationMB IB A%%i !in& that Na valuation is ,.? a t and ,.? s#ien#eMB <0 O*,a)i@ati$)a# (**$* AB Makin& a valuation <ithout #he#kin& the %o e#asts !ade b* the #lientB BB !ommissioning a valuation from an investment bank without having any involvement in it. "B Involvin& onl* the %inan#e depa t!ent in valuin& a ta &et #o!pan*B +B 4B 0B -B ,B 3B 6B 2B

IESE Business School-University of Navarra - /=

%eferences
'realey, R.!. and ).C. 4yer" ,2000., FPrin(iple" o8 Corpora3e Finan(e,G L35 edi3ion, 4(Ara9E Kill, Ne9 Qork. Copeland, *. 7., *. ?oller and J. 4urrin ,2000., FIalua3ion+ 4ea"uring and 4anaging 35e Ialue o8 Co1panie"G, &rd edi3ion, Wiley, Ne9 Qork. Copeland and We"3on ,#9%%., FFinan(ial *5eory and Corpora3e Poli(y$G &rd edi3ion, !ddi"onE We"ley, Reading, 4a""a(5u"e33". Fau", Jo"ep ,#99L., FFinan a" opera3iva",G 'iblio3e(a I7)7 de Ae"3i@n de 71pre"a", 7di(ione" Folio. Fernnde , Pablo ,200#a., FIn3erne3 Ialua3ion"+ *5e Ca"e o8 *erraEHy(o"G, ))RN Working Paper n. 2L/L0%. Fernande , Pablo ,200#b., FIalua3ion u"ing 1ul3iple". Ko9 do analy"3" (on(lu"ion"[,G ))RN Working Paper n. 274972. rea(5 35eir

Fernnde , Pablo ,200#(., FIaluing real op3ion"+ 8re=uen3ly 1ade error",G ))RN Working Paper n. 274%//. Fernnde , Pablo ,2002., FIalua3ion 4e35od" and )5are5older Ialue Crea3ion$G !(ade1i( Pre"", )an >iego, C!. Fernnde , Pablo ,2004., F*5e Ialue o8 *a0 )5ield" i" NO* 7=ual 3o 35e Pre"en3 Ialue o8 *a0 )5ield",G %ournal o& Financial Econo'ics, Iol. 7&C#, ,July., pp. #4/E#L/. Fernnde , Pablo ,2004b., FIaluing Co1panie" by Ca"5 Flo9 >i"(oun3ing+ *en 4e35od" and Nine *5eorie",U ))RN Working Paper n. 2/L9%7. Fernnde , Pablo and Jo"e 4aria Carabia" ,200L., F9L Co11on and Bn(o11on 7rror" in Co1pany Ialua3ion,G ))RN Working Paper n. %9/#/#. 4iller, 4.K. ,#9%L., F'e5avioral Ra3ionali3y in Finan(e+ *5e Ca"e o8 >ividend",G %ournal o& (usiness, No. /9, o(3ober, pp. 4/#E4L%. )oren"en, 7. K. and >.!. Willia1"on ,#9%/., F)o1e eviden(e on 35e value o8 35e dividend di"(oun3 1odel,G Financial )nalysts %ournal, 4#, pp. L0EL9.

4? - IESE Business School-University of Navarra