Valuation

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VALUATION TECHNIQUES

Vault Guide to Finance Interviews Valuation Techniques

How Much is it Worth?
Imagine yourself as the CEO of a publicly traded company that makes widgets. You’ve had a highly successful business so far and want to sell the company to anyone interested in buying it. How do you know how much to sell it for? Likewise, consider the Bank of America acquisition of Fleet. How did B of A decide how much it should pay to buy Fleet? For starters, you should understand that the value of a company is equal to the value of its assets, and that Value of Assets = Debt + Equity or Assets = D + E If I buy a company, I buy its stock (equity) and assume its debt (bonds and loans). Buying a company’s equity means that I actually gain ownership of the company – if I buy 50 percent of a company’s equity, I own 50 percent of the company. Assuming a company’s debt means that I promise to pay the company’s lenders the amount owed by the previous owner. The value of debt is easy to calculate: the market value of debt is equal to the book value of debt. (Unless the debt trades and thus has a real “market value.” This information, however, is hard to come by, so it is safe to use the book value.) Figuring out the market value of equity is trickier, and that’s where valuation techniques come into play. The four most commonly used techniques are: 1. 2. 3. 4. Discounted cash flow (DCF) analysis Multiples method Market valuation Comparable transactions method

Generally, before we can understand valuation, we need to understand accounting, the language upon which valuation is based.

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Vault Guide to Finance Interviews Valuation Techniques

Basic Accounting Concepts
Before we look at these valuation techniques, let’s take a look at basic accounting concepts that underpin valuation. MBAs interested in finance careers should definitely be comfortable with these concepts (and may find this overview to be very basic). Undergrads who have taken accounting classes should already be familiar with these concepts as well. Basic overview of financial statements There are four basic financial statements that provide the information you need to evaluate a company: • Balance Sheets • Income Statements • Statements of Cash Flows • Statements of Retained Earnings These four statements are provided in the annual reports (also referred to as “10Ks”) published by public companies. In addition, a company’s annual report is almost always accompanied by notes to the financial statements. These notes provide additional information about each line item of numbers provided in the four basic financial statements. The Balance Sheet The Balance Sheet presents the financial position of a company at a given point in time. It is comprised of three parts: Assets, Liabilities, and Shareholder’s Equity. Assets are the economic resources of a company. They are the resources that the company uses to operate its business and include Cash, Inventory, and Equipment. (Both financial statements and accounts in financial statements are capitalized.) A company normally obtains the resources it uses to operate its business by incurring debt, obtaining new investors, or through operating earnings. The Liabilities section of the Balance Sheet presents the debts of the company. Liabilities are the claims that creditors have on the company’s resources. The Equity section of the Balance Sheet presents the net worth of a company, which equals the assets that the company owns less the debts it owes to creditors. In other words, equity is comprised of the claims that investors have on the company’s resources after debt is paid off.

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Vault Guide to Finance Interviews Valuation Techniques

The most important equation to remember is that Assets (A) = Liabilities (L) + Shareholder’s Equity...
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