Business valuation

BY:
CPA KIBHULI MWITA, BAF(MU), CPA(T), CPB(IP).
Welcome to Business valuation
• “There are two fools in
every market. The one
who charges very high
price and the other
who charges a very low
price”.
• The same applies to the
business valuation.
Introduction
• Business Valuation is vital function of the owner of
the business to know the worth of its business or
for the buyer to know the minimum price to offer.
• Business valuation involves assigning of value to
various assets own by the business and weighting
the liabilities of the business.
• In business valuation, the owner may be interested
to know the value of business as whole or just the
value of his capital portion in the entity.
Definition
• Business valuation is the process of determining the
price of business.

• Those business can be either quoted or unquoted

companies.
• Thus, the reason for valuing the business can be
different for those two types of the companies.
Reasons for business valuation-
for quoted companies
• Quoted company they are already have a share
price valuation available in the stock market.

• The only reason for valuation of quoted company is

when there is a takeover bid- To know how much
to offer as a bidder.
Reasons for business valuation
– for unquoted companies
• Valuation of unquoted business is required for the
following reasons:-
• 1. Conversion into a public limited company
• When a company comes to the stock market for the first
time, an issue price for the share has to be decided.
• The business valuation will help to establish the value of
the company as whole and the divide it with the total
authorised number of shares to arrive at the price per
shares.
Reasons for business valuation
– for unquoted companies
• 2. Sells of unquoted company
• Different people can place different value to the
business depending on the reason for selling and buying
the business.

• Business valuation helps the seller to decide the

minimum price is willing to accept and

• Business valuation helps the buyer to decide the

maximum price is willing to pay.
Reasons for business valuation
– for unquoted companies
• 3. Existence of merger
• Merger exist when two or more companies comes
together to carry out business as a single entity.

• Before engaging into the merger, the terms and

condition need to be agreed upon such how are they
going to share profit or loss, capital structure of the
business.

• Business valuation is needed as a basis for deciding on

the term of the merger.
Reasons for business valuation
– for unquoted companies
• 4. Establishment of tax liability
• When a shareholder of unquoted company dies,
valuation is needed for purpose of establishing the tax
liability on his estate(death tax) or inheritance tax.
Information needed for business
valuation
• There is a wide range of information required in
order to value a business:-
• Financial statements
• Non- current asset register
• Aged account receivable summary
• Aged account payable summary
• Details of any existing contracts
• List of shareholders
• Budgets and projections
Business valuation basis
• There are several bases of valuation some of them
are: -
• Net asset basis

• Dividend based valuation

• Discounted cash flow valuation

• Earning based valuation

Net asset basis
• Uses the tangible assets and liabilities of the
business as a valuation basis
• Very useful for asset stripping and identification of
minimum price in a takeover
• Net asset basis can be further divided into: -

• Book value

• Realisable value

• Replacement value
Net asset basis
• Book value
• This approach uses the book value of assets and
liabilities and is used to provide the minimum value of
the target company.
• Book value does not bear any resemblance to a
company’s current value
• Any intangible assets such as internal generated
goodwill and the value of company’s human capital are
ignored because they are not included in the statement
of financial position
Example 1
• The following is extract statement of DH limited for the year
ended 31st December 2020
• Assets
• Property, Plant and Equipment 300,000,000
• Investment property 20,000,000
• Receivable 27,500,000
• Cash and cash equivalents 12,500,000
• Long term borrowing 22,500,000
• Short term borrowings 8,000,000
• Trade payable 2,000,000
• Required: Calculate the value of the business
Net asset basis
• Net realisable value
• May be used when the asset of the companies are
valuables and their current disposable value might be
more than the expected future dividends or earnings
that the company will provide from using the assets.

• This approach is appropriate if the intention for the

business valuation is to liquidated the business and
realised all assets controlled by the company.

• The liquidation approach assumes that the company can

never be worth less than its break up basis
Net asset basis
• Replacement value
• This approach measures the value of the net assets at
their cost of acquisition on the open market and likely to
be more accurate than book value.

• However, it will still undervalue the company as

intangible asset will be excluded.

• The major limitation is that it is very difficult to identify

and value individual assets and liabilities.
Income based valuation
• Under this method, valuer focus on future earning
ability as a basis of valuing a business.

• Income based valuation include:-

• Price earning ratio method and

• Earning yield method.

Price earnings ratio method
• Refer to a ratio of market value of share to the
annual earnings per share.
• For the quoted companies, there is already price
earning ratio in the market hence it simple to value
them.
• But in case of unquoted companies, a suitable
price earning ration need to be established by the
valuer and will be used to value the business.
Price-earning ratio method
•
• Price earnings ratio method is suitable for valuation
of:
• Private company seeking a stock valuation for the first
time

• Company for the purpose of takeover.

Price- earning ratio method
• Advantages of this method are :-

• Simplicity and

• Provides a useful benchmark valuation for negotiation in

a takeover
Price-earning ratio method
• Weakness of this method are: -
• It is based on subjective opinion on estimation of the
price earning ratio to be used to value unquoted
companies
• It is based on accounting measures (accounting profit)
and not cash flow.
Example 2
• DreamHut is a private company with TZS 450,000 as
earning for the precious year and this earning is
expected to increase to TZS 540,000 in the coming
year. Similar company those shares are quoted in
the stock exchange have a P/E ratio of 10.0.

• Required:
• Calculate the value of Dreamhut.
Earning yield method
• A company share is valued using its annual earnings
and a suitable earning yield.

• It is suggested that, it is better to select a suitable

earning yield which is higher than earning yield for
the similar quoted company to allow for the higher
risk of investing in a private company.
Example 3
• The earnings of BAF Ltd, a private company, were
TZS 9,000,000 last year. Stock market companies in
the same industry provide an earnings yield of
about 9% to their shareholders.
• Required:
• Using the earnings yield method of valuation,
suggest a suitable valuation for the BAF Ltd.
Example 4
• Company A has earnings of TZS300,000,000.
A similar listed company has an earnings yield
of 12.5%.
Company B has earnings of TZS420,500,000.
A similar listed company has a P/E ratio of 7.

• Required:
Estimate the value of each company.
Dividend valuation method
• Under this method, valuers focus on future divided
to be paid by the company to the shareholders as a
basis of valuing the company.

• Dividend valuation approach includes:-

• Dividend valuation with constant annual dividends

• Dividend valuation with constant rate of growth in

annual dividend.
Dividend valuation model with
constant annual dividend
• Basic assumption with dividend valuation model is
that the value of shares to shareholders is the value
of future dividends that they expect to received
from those shares in the future.
• The value of the shares is obtained by discounting
the future dividends to a present value at the
shareholders cost of capital.

• Note: cum -dividend price valuation equal to ex-

dividend price plus the current dividend.
Example 5
Kinax Ltd is expected to pay an annual dividend of 850 cents
per share into the foreseeable future and the shareholders’
cost of capital is 12%. The most recent annual dividend has
just been paid.
Required:
a) Using the dividend valuation model, suggest what the
value of the shares should be.
b) Show how this valuation would change if the expected
annual dividend in future years is 995 cents.
c) Show how this valuation would change if the expected
annual dividend in future years is 850 cents but the cost of
equity capital is 12.5%
Dividend valuation model with constant
growth rate in annual dividend.
• Major assumption is that the shareholders expect
annual dividend to grow at a constant annual
percentages rate.

• Therefore, the value of shares can be calculated by

taking future dividend divided by the differences
between shareholders cost of capital and growth
rate.
Example 6
• Kinax has just paid an annual dividend of 850 cents
per share. Dividends are expected to grow by 4%
each year in foreseeable future. The shareholder’s
cost of capital is 12%.
• Required:
• Calculate the expected value of share
Example 7
• The share price of BAF Ltd is currently TZS 400. The cost of
equity capital is 12%. The annual dividend has just been paid. It
is expected that the annual dividend next year will be 200 cents
per share and that annual dividends will then grow at a
constant annual rate into the foreseeable future.
• Required:
(a) Calculate the expected annual growth rate in dividends from
next year onwards.
(b) Due to unforeseen circumstances, Investors now expect that
the annual dividend next year will be 10% lower than previously
expected, and that annual growth in dividends in subsequent
years will be only 4%. Calculate the price that should now be
expected for shares in BAF Ltd.
Example 8
• A company paid a dividend of TZS25,000,000 this
year. The current return to shareholders of
companies in the same industry is 12%, although it
is expected that an additional risk premium of 2%
will be applicable to the company, being a smaller
and unquoted company.
• Compute the expected valuation of the company, if:
(a) The current level of dividend is expected to
continue into the foreseeable future, or
(b) The dividend is expected to grow at a rate of
4% pa into the foreseeable future.
Example 9
• A company has the following financial
information available:
• Share capital in issue: 4 million ordinary shares at a
par value of TZS50.
• Current dividend per share (just paid) TZS24.
• Dividend four year ago TZS15.25.
• Current equity beta 0.80.
• Current market return 15%.
• Risk-free rate 8%.
Required:
Find the market capitalization of the company.
Cash flows Valuation method
• This an income based approach that is truly future
oriented.
• The value of the company is obtained by taking the
present value of the future earnings and adding
this number to the present value of the terminal
value.
• Discounted cash flow method requires actual
projection of the future cash flows and do not
permit the use of the past figure in the analysis.
Cash flows valuation method
• Steps for using the discounted cash flow method are: -
• Determine the appropriate discount rate

• Project the amount and timing of future cash flows for at least five
years

• Determine the terminal value at the end of the projection period

by capitalizing the final earnings

• Discount the future earnings and the terminal value to the present
using the appropriate discount rate.

• Add the discounted future earnings and discounted terminal value

to determine the total value of the business
When is the discounted cash
flow method appropriate?
• Situations in which you should consider using the
discounted cash flow method includes: -
• Purchases or sales of the business

• Regular and irregular cash flow can be projected

• Start-up companies with no earning history

• Rapidly growing businesses

• Damage cases that involves a loss of income

• Other litigation such as dissenting shareholders cases

Example 10
• DH Ltd is considering the acquisition of 100% of IDM, a private company.
It is expected that if the takeover bid is successful, it will be necessary to
invest TZS 6 million immediately in capital equipment which will qualify
for capital allowances at an annual rate of 25% by the straight-line
method. This equipment will have no expected residual value.
• It is expected that annual cash profits of the acquired company would
be TZS 1 million in the first year, rising to TZS 2 million in the second
year, TZS 3 million in the third year and TZS 4 million in the fourth and
subsequent years.
• Taxation is 30% and is payable in the same year as the profits to which
they relate. The cost of capital for evaluating the acquisition is 14%.
• Required
• What is the maximum price that DH Ltd should offer to acquire the
whole of IDM?
Take home
• Go and read on:-
• Discounted free cash flow
• Shareholders value analysis(SVA)
• Economic value Added(EVA)
Thank you for listening…….
• ANNOUNCEMENT

• TEST TWO ON ACC 221

WILL BE HELD ON
THURSDAY(28/06/2022
FROM 2000HRS.

• BETTER BE PREPARED