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Business valuation

Valuation of IT-companies in the area of Jönköping

Written by Emma Jonsson, Linda Samuelsson

Paper category

Master Thesis

Subject

Business Administration>Finance

Year

2008

Abstract

Master Thesis: Commercial valuation methods Each valuation must be subjectively estimated, which will affect the final value. Some factors are related to the useful life of the asset, future prospects and capital cost requirements. The motivations of buyers and sellers also affect the value of the company. Due to rationalization of benefits and synergies, the acquirer may be willing to pay a high price, see section 3.1.3. Due to lack of money, sellers may be willing to sell quickly at low prices (Holmström, 2005). Appraisers also need to add other information, such as industry data, relevant economic information, market data on similar transactions, and the available rate of return on similar ventures (Mellen & Sullivan, 2007). It is difficult to conduct internal analysis of the company because only external information is provided in the public annual report. Here, one should consider factors such as the status quo, environment, market, competitors, accounts, and press releases (Holmström, 2005). 3.4.1 Net asset value method When using the net asset value method, the company's assets are valued separately. The net asset value in the balance sheet is taxable equity and untaxed reserves minus deferred income tax liabilities (Gorton, 2002). The value of specific assets and liabilities is subsequently adjusted based on the difference between the book value and the market value. To perform this kind of valuation, the starting point must be the assumption that the company is a going concern (Öhrlings Pricewa-terhouse Coopers Gruppen AB, 2005). Valuation can be done in two ways. If the business is closed, the assets will be valued based on the value of sales, or they can be valued based on the cost of the buyer's purchase of equivalent assets to continue the business (Gorton, 2002). The value of each stock is called the net asset value (NAV) and is calculated according to the formula (Bodie, Kane, Marcus, Perrakis & Ryan, 2005); for knowledge-based and service-oriented companies, asset valuation is more complicated. In these companies, most of the assets are intangible and are not included in the net asset value. A good method for assessing human capital has not been developed yet. However, many companies try to evaluate the value of their most important employees by using the present value calculation of future wages (Holmström, 2005). According to Gorton (2002), the net asset value method seems most useful when the buyer intends to close the business and sell a single asset. On the other hand, Lundén & Ohlsson (2007) pointed out that it is common to start valuing companies using the net asset value method. This is to compare the value of using the net asset method with the value received when using other valuation methods (Lundén & Ohlsson, 2007). 3.4.2 Net present value method Capital budgeting is an attempt to determine whether an investment will exceed its cost once its value is in place. Net present value (NPV) is a measure of how much value is created or added through investment today. The capital budgeting process can be seen as a process of finding positive NPV. The risk of NPV is that there is no guarantee that the estimated results are correct. In addition, it is easier to make investment decisions when the market contains other assets similar to the asset under consideration. The situation becomes complicated when market prices for roughly comparable investments cannot even be observed (Ross, Westerfield, and Jordan 2008). According to Lundén & Ohlsson (2007), the net present value method is mainly used for knowledge-intensive companies, where the balance sheet does not include many assets. Profits are based on things other than employees, business ideas, markets, or balance sheets. However, when valuing companies that experience losses, the net present value method is not available. When valuing these companies, other valuation methods must be used (Lundén & Ohlsson, 2007). When valuing companies based on NPV, basic discounted cash flow (DCF) is used to estimate future cash flows (Ross, Westerfield, and Jordan, 2008). 3.4.3 Relative valuation method Relative valuation focuses on valuing assets based on the pricing of similar assets in the market at the time (Damodaran, 2001a and Öhrlings PricewaterhouseCoopers Gruppen AB, 2005). The model consists of two components. First, prices must always be standardized, converting them into multiples of earnings, book value, or sales, and valuing assets in a relative manner. Second, there are no identical companies in the market, which means that it is difficult to find similar companies in the same industry because of differences in risk, growth potential and cash flow (Damodaran, 2001b). Compared with the DCF valuation, multiple P/E ratios (P/E) are used: P/E ratio is the ratio of the stock price to last year's earnings per share. It reports how much stock buyers must pay for every dollar of earnings the company generates. It varies greatly between different companies. When using the P/E ratio, it is important to consider the company's long-term prospects and current earnings per share relative to the long-term trend line. The high price-earnings ratio indicates that the company has good growth opportunities. It can also be said that riskier stocks have lower P/E ratios (Bodie et al. 2005). The P/E calculation formula is (Damodaran, 2001b); Book Value (PBV): The estimate of the value of an enterprise usually differs greatly between the content provided by the market and the content provided by the accountant. Read Less