Business Valuation Assignment Defining Different Estimation Techniques

Question

Task: A firm’s value is the discounted value of its future cash flows. A firm’s market value is the total value of its outstanding securities. Discuss to what extent you believe the forecast of business / industry growth can aid to firm value measurements and predictions.

The tutor has given this essay is such a format that no one could make it from different means so that’s why the tutor expects us to study the different types of valuation method and divide the valuation methods

• The valuation methods which are depend on future cash flows
• The valuation methods which are depended of market values

For example types of valuation methods

• Dividend growth model
• Asset Valuation method etc

And see if these valuation methods really are useful to determine the companies growth or not, like an argument and take a side or be neutral.

Please follow these points this is the real meaning of the question which my tutor has given.

Answer

Introduction
Consideration of appropriate business valuation method in this business valuation assignment is important for identifying the economic value of a business. It is essential to a business to develop an economic value for enhancing organizational competitiveness in the market. A corporate business valuation helps to identify investment and security of assets for enhancing future earnings-generating capacity. The current study has focused on the critical description of corporate valuation methods and all methods have been applied by considering proper examples. Two anatomies of corporate valuation techniques including cash-based method and market value-based methods have been discussed in the study.

Discussion
Different Corporate Valuation Methods: Valuation Methods based on future Cash Flows
Dividend Growth/Discount Model: As stated by Belo et al., (2015), the dividend-growth model focuses on the fair value of the stock by considering the premises that dividend has grown either at a stable or different rate over various times. The undervaluation and overvaluation of stock have been easily identified based on the dividend growth model and it helps to identify whether a stock is good for buying or selling in the market. As mentioned by Sim and Wright, (2017), the key rationale of this model is the valuation of the present value of dividend cash flows is a fair estimation of the worth of stock. This model is worldwide accepted as it focuses on the time value of money and expected dividends of a company have been considered based on the growth rate. Hence, future growth estimation regarding a specific industry helps to measure business value and organizational performance has been developed. As based on a future estimation of industrial growth, a company can identify over and undervaluation of stock and future strategies can be adopted. The step, which is needed to be adopted by a company, can be identified by value measurement. As mentioned by Lazzati and Menichini, (2015), the identification of a stable growth rate of dividend is a key problem to apply this model. This is because operating performance in the modern business world is changing quickly for maintaining business consistency and it can be said that stable growth rate maintenance is not possible in the competitive business environment. Hence, business value measurement cannot provide appropriate result always in the current competitive business environment. Nevertheless, the overall discussion says that Dividend growth model is important to determine the growth of a company.

Discounted Cash Flow Method: As depicted by Dewasiri and Banda, (2015), discounted cash flow method of business valuation helps to identify the value of an investment based on cash flows in future. This is because discounted cash flow considers the time value of money, which ensures the actual present value of an investment, and the actual project return can be easily identified. The key factor of this model illustrated within this business valuation assignment is the cost of capital and it has been identified by Capital Asset pricing model developed by Sharpe and Linter. This model is worldwide accepted as a risk-free return and risk premium both have been considered in the model for identifying discounted cash flow. As stated by Boularhmane and Aboulaich, (2016), the discounted cash flow method is essential to a business enterprise as it helps to identify the actual value of an investment and industrial growth has been ensured. On the negative side, Copiello, (2016), has stated that discounted cash flow method cannot provide fruitful result in case of business value measurement as consideration of the risk-free rate of return is not accurate and it fluctuates on daily basis. Hence, the concept of discounted cash flow method has been accepted positive and adversely from both aspects. Nevertheless, as the time value of money has been considered in the technique, it helps to measure business value and growth prospects effectively. Forecasting of industrial or business growth helps to estimate future and it assists to enhance business value measurement and predictions.

Different Corporate Valuation Methods discussed in this business valuation assignment based on market value
Asset Valuation method: As mentioned by Hermoza and Molina, (2017), the asset valuation process of a business enterprise includes intangible and tangible items both for identifying the actual income-generating capacity of a business. The market value of assets reveals the actual worth of business and net asset value has been considered for identifying the actual position of a business in the current environment. According to Li, (2018), forecasting of business and industrial growth helps to evaluate actual market values of assets of a business and it ensures the actual net assets value. Continuing along the same line Lin et al., (2017), have stated that market value-based asset valuation is important to a business enterprise for analyzing the effectiveness of capital structure, prospects of earnings and growth of revenues. The valuation of net assets based on market value is important for increasing the business value of an entity and it is essential for enhancing the potential savings of an entity. Hence, a firm's value is needed to be evaluated accurately for ensuring business growth of an organisation and it would ensure industrial growth.

Firm’s value, Growth importance of valuation methods: As asserted by Tantalo and Priem, (2016), market share and sales development help an enterprise to ensure market growth of a business and it helps to develop industrial growth. Each organisation has to increase its ambit of development in the modern competitive world as it would help to increase customer base and organizational consistency would be improved. As mentioned by Miglietta et al., (2018), value firm can be considered as some of the claims of shareholders of the company and its creditors. On the contrary, the value of a firm has been evaluated based on the evaluation of value to the shareholders. Hence, wealth maximization concept is popular throughout the world as it helps to identify the capability of a business to enhance operating performance in the market. As given by Heminway, (2017), wealth maximization is essential to ensure industrial growth as it depicts that the shareholder of a company has obtained the best possible return from the firm's operating activities. Hence, industrial growth helps to identify the value of different business firms of the same industry and top-level management of a business entity can make a future prediction regarding industrial growth. Forecast of business growth of an entity helps to measure the value of a firm and future prediction can be made based on competitive analysis.

Based on the opinion of Copiello, (2016), it has been identified that forecasting is an indispensable component of an entity as it helps to adopt correct decisions regarding the application of the valuation method. Hence, forecasting helps to ensure the future growth of a business enterprise and future growth has been evaluated based on the value measurement of a firm. Industrial or business growth prediction is important to the management of a business enterprise for identifying the importance of value or wealth maximization of business. As mentioned by Hermoza and Molina, (2017) in this business valuation assignment, the value of firm reveals that an organisation needs to enhance organizational consistency in the long run and it can be made by adopting the suitable method of valuation. Shareholders and other stakeholders of a company focus on the maximization of their return and it can be made by implementing the technique of valuation of the business. Hence, enhancement of value to the shareholders helps an enterprise to ensure their growth and it clearly says that an entity needs to consider forecasting of business or industry growth for measuring the value of a firm. To evaluate a firm's value, an enterprise has to consider various valuation methods including dividend growth model, asset valuation method and so on. As mentioned by Joshi, (2019), time value of money is important for measuring the value of the firm and hence, it is true that firm's value is discounted value of future cash flows. Sim and Wright, (2017), have argued that discounted value is the actual value of the business but consideration of discounting factor is important for identifying actual value.

Usage of Valuation methods by companies and Market Growth Forecasts
Application of Dividend Growth Model: Considering the cost of equity of TESCO, it has been identified that current Weighted Average Cost of Capital of TESCO is 5.46%. The dividend growth rate of the company as per 2019 has been identified as 2.67% (morningstar.co.uk, 2016). A per-share dividend of the company has been identified 3.67 and considering this information, the intrinsic value of the stock has been given below.

The formula of Dividend Growth Model
Intrinsic Value (P) = D1/ (r-g) [g= annual growth rate, D1 = current dividend of the company and r = cost of capital]
=3.67/ (0.0546-0.0267)
= 131 GBP

Based on the above intrinsic value discussed in this business valuation assignment it can be said that stock is undervalued or overvalued by comparing the value with net assets value. If the intrinsic value is lower than the value of assets, it can be said that stock is undervalued and if the intrinsic value is higher than the value of assets, it might be clearly said that stock is overvalued. The present value of dividend cash flow is 3.67 and it has been considered in the calculation of fair estimation of the price of the stock. Hence, the time value of money has been considered in the dividend growth model and it helps to identify actual intrinsic value. Based on this intrinsic value calculation, the company may make a future forecast regarding the price of the stock. Here, value has been considered per share hence and it can be said that the firm’s value is aggregate of the value of outstanding securities. This is because; total value to the shareholders has been divided by outstanding securities for identifying per share dividend.

Application of Discounted Cash Flow Method Let earnings before interest, depreciation, taxation and amortization for 5 years of Tesco has been increased by 5%. The calculation of discounted cash flow has been given below.

Table 1: Identifying Discounted Cash Flow
(Source: Developed by Author)

Based on the above example provided in this business valuation assignment, it has been identified that free cash flow calculation is essential to a business enterprise for identifying discounted cash flow. As depreciation and amortization are non-cash items, the same has been added back with the tax adjusted EBIT. Considering 5.46% cost of capital, the discounted cash flow has been considered which reveals actual value of cash flow. Discounted cash flow has been used for identifying NPV and IRR, which is important to forecast actual rate of return on investment.

Application of Asset Valuation Method (Based on Market Value)

Table 2: Calculation of Net Assets based on Asset Valuation Method
(Source: Developed by Learner)

Based on TESCO’s total assets and total liabilities it has been identified that that company has a net asset value of 13456 GBP for the year 2019. It reveals the actual capability of a business in terms of income generation for a particular period. Intangible and tangible assets both have been considered in the total asset value calculation and total liabilities have been deducted for identifying net asset value and this measurement would help the company to enhance strategic decisions.

Conclusion
Based on the above discussion in this business valuation assignment, it has been identified that the dividend growth model and discounted cash flow method both are essential to determine the growth of a company. Furthermore, it has been identified that a firm's value is the aggregate of the discounted value of its future cash flows. Considering the example of the dividend growth model, it has been found that a firm’s market value is the aggregate of its outstanding shares or securities. Hence, corporate valuation methods are essential to ensure industry and business growth.

Reference List
Belo, F., Collin?Dufresne, P. and Goldstein, R.S., 2015. Dividend dynamics and the term structure of dividend strips. Business valuation assignment The Journal of Finance, 70(3), pp.1115-1160.

Boularhmane, I. and Aboulaich, R., 2016. Valuation of quarterly stock prices: applying ethical principles to discounted cash flow method. International Journal of Economics and Financial Issues, 6(3), pp.1254-1261.

Copiello, S., 2016. A Discounted Cash Flow variant to detect the optimal amount of additional burdens in Public-Private Partnership transactions. MethodsX, 3, pp.195-204.

Dewasiri, N.J. and Banda, Y.W., 2015. Dividend Policy and Stock Price Volatility: An Error Corrected Approach. Asia-Pacific Journal of Management Research and Innovation, 11(3), pp.165-171.

Heminway, J.M., 2017. Shareholder wealth maximization as a function of statutes, decisional law, and organic documents. Wash. & Lee L. Rev., 74, p.939.

Hermoza, J.C.R. and Molina, J.E., 2017. Brief considerations on business valuation methods. Tendencias, 18(2), pp.168-182.

Joshi, V., 2019. An Overview of Mathematics of Finance With Reference to ‘Time Value of Money’. Available at SSRN 3351683.

Lazzati, N. and Menichini, A.A., 2015. A dynamic approach to the dividend discount model. Review of Pacific Basin Financial Markets and Policies, 18(03), p.1550018.

Li, W.S., 2018. Strategic Value Analysis: Business Valuation. In Strategic Management Accounting (pp. 171-192). Springer, Singapore.

Lin, Y.H., Lin, S., Fornaro, J.M. and Huang, H.W.S., 2017. Fair value measurement and accounting restatements. Advances in accounting, 38, pp.30-45.

Miglietta, N., Battisti, E. and Garcia-Perez, A., 2018. Shareholder value and open innovation: evidence from Dividend Champions. Management Decision, 56(6), pp.1384-1397.

morningstar.co.uk. 2016. Tesco Dividends | TSCO | Morningstar . Available at: http://tools.morningstar.co.uk/uk/stockreport/default.aspx?tab=10&vw=div&SecurityToken=0P00007OYV%5D3%5D0%5DE0WWE%24%24ALL&Id=0P00007OYV&ClientFund=0&CurrencyId=BAS [Accessed 30 Dec. 2019].

Sim, T. and Wright, R.H., 2017. Stock valuation using the dividend discount model: An internal rate of return Approach. In Growing Presence of Real Options in Global Financial Markets (pp. 19-32). Emerald Publishing Limited.

Tantalo, C. and Priem, R.L., 2016. Business valuation assignment Value creation through stakeholder synergy. Strategic Management Journal, 37(2), pp.314-329.