Business Valuation Basics and Approaches for CA Final AFM

Understand Business Valuation Basics and Approaches

Key rules to remember

Net asset value (adjusted book value)

Net assets = Fair or realisable value of all assets − Outside liabilities (including contingent liabilities that are likely to crystallise)

Exclude fictitious assets such as preliminary expenses and deferred losses. Value per share = Net assets ÷ Number of equity shares, after deducting preference capital if any.

Enterprise value

EV = Equity value + Debt − Cash and cash equivalents (+ minority interest and preference capital where relevant)

Use EV-based multiples to get EV first, then bridge back to equity value.

Capitalisation of earnings

Value = Maintainable earnings ÷ Capitalisation rate

Use normalised earnings. The rate must match the earnings measure (pre-debt earnings with WACC, equity earnings with cost of equity).

DCF value (income approach)

Value = Σ [CFt ÷ (1 + r)^t] + Terminal value ÷ (1 + r)^n

FCFF is discounted at WACC to get enterprise value. FCFE is discounted at cost of equity to get equity value.

Relative valuation by multiple

Value of firm = Comparable multiple × Firm's metric (e.g. P/E × EPS)

Choose comparables of similar business, size, growth and risk. Adjust for one-time items.

Weighted value from multiple approaches

Final value = Σ (Weight × Value under each method), where weights add to 1

Weights reflect reliability of each method for that business and are a matter of judgement.

How to solve Business Valuation Basics and Approaches questions

1. 1Identify the purpose of valuation (merger, sale, tax, liquidation, fund raising) from the case facts.
2. 2Name the standard of value that fits the purpose: fair value, intrinsic value, liquidation value or going concern value.
3. 3Note the nature of the business: asset-heavy, cash-generating, loss-making, startup, or listed with peers.
4. 4Select the approach or approaches that suit these facts and say why in one line each.
5. 5Collect and normalise the data: remove non-recurring items, fictitious assets, non-operating assets, and adjust for contingent liabilities.
6. 6Compute the value under each chosen method, showing formula, working and unit (total or per share).
7. 7Compare the results, explain differences, and give a reasoned conclusion or weighted value.
8. 8State key assumptions and limitations in one or two lines.

Quickest way: Purpose, business type, approach

Common mistakes in Business Valuation Basics and Approaches

• Treating fair value and intrinsic value as the same thing.

  Both are described as 'worth' and the terms are used loosely in textbooks.

  Fix: Say fair value is a transaction price between informed, willing parties; intrinsic value is a fundamentals-based estimate that may differ from market price.

• Using book value as the asset-based value without adjustment.

  Students copy net worth from the balance sheet.

  Fix: Revalue assets to realisable or replacement value, drop fictitious assets, and include all outside liabilities and likely contingent liabilities.

• Applying one approach to every business.

  Students memorise a favourite method such as DCF.

  Fix: Match the approach to the business facts and mention a cross-check with another method.

• Mixing the earnings measure and the rate in capitalisation or multiples.

  Equity earnings are capitalised at WACC, or EV multiples give a figure treated as equity value.

  Fix: Pair FCFF or EBITDA with WACC or EV multiples, then subtract net debt. Pair equity earnings with cost of equity or P/E.

• Ignoring surplus or non-operating assets and debt-like items.

  The focus stays on operating profit or cash flow.

  Fix: Add non-operating assets separately and deduct debt and similar claims when moving from enterprise to equity value.

Worked examples