Valuation Methods
In general, it is viewed that the intrinsic worth of a company is supported either by its assets or by its earnings potential. Accordingly, valuation methodologies are either asset-based or earnings-based. However, there is no single correct approach or method of estimating the value of a company. The uncertainties surrounding the estimation of values make it unrealistic to think in terms of a single future estimate. For these reasons, more than one valuation estimation is usually made to cross-check the results of any one method and to define the limits of a reasonable range of fair values for a particular company.
The asset-based valuation methodology considers that the value of a company is thenet realizable value of its assets less its liabilities and preferred stockholdings. TheNAV Method is the most commonly used asset-based valuation approach. The earnings-based methods, on the other hand, adopt the viewpoint of a potential investor who considers anticipated earnings or cash inflows as the fundamental basis of corporate value. Corporate value is therefore considered as the present equivalent of future earnings or the sum of future cash inflows, discounted at the rate of returnexpected by the investor on his capital investment. The earnings-based approach used in this study is the sum of discounted future cash flows, otherwise known as the DCF Method. The details of the NAV and the DCF Methods are discussed below:
1. Net Asset Value (NAV) Method
As mentioned earlier, the NAV Method bases the valuation of a company on the net realizable value of its assets less its liabilities and preferred stockholdings. For this Study, the most recent audited Balance Sheets of Gerontology (i.e., as of December 31, 2005) were used as basis for the NAVvaluation of the Company. In applying this method, certain balance sheet accounts will have to beadjusted as book values reflect historical costs and do not necessarily
reflect the current market value of the company’s assets. Fixed assets are usually adjusted to reflect their appraised values, while receivables and other
assets are valued at their realizable amounts. Contingent liabilities, if any,
are also recognized.
2. Discounted Cash Flow (DCF) Method
The DCF Method adopts the viewpoint that considers the anticipated
earnings or cash-inflows as the fundamental basis of common-equity value. Under
this method, operating cash flow forecasts are prepared, capital expenditure requirements are estimated, and the terminal value of residual assets are determined. The resulting free cash flows are then discounted using an appropriate rate of return on investment.
Under the DCF Method, there are three critical factors to be considered to arrive at a value for the company’s shares of stock. These factors are as follows:
a. Excess
cash flows – This is
the amount of cash that should be available for distribution to the owners after all capital expenditures andpayments necessary for prudent operations have been made. Cash flows should therefore reflect all receipts and expenditures that affect the balance sheet and the income statement, including investments in capital assets for new and/or expanded operations.
b. Discount
rate – This
rate is equivalent to the rate of return that investors require from their investment. The discount rate should score high in addressing the safety of the principal or invested capital, sensitivity to market conditions, and satisfaction of the investors profit objectives. The choices for a discount rate can range from the cost of debt (e.g., weighted average of the interest rates it pays on its outstanding loans and obligations, prime lending rate, etc.) to the expected returns on investments available in the market. The discount rate should usually account for country, market and business risks which a subject company may face during the forecast period.Relatively risk-free investments would usually refer to Government debt instruments. Investments in companies or financial instruments other than those of the Government would usually be considered riskier. The benchmark return for risk-free investments would be the net return on Government treasury bills (T-bills) or bonds (T-bonds). In order to account for country, market and business risks, a risk premium is usually added to the risk-free rate.
c. Terminal
value – In
valuation studies, the fact that the life of a business is essentially infinite cannot be ignored. Cash flows from business operations will not end after the forecast period. To account for this, a terminal value at the end of the forecast period is usually established. For this Study, the Residual Net Assets Method was used in determining the terminal value of Gerontology. The Residual Net Assets Method assumes that the Company’s total assets at the end of the projection period will be realized in cash and distributed to the creditors and shareholders.
The realizable amount is estimated to be equal to the total stockholders’ equity, minus the cash balance at the end of the projection period, plus the cash balance at the beginning of the projection period. The ending cash balance is deducted from the equity because this method assumes that all remaining cash at the end of each year is paid out to the shareholders in the form of dividends.
The terminal value is discounted back using the appropriate rate to arrive at its present value.
Valuation
Presented in this Chapter are the specific activities undertaken by P&A in relation toGerontology’s valuation, the application of the valuation procedures, and the resulting values.
A. Activities Undertaken for Gerontology’s Valuation
As mentioned in Chapter I, the objective of this Study is to determine a range of values for Gerontology using the NAV and DCF Methods. Towards this end, P&A performed the following tasks:
1. Compiled the Company’s forecast balance sheets, statements of income
andcash flows for each of the six years in the forecast period; and
2. Established a range of values for Gerontology using the NAV and DCF Methods. The NAV was based on the audited 2005 financial statements while the DCF valuation was based on the compiled forecast financial statements.
B. Valuation Procedures
As discussed in Chapter I, the range of values of a company may be determined through several methods, the most prevalent of which are based on the Company’s assets as well as its earnings and cash flow potential. For the asset-based approach,the NAV Method was used. For the earnings-based approach, the DCF method was applied. As a pre-requisite to the application of the earnings-based valuation methods, P&A compiled Gerontology’s forecast balance sheets, statements of income and cash flows for the five-year period from December 31, 2006 to December 31, 2011 (seeAnnexes C.1 to C.4) based on the representations and assumptions made by theGerontology Management.
The process of determining the factors used for the valuation under each valuation method and the results of the Valuation Study are presented below.
1. Net Asset Value (NAV) Method
Under this approach, the value of the Company is the fair market/net realizable value of its assets less its liabilities and preferred stockholdings, if any. P&A used the audited balance sheet ending December 31, 2005 as the basis for the valuation of Gerontology using the NAV method. Accountswere analyzed to ascertain any adjustments needed. In particular, P&A checked on any recent appraisal of the Company’s real estate properties (of which there has been none over the past three years), possible write-offs and contingent liabilities. After such analysis, there were no adjustments deemed necessary on the audited balances as of December 31, 2005. However,included in the liabilities of the Company are advances from stockholders in the amount of Php25.9 million which Gerontology plans to convert intoequity. In this regard, the computation of the NAV of Gerontology is shown in Table II-1 below.
Under the NAV Method, the value of Gerontology as of December 31, 2005 is Php33.8 million.
|
II－1 Gerontology Evaluation (Php） |
|
|
項目 |
31th Dec 2006 |
|
Total Assets |
74,802,878 |
| Less: Total Liabilities |
66,880,939 |
|
Total Stockholders' Equity |
7,921,939 |
|
Adjustments |
|
|
Preferred stockholders' equity |
- |
|
Preferred stockholders' equity |
- |
|
Contingent liabilities |
- |
|
|
7,921,939 |
|
Advances from stockholders for conversion to |
|
|
equity |
25,876,975 |
|
Net Asset Value |
33,798,914 |
2. Discounted Cash Flow (DCF) Method
As discussed in Section I.C, there are three critical factors to be
considered in computing the value of a company under the DCF Method. Their determination for the purpose of this Study is presented below.
a. Excess
cash flows – The
relevant excess cash flows used in this Study were the operating cash flows, which were derived by adding back to the net income all non-cash expenses (e.g., depreciation and amortization) and adding or deducting changes in operating assets and liabilities. After deriving the operating cash flows, the capital expenditures projected to be incurred by the Company within the forecast period were then deducted to arrive at the excess cash flows.
The excess cash flows for Gerontology’s valuation are presented in Annex D.
b. Discount
rate – As noted
earlier, the discount rate refers to the rate of return that investors require to finance a project. For consistency and whenever applicable, discount rates are presented net of tax if such discount rates are applied to after-tax cash flows and vice-versa. The discount rates were determined through the following criteria: safety of the principal or invested capital, sensitivity to market conditions, and satisfaction of the investors’ profit objective. For this Study, P&A deemed it reasonable to use as an appropriate risk-free rate the yield of the Republic of the Philippines Peso denominated 5-year bonds (ROP 5-yr Peso Bonds). The prevailing yield rate of the ROP 5-yr Peso Bonds is 7.136%. With a withholding tax of 20%, the effective yield is 5.709%.
This selected interest rate was based on the alternative investments or financial instruments available to an investor who is essentially evaluating various alternative investments in the Philippines under current market conditions.
A risk premium was added to the determined risk-free rate. The typical range of risk premiums is 3% to 5%. P&A considered Gerontology’s business nature and other potential risks, and deemed it reasonable to use a 4% risk premium for Gerontology. Therefore, the discount rate used in this Study is 9.709%.
c. Terminal value – For this Study, the Residual Net Assets Method was used in estimating the terminal value of Gerontology. This method was described in detail in Section I.C.3. Based on the above-mentioned factors, the DCF value of Gerontology is estimated at Php140.2 million. The details of the DCF valuation are presented in Annexes E and F.
C. Range of Values
The comparative values of Gerontology under the two valuation methods applied are summarized in Table II-2 below.
The NAV represents the fair market/net realizable value of the Company’s net assets. On the other hand, the DCF approach to valuation shows the operating potential of the Company as forecast by its Management over the next six years.
Using these methods, the resultant range of values for Gerontology is from Php33.8 million to Php140.2 million.lue
| TabII－2 Gerontology Range of Values （in Million Php） | |
| Method | Value |
| Net Asset Valu | 33.8 |
| Discounted Cash Flow | 140.2 |
Table II-2
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