{"id":22556,"date":"2023-04-26T16:00:43","date_gmt":"2023-04-26T10:30:43","guid":{"rendered":"https:\/\/gstguntur.com\/?p=22556"},"modified":"2023-04-26T16:03:00","modified_gmt":"2023-04-26T10:33:00","slug":"overview-of-business-valuation-cs-professional-study-material","status":"publish","type":"post","link":"https:\/\/gstguntur.com\/overview-of-business-valuation-cs-professional-study-material\/","title":{"rendered":"Overview of Business Valuation – CS Professional Study Material"},"content":{"rendered":"

Chapter 1 Overview of Business Valuation – CS Professional Valuations and Business Modelling Study Material<\/a> is designed strictly as per the latest syllabus and exam pattern.<\/p>\n

Overview of Business Valuation – CS Professional Valuations and Business Modelling Study Material<\/h2>\n

Question 1.
\n(b) What are the misconceptions about Valuation? (June 2013, 5 marks) [CMA Final]
\n(c) How do you minimize Valuation bias? (5 marks) [CMA Final]
\nAnswer:
\n(b) There are a number of misconceptions about valuation. Some of the misconceptions are as under:<\/p>\n

    \n
  1. A valuation is an objective search for true value<\/li>\n
  2. A good valuation provides a precise estimate of value<\/li>\n
  3. The more quantitative, the better the valuation<\/li>\n
  4. Valuing a private business should be done only when the business is ready to be sold<\/li>\n
  5. Business in an industry always sell for \u2018X\u2019 times the annual revenue. So why should valuation of the business be done by external valuer<\/li>\n
  6. The business should be at least worth equivalent to what a competitor sold his business recently<\/li>\n
  7. The business loses money, so it is not worth much.<\/li>\n<\/ol>\n

    (c) Valuation bias exists and no valuation is completely objective or \u2018true\u2019. The effort can be made to minimize the direction (i.e. over or under valuation) and magnitude(how much is the variation) of the bias. Bias may be introduced due to personal views of valuer, source of data, assumptions made, which party has commissioned the valuation (buyer or seller) etc.
    \nBias can’t be regulated or legislated out of existence, However, there are ways in which we can mitigate the-effects of bias on valuation: –<\/p>\n

    Reduce institutional Pressures
    \nA significant portion of bias can be attributed to pressures Institutional factors. Equity-research analysts in the 1990s, for instance, in addition to dealing with all of the standard sources of bias had to grapple with the demand from their employers that they bring in investment banking business. Institutions that want honest sell-side equity research should protect their equity research analysts from such bias.<\/p>\n

    De-link valuations from reward\/punishment
    \nAny valuation process where the reward or punishment is conditioned on the outcome of the valuation will result in biased valuations. In other words, if we want acquisition valuations to be unbiased, we have to separate the deal analysis from the deal making to reduce bias.<\/p>\n

    No pre-commitments
    \nDecision makers should avoid taking strong public positions on the value of a firm before the valuation is complete: An acquiring firm that comes up with a price prior to the valuation of a target firm has put analysts in an untenable position, where they are-called upon to justify this price. In far too many cases, the decision on whether a firm is under or overvalued precedes the actual valuation, leading to seriously biased analyses.<\/p>\n

    Self-Awareness The best antidote to bias is awareness. An analyst who is aware of the biases he or she brings to the valuation process can either actively try to confront these biases when making input choices or open the process up to more objective points of view about a company\u2019s future.<\/p>\n

    Honest reporting
    \nIn Bayesian statistics, analysts are required to reveal their priors (biases) before they present their results from an analysis. Thus, an environmentalist will have to reveal that he or she strongly believes that there is a hole In the ozone layer before presenting empirical evidence to that effect. The person reviewing the study can then factor that bias in while looking at the conclusions. Valuations would be much more useful if analysts revealed their biases up front. While we cannot eliminate bias in valuations, we can try to minimize its impact by designing valuation processes that are more protected from overt outside influences and by report our biases with our estimated values.<\/p>\n

    \"Overview<\/p>\n

    Question 2.
    \nWhat are the uncertainties in business valuation? (Dec 2013, 4 marks) [CMA Final]
    \nAnswer:<\/p>\n

      \n
    • Starting early in life, we are taught that if we do things right, we will get the right answers. In other words, the precision of the answer is used as a measure of the quality of the process that yielded the answer.<\/li>\n
    • While this may be appropriate in mathematics or physics, it is a poor measure of quality in valuation.<\/li>\n
    • Barring a very small subset of assets, there will always be uncertainty associated with valuations, and even the best valuations come with a substantial margin for error.<\/li>\n
    • This arises due to the sources of uncertainty which have an effect on the valuation.<\/li>\n
    • The value of a business is not a static figure. It depends on change in purpose or circumstances.<\/li>\n<\/ul>\n

      There are a number of uncertainties involved in the valuation process which if not handled appropriately, would lead to an absurd value. We may design complex financial models with several inputs to handle uncertainties but that does not mean that the value derived is reasonable or the process is sound. What we need to understand is the impact of each input on the value.<\/p>\n

      The following factors are crucial:<\/p>\n

        \n
      1. The macro economic factors.<\/li>\n
      2. The business.<\/li>\n
      3. Its growth potential in the industry in which it operates.<\/li>\n
      4. How is the business positioned?<\/li>\n
      5. Who are competitors?<\/li>\n
      6. What is the quality and stability of the company’s management?<\/li>\n<\/ol>\n

        Question 3.
        \nWhat are the misconceptions about valuation? (Dec 2014, 5 marks) [CMA Final]
        \nAnswer:
        \nThere are a number of misconceptions about valuation. Some of the misconceptions are as under:<\/p>\n

          \n
        1. A valuation is an objective search for true value.<\/li>\n
        2. A good valuation provides a precise estimate of value.<\/li>\n
        3. The more quantitative, the better the valuation.<\/li>\n
        4. Valuing a private business should be done only when the business is ready to be sold.<\/li>\n
        5. Business in an industry always sells for \u2018x\u2019 times the annual revenue. So why should valuation of the business be done by external valuer.<\/li>\n
        6. The business should be at least worth equivalent to what a competitor sold his business recently.<\/li>\n
        7. The business loses money, so it is not worth much.<\/li>\n<\/ol>\n

          Question 4.
          \nThere are a number of factors both macro economic and micro economic which have an impact on business. Valuation of a business involves making forecasts for the future. Comment on the sources of uncertainties in business valuation in the light of the above. (June 2015, 5 marks) [CMA Final]
          \nAnswer:
          \nSources of uncertainties:
          \nUncertainty is part and parcel of the valuation process, both at the point in time that we value a business and in how that value evolves over time as we get new information that impacts the valuation. That information can be specific to the firm being valued, more generally about the sector in which the firm operates or even be general market information (about interest rates and the economy).<\/p>\n

          When valuing an asset at any point in time, we make forecasts for the future. Since none of us possess crystal balls we have to make our best estimates, give the information that we have at the time of the valuation. Our estimates of value can be wrong for a number of reasons, and we can categorize these reasons into three groups.<\/p>\n

          Estimation Uncertainty: Even if our information sources are impeccable, we have to convert raw information into inputs and use these inputs in models. Any mistakes or mis-assessments that we make at either stage of this process will cause estimation error.<\/p>\n

          Firm-specific Uncertainty: The path that we envision for a firm can prove to be hopelessly wrong. The firm may do much better or much worse than we expected it to perform and the resulting earnings and cash flows will be very different from our estimates.<\/p>\n

          Macroeconomic Uncertainty: Even if a firm evolves exactly the way we expected it to, the macroeconomic environment can change in unpredictable ways. Interest rates can go up or down and the economy can do much better or worse than expected. These macroeconomic changes will affect value.<\/p>\n

          \"Overview<\/p>\n

          Question 5.
          \n(a) \u201cThere are a number of factors both macro- economic and micro-economic which have an impact on business. Valuation of a business involves making forecasts for the future\u201d.
          \nComment on the sources of uncertainties in business valuation in the light of the above. (5 marks)
          \n(b) State under what conditions\/assumptions the following statements are true (state only one important condition\/assumption for each):
          \n(i) Fair Value of an asset is always equal to its Market Value. (June 2019, 5 marks)
          \nAnswer:
          \n(a) Sources of Uncertainties: Uncertainty is part and parcel of the valuation process both at the point of time when-the valuation is made and also on basis of how the business evolves over time. The valuation involves a process where the valuer has to make various forecasts about the future both in terms of general economic conditions as well as how the firm will perform individually.<\/p>\n

          Valuation uncertainty is defined as – \u2018The possibility that the estimate value may differ from the price that could be obtained in a transfer of the same asset or liability taking place at the same time under the same terms and within the same market environment\u2019.<\/p>\n

          It is important to note that a valuation is not a fact; it is an estimate of the most probable of a range of possible outcomes based on the assumptions made in the valuation process. Market valuations are estimates of the most probable price that would be paid in a transaction on the valuation date.<\/p>\n

          However, even where assets are identical and exchanged in contemporaneous transactions, fluctuations in the prices agreed between different transactions can often be observed. These fluctuations can be caused by factors such as differences in the objectives, knowledge or motivation of the parties. Consequently, an element of uncertainty is inherent in most market valuations as there is rarely a single price with which the valuation can be compared.<\/p>\n

          The valuation involves a process where the valuer has to make forecasts about the future both in terms of general economic conditions as well as how the firm will perform individually.<\/p>\n

          Uncertainties caused by these various conditions and factors can be broadly categorized into the following three groups based on the reasons\/sources of these uncertainties.<\/p>\n

          Estimated\/Model\/Input Uncertainty: Even if our information sources are impeccable, we have to convert raw information into inputs and use these inputs in models. Any mistakes or mis-assessment that we make at either stage of this process will cause estimation error.<\/p>\n

          Further, uncertainty arises from characteristics of either the valuation model, or method, used. For certain asset types, more than one method may be customarily used to estimate value. However, those models may not always produce the same outcome and therefore the selection of the most appropriate method may of itself be a source of uncertainty.<\/p>\n

          Also uncertainty arises where there are a number of equally reasonable or feasible inputs or assumptions that can be used from the degrees of veracity that can be attached to the data inputs used in the valuation and their impact on the outcome.<\/p>\n

          Firm-specific Uncertainty: The specific risks associated with the firms Business, Modus Operandi may also add to uncertainty in the business valuation. The firm may do much better or much worse than we expected it to perform, and the resulting earnings and cash flows will be very different from our estimates.<\/p>\n

          Macroeconomic Uncertainty\/Market Uncertainty: Even if a firm evolves exactly the way we expected it to, the macroeconomic environment can change in unpredictable ways. Interest rates can go up or down and the economy can do much better or worse than expected. These macro-economic changes will affect value.
          \nFurther, uncertainty arises when a market is disrupted at the valuation date by current or very recent events such as sudden economic or political crises.<\/p>\n

          The disruption can manifest itself in a number of ways, for example, either through panic buying or selling or by a loss of liquidity due to disinclination by market participants to trade. An outbreak of sudden trading activity in response to a crises may cause rapid price changes that are not necessarily representative of those that would be agreed between parties acting \u201cknowledgeably and prudently\u201d. Conversely, a loss of liquidity will mean fewer contemporaneous or relevant recent transactions which may impact on the reliability on the valuation.<\/p>\n

          (b)
          \n(i) Fair value of an asset is always equal to its Market Value, when markets are efficient.<\/p>\n

          Question 6.
          \nEverest, Manufacturing Industrial Limited started 4 years ago, is expected to grow at a higher rate of 4 years in the coming years and thereafter the growth rate will fall and stabilize at a lower level. The following information has been made available to you for your analysis:<\/p>\n\n\n\n\n\n\n\n\n\n\n\n\n
          \n

          Base Year (Year 0) Information<\/p>\n<\/td>\n<\/tr>\n

          <\/td>\n(In Million \u20b9)<\/td>\n<\/tr>\n
          Revenues<\/td>\n3000 Million<\/td>\n<\/tr>\n
          EBIT<\/td>\n500 Million<\/td>\n<\/tr>\n
          Capital Expenditure<\/td>\n350 Million<\/td>\n<\/tr>\n
          Depreciation<\/td>\n250 Million<\/td>\n<\/tr>\n
          Net Working Capital as a percentage of EBIT<\/td>\n25%<\/td>\n<\/tr>\n
          Corporate tax rate (for all scenarios)<\/td>\n30%<\/td>\n<\/tr>\n
          Paid-up Equity Capital (10 Face Value)<\/td>\n400 Million<\/td>\n<\/tr>\n
          Market Value of debt<\/td>\n1200 Million<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n
          \n

          Inputs for the High Growth Phase<\/p>\n<\/td>\n<\/tr>\n

          Length of high growth phase<\/td>\n4 years<\/td>\n<\/tr>\n
          Growth rate in revenues, depreciation<\/td>\n20%<\/td>\n<\/tr>\n
          EBIT and Capital expenditure:<\/td>\n<\/td>\n<\/tr>\n
          Net Working Capital as a percentage of EBIT<\/td>\n25%<\/td>\n<\/tr>\n
          Cost of debt (pre-tax)<\/td>\n13%<\/td>\n<\/tr>\n
          Debt-equity ratio<\/td>\n1:1<\/td>\n<\/tr>\n
          Risk-free rate<\/td>\n11%<\/td>\n<\/tr>\n
          Market risk premium<\/td>\n7%<\/td>\n<\/tr>\n
          Equity Beta<\/td>\n1.129<\/td>\n<\/tr>\n
          Cost of debt (pre-tax)<\/td>\n12.14%<\/td>\n<\/tr>\n
          Risk-free rate<\/td>\n10%<\/td>\n<\/tr>\n
          Market risk premium<\/td>\n6%<\/td>\n<\/tr>\n
          Equity Beta<\/td>\n1.0<\/td>\n<\/tr>\n
          Debt-equity ratio<\/td>\n2:3<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

          With above information background, answer the following questions of the Management:<\/p>\n

          (i) What is the Cost of Capital and Weighted Average Cost of Capital (WACC) for the high growth phase and for the stable growth phase. (Dec 2019, 10 marks)
          \n(ii) What is the Value of the Firm? (Dec 2019, 10 marks)
          \n(iii) What will be the Cost of Capital and WACC for the high growth phase and for the stable growth phase, if the debt-equity ratio is 1:2 during high growth phase and 3:2 in the stable growth phase? Will this change impact the Value of the Firm? If yes, what will be the value of the Firm with revised debt equity ratio? (Dec 2019, 10 marks)
          \n(iv) Comparing the given case, discuss on the advantages and disadvantages of the Dividend Discount Models. (Dec 2019, 10 marks)<\/p>\n

          \"Overview<\/p>\n

          Question 7.
          \nA listed Company has a beta of 1.5 and the riskless rate for one-year Treasury bills is 5.2% and the expected return for the market is 13.5%. What is the company\u2019s capitalization rate? Suppose the company has expected earnings of \u20b9 6.80 per share that have been growing at a rate of 5.5%. The Company retains 25%. What should be the company\u2019s share price using a capitalization of earnings approach? (Dec 2019, 5 marks)<\/p>\n

          (b) Abishek Powers Ltd. has a constant dividend growth rate of 5% per annum for perpetuity. This year the company has given a dividend of \u20b9 6 per share. Further, the required rate of return for the company is 10% per annum. Then, what should be the purchase price for a share of Abishek Powers Ltd. ? (Dec 2019, 5 marks)<\/p>\n","protected":false},"excerpt":{"rendered":"

          Chapter 1 Overview of Business Valuation – CS Professional Valuations and Business Modelling Study Material is designed strictly as per the latest syllabus and exam pattern. Overview of Business Valuation – CS Professional Valuations and Business Modelling Study Material Question 1. (b) What are the misconceptions about Valuation? (June 2013, 5 marks) [CMA Final] (c) …<\/p>\n

          Overview of Business Valuation – CS Professional Study Material<\/span> Read More »<\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"spay_email":"","footnotes":""},"categories":[165],"tags":[],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/22556"}],"collection":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/comments?post=22556"}],"version-history":[{"count":9,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/22556\/revisions"}],"predecessor-version":[{"id":22561,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/22556\/revisions\/22561"}],"wp:attachment":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/media?parent=22556"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/categories?post=22556"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/tags?post=22556"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}