| Topic : Approaches to Valuation in M&A |
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Activity:
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last activity : 07 06 2010 20:18:09 +0000
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Discounted Cash Flow (DCF)
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Enterprise-Value-to-Sales Ratio (EV/Sales)
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Replacement Cost
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Price-Earnings Ratio (P/E Ratio)
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A key valuation tool in M&A, discounted cash flow analysis determines a company's current value according to its estimated future cash flows. Forecasted free cash flows (net income + depreciation/amortization - capital expenditures - change in working capital) are discounted to a present value using the company's weighted average costs of capital (WACC). Admittedly, DCF is tricky to get right, but few tools can rival this valuation method. |
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DCF is more appropriate where one has to take into consideration the "economic value" of the firm which the replacement cost valuation may not address. P/E valuation comes closer where p/e is derived again from market ralities which takes into consideration the economic value of the firm rather than the plant and equipment value.
Discounted Cash Flow (DCF) is what someone is willing to pay today in order to receive the anticipated cash flow in future years. DCF means converting future earnings to today's price . The future cash flows must be discounted in order to express their present values in order to properly determine the value of a company or project under consideration as a whole. The discount factor here is to be determined as the rate of return expected by the investors which is inc lusive of risk premium. So DCF is a proper method for valuation where the price is determined on the logical base of returns.
DCF is the most mordern and scientific approach used by most of the firm these days..
Also the DCF takes into consideration many aspects of the business and the margin of error is the least..
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This ratio is helpful when the acquiring
company makes an offer as a multiple of the revenues, again, while being aware
of the price-to-sales ratio of other companies in the industry. |
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Profitability is more important than the quantum of sales isn't it ? Volume of sales is also important but not alone and should be studied with the profitability.So the method should incorporate the profitability.Then the next question is what about cash flow, is profitability alone important in the valuation.The answer is cashflow and profitability are equally important.
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In a few cases, acquisitions are based on the cost of replacing the target company. For simplicity's sake, suppose the value of a company is simply the sum of all its equipment and staffing costs. The acquiring company can literally order the target to sell at that price, or it will create a competitor for the same cost. |
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Naturally, it takes a long time to assemble good management, acquire property and get the right equipment. This method of establishing a price certainly wouldn't make much sense in a service industry where the key assets - people and ideas - are hard to value and develop.
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With the use of this ratio, an
acquiring company makes an offer that is a multiple of the
earnings of the target company. Looking at the P/E for all the stocks within
the same industry group will give the acquiring company good guidance for
what the target's P/E multiple should be. |
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