Exploring Valuation Techniques in Asset Revaluation

To reflect the true market value of assets for revaluation, asset valuation is considered an integral part of financial management. Many methods exist for determining the fair value of assets, with the discounted cash flow (DCF) analysis, comparative company analysis (CCA), and net asset value (NAV) methods being the most prominent ones. Every method consists of a particular approach and technique that businesses use according to their requirements.

Discounted Cash Flow (DCF) Analysis

We mostly use this analysis to estimate the value of an investment based on its expected future cash flows. We discount these cash flows back to their present value using an appropriate discount rate, typically the weighted average cost of capital (WACC).

Example:

Consider a technology startup in Bangalore projecting future cash flows of INR 10 million, 15 million, and 20 million for the next three years, respectively. We would calculate the present value of these cash flows, assuming a discount rate of 12%.

• Year 1: INR 10 million / (1 + 0.12) = INR 8.93 million
• Year 2: INR 15 million / (1 + 0.12) ^2 = INR 11.96 million
• Year 3: INR 20 million / (1 + 0.12) ^3 = INR 14.25 million

Summing these present values gives a total DCF valuation of approximately INR 35.14 million. This method is particularly useful for startups and companies with significant future growth potential, as it focuses on cash flows rather than accounting profits.

Comparable Company Analysis (CCA)

Comparable Company Analysis (CCA) is a method to estimate a company’s value by comparing it to similar companies in the same industry. It uses valuation multiples from these comparable companies, such as price-to-earnings (P/E), enterprise value-to-EBITDA (EV/EBITDA), and price-to-sales (P/S) ratios, to determine the target company’s value.

• Price-to-Earnings (P/E) Ratio: – The P/E ratio measures a company’s current share price relative to its earnings per share (EPS).
• Enterprise Value-to-EBITDA (EV/EBITDA) Ratio: – The EV/EBITDA ratio compares a company’s enterprise value (EV) to its earnings before interest, taxes, depreciation, and amortization (EBITDA).
• Price-to-Sales (P/S) Ratio: -The P/S ratio measures a company’s market capitalization relative to its total sales or revenue.

Example:

Let’s examine a mid-sized pharmaceutical company in Mumbai. Assume that comparable industry companies have an average P/E ratio of 20. If the Mumbai-based company’s earnings are INR 50 million, its valuation using the P/E multiple would be:

• Valuation = Earnings * P/E Ratio
• =INR 50 million * 20
• =INR 1,000 million

CCA would be highly relevant because it relies on market-based evidence to determine fair value. Therefore, any realization obtained through the method would result in a realistic evaluation reflecting the market sentiments and conditions prevailing during a given period. The technique would be most applicable to entities located in mature industries where comparability data is easy to obtain.

Net Asset Value (NAV) method

The Net Asset Value method values an entity by estimating the difference between the total assets and total liabilities of the entity. Real estate companies, investment trusts, and holding companies frequently use this straightforward method for valuation.

Example:

For a real estate company in Delhi with total assets worth INR 500 million and liabilities amounting to INR 200 million, the Net Asset Value (NAV) is calculated as follows:

• NAV=Total Assets−Total Liabilities
• Substituting the given values:
• NAV=500million INR−200million INR
• NAV=300million INR

This valuation method is especially relevant for companies with substantial tangible assets. The NAV method provides a clear and accurate assessment of a company’s value in India, where real estate and physical assets hold significant value.

Questions to understand your ability

Q: What is the primary estimate for discounted cash flow?

1. A company’s market capitalization
2. Current price share
3. Future expectations guide the calculation of an investment’s cash flow.
4. Total sales or revenue

Q: What is the most commonly used discount rate in discounted cash flow (DCF) analysis?

• Price-to-Earnings (P/E) ratio
• Enterprise value-to-EBITDA (EV/EBITDA) ratio
• Weighted Average Cost of Capital (WACC)
• Net Asset Value (NAV)

Q: Which things does Comparable Company Analysis use to estimate company value?

1. Future cash flows are expected.
2. Valuation multiples from similar companies
3. Total liabilities and assets
4. Capitalization of the Market

Q: What ratio determines the relationship between the current share price and earnings per share (EPS)?

• Price-to-Sales (P/S) ratio
• Enterprise value-to-EBITDA (EV/EBITDA) ratio
• Price-to-Earnings (P/E) ratio
• Net Asset Value (NAV) ratio

Q: Which of the following statements corresponds to the commonly used net asset value method?

• Estimating future cash flows from an investment is an important task.
• The process involves comparing a company’s value to that of similar companies.
• The valuation process involves assessing investment trusts, holding companies, and real estate companies.
• To measure a company’s market capitalization relative to total sales

Conclusion

Valuation techniques such as DCF, CCA, and NAV are essential for Indian businesses’ financial assessment and strategic planning. Each method provides unique insights and is suitable for different types of assets and industries. DCF is perfect for high-growth companies with reliable cash flows; CCA is ideal for industries with plenty of comparable data; and NAV is best for asset-rich companies. Grasping and applying these methods can lead to a more precise and fair valuation of assets, helping investors and managers make informed decisions.