Business Valuation: Standard Approaches and Applications

Abstract

This note provides an introduction to the standard approaches used to value businesses from the perspective of the investor (e.g., discounted cash flow, market multiples). Each approach is illustrated with a specific practical application. The note provides an in-depth example of discounted cash flow valuation of a firm including cash flow forecasting, terminal value estimation, and cost of capital determination. To focus the analysis, the note does not treat the specific complexities associated with M&A analysis. Excerpt UVA-F-1684 Rev. Apr. 27, 2018 Business Valuation: Standard Approaches and Applications Determining the value of a business is critical to many important managerial decisions. Because the future of any enterprise is uncertain, business valuations are rarely identical across analysts. Moreover, because of the complicated nature of assessing a business value, methods vary. In this note we review standard approaches to valuing businesses from the perspective of the investor and practical applications of each. Although we do not treat the specific complexities associated with combining businesses, such as in M&A analysis, we provide tools that are foundational to such analysis. Basic Frameworks To set an investor-based framework for our discussion of business valuation, Figure 1 presents what might be called an investor's balance sheet. This balance sheet for a business is somewhat different from the standard total asset format published in company financial statements in that it focuses on the net assets or total capital invested in the business by debt and equity investors. On the left side, net assets are divided into two categories. Net working capital captures the net investment in liquid operating assets—current assets less non-interest-bearing current liabilities. Net fixed assets captures the net investment in long-term assets such as property, plant, and equipment. The sum of these two categories is termed net assets. . . .