This chapter has examined the important but difficult subject of business valuation. It described three approaches:
1. Asset based: The first valuation approach is asset-based: equity book value, adjusted book value, liquidation value, and replacement value. In general, these methods are easy to calculate and understand, but have notable weaknesses. Except for replacement and adjusted book methods, they fail to reflect the actual market values of assets; they also fail to recognize the intangible value of an ongoing enterprise, which derives much of its wealth-generating power form human knowledge, skill, and reputation.
2. Earnings based. The second valuation approach described is the earnings-based: P/E method, the EBIT, and EBITDA methods. The earnings-based approach is generally superior to asset-based methods, but depends on the availability of comparable businesses whose P/E multiples are known.
3. Cash-flow based. Finally, the discounted cash flow method, which is based on the concepts of the time value of money. The DCF method has many advantages, the most important being its future-looking orientation. This method estimates future cash flows in terms of what a new owner could achieve. It also recognizes the buyer's cost of capital. The major weakness of the method is the difficulty inherent in producing reliable estimates of future cash flows.
In the end, these different approaches to valuation are bound to produce different outcomes. Even the same method applied by two experienced professionals can produce different results. For this reason, most appraisers use more than one method in approximating the true value of an asset or a business.
1. Asset based: The first valuation approach is asset-based: equity book value, adjusted book value, liquidation value, and replacement value. In general, these methods are easy to calculate and understand, but have notable weaknesses. Except for replacement and adjusted book methods, they fail to reflect the actual market values of assets; they also fail to recognize the intangible value of an ongoing enterprise, which derives much of its wealth-generating power form human knowledge, skill, and reputation.
2. Earnings based. The second valuation approach described is the earnings-based: P/E method, the EBIT, and EBITDA methods. The earnings-based approach is generally superior to asset-based methods, but depends on the availability of comparable businesses whose P/E multiples are known.
3. Cash-flow based. Finally, the discounted cash flow method, which is based on the concepts of the time value of money. The DCF method has many advantages, the most important being its future-looking orientation. This method estimates future cash flows in terms of what a new owner could achieve. It also recognizes the buyer's cost of capital. The major weakness of the method is the difficulty inherent in producing reliable estimates of future cash flows.
In the end, these different approaches to valuation are bound to produce different outcomes. Even the same method applied by two experienced professionals can produce different results. For this reason, most appraisers use more than one method in approximating the true value of an asset or a business.
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