Business Valuation Techniques Selection

Every enterprise requires good record keeping. Valuing a business is critical to its success. It is prudent to establish the valuation techniques that suit one’s business. Adjusted Present Value and Net Present Value are some of the valuation techniques to examine.

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Adjusted Present Value

It is the Net Present Value of a project if the method of financing is solely equity in addition to the current value of investment benefits. It is the critical method for evaluating investments. It uses the cost of capital as the discounting rate (Slee, 2011). The tax shields are critical for the application of the Adjusted Present Value. It is the best-suited method of valuing a business for highly leveraged companies.

Adjusted Present Value works efficiently for firms that have tax implications affecting the outcome. A leveraged buyout would fit into this description better because of the charges incurred (Damodaran, 2012). It is essential for comparison with more standard methods of valuation.

The formula for this valuation technique is as follows:

  • APV= NPV (of a venture financed solely with equity capital) + PV of financing

There are steps to follow in the assessment of a firm when using this method (Slee, 2011). The first procedure is to estimate a company’s value without leverage on its financial records. It involves the calculation of the Net Present Value. The calculation has to be at the cost of equity as the discount rate. The second stage is to calculate the tax benefits from the debt financing level. The application of the discount has to be at the cost of debt. However, it is still allowed when the discount is at a higher rate. There are also some uncertainties about the tax effects. The formula also allows the addition of the NPV to its base. Lastly, it is to evaluate the effect of borrowing on the probability that the company will go bankrupt, and the expected cost of bankruptcy (Damodaran, 2012).

Relationship with Net Present Value

NPV is usually the difference between the present value of cash inflows and the present value of cash outflows. It measures a currency’s value today, and compares it to the future price. The Adjusted Present Value is an upgraded Net Present Value with the addition of leveraged amount. While NPV can work with any business, the APV works better with the highly leveraged companies (Slee, 2011). The APV cannot function without the NPV results. For the APV, using debt has benefits because of the tax deductibles which are a source of value to the firm. The NPV does not have this additional value. Therefore, it is important to calculate the Net Present Value first before getting the APV.

Other Valuation Methods

Capital Asset Pricing Model

It is a model that measures the relationship between risk and the expected return from an asset. The measurement relies on the sensitivity of the asset and the movements in the stock market. It prices the asset’s risk (Damodaran, 2012). The two types of risk are the idiosyncratic risk and systematic risk. There should be compensation for both risks with the essence of the time value of money in place. It also measures the required rate of return. The RRR is critical to the business because it determines the estimated value of a project.

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Discounted Cash Flow Method

It is one of the valuation methods that estimate the attractiveness of an investment opportunity. It uses the future free cash flow projections (Slee, 2011). It discounts them to arrive at the estimated present value. The result is critical to evaluating the potential for investment. The higher the Discount Cash Flow the better the investment opportunity.

Business valuation is critical to establishing the stability of a firm’s future. It also helps to set the vision of the firm. The assessments are also useful to intended investors. They use them to validate the ability of a project to bring income.

References

Damodaran, A. (2012). Investment valuation. Hoboken, NJ: Wiley.

Slee, R. (2011). Private capital markets. Hoboken, NJ: Wiley.

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