Unit
- Valuation purpose: Valuation estimates the intrinsic worth of an asset or business based on fundamental cash flows, risk, and growth. It is used for investment analysis, merger pricing, and financial reporting under standards like IFRS and GAAP.
- Intrinsic vs. relative value: Intrinsic valuation focuses on the company's own cash-generating ability, while relative valuation compares it to similar firms using multiples. Both approaches are complementary and used together in practice.
- Market efficiency assumption: In efficient markets, prices reflect all available information. However, behavioral biases and information asymmetry cause deviations, creating opportunities for valuation analysts to identify mispriced assets.
- Going-concern premise: Most valuations assume the business will continue operating indefinitely. This justifies using projected cash flows and terminal values. For distressed firms, liquidation value may be more appropriate.
- Value drivers: The primary drivers of value are revenue growth, operating margins, investment in working capital and fixed assets, cost of capital, and competitive advantage period. Small changes in these inputs significantly affect valuation outcomes.
- Valuation date: Every valuation is as of a specific date. Financial statements, market data, and forecasts must be aligned to that date. Changes in market conditions after the valuation date are not considered.
- Standard of value: Fair market value, investment value, and intrinsic value differ. Fair market value assumes willing buyer and seller. Investment value includes synergies specific to a particular buyer.
- Regulatory context: Valuations for financial reporting require adherence to ASC 820 (US GAAP) or IFRS 13. Tax and litigation valuations follow additional guidelines. Analysts must document assumptions and methodologies for audit trails.
Financial Formula
Basic Valuation Equation
V = CF1/(1+r)^1 + CF2/(1+r)^2 + ... + CFn/(1+r)^n
V = CF1/(1+r)^1 + CF2/(1+r)^2 + ... + CFn/(1+r)^n
Where:
- V: Present value of the asset
- CFi: Cash flow in period i
- r: Discount rate reflecting risk
- n: Number of periods
Quick Revision
- Valuation estimates the economic worth of a business or asset using cash flows, risk, and growth assumptions.
- Intrinsic and relative valuation are complementary approaches used to cross-check estimates.
- Key value drivers include revenue growth, margins, investment efficiency, cost of capital, and competitive advantage duration.
- Valuation always reflects a specific date and standard of value, with regulatory compliance for reporting purposes.