Corporate value

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Teaching Note on “Corporate Value”
When you ask the question “what is the value of a company?”, the answer is quite often: “the price somebody’s ready to pay for it”. This answer looks reasonable, but is useless when it comes to set up the conditions of an IPO or take an investment or divestment decision. The price paid by anybody is the result of a transaction. In any transaction, there is abuyer and a seller. If the transaction price is, say, $100, it means that both parties agreed to exchange the asset against this amount of money. But, if the buyer is happy to pay $100 for the asset, it means that he or she is convinced that the “true” value of the asset is more. The same for the seller, who is convinced that the “true” value is less than $100. Thus, a transaction may happen andproduce a transaction price if there is a disagreement on the value. If both, buyer and seller, are convinced that the value is $100, none of them is going to pay transaction fees in order to make a zero-NPV investment. As a consequence, in order to make any decision involving an asset, you need two opinions: the market opinion tells you at which price the asset is offered, your personal opiniontells you if it’s worth the price. Consider an investment, say buy a machine to save costs. You will actually approve the investment if the value of the machine (cash flows discounted at the cost of capital) exceeds its cost, the difference between these two figures being named the Net Present Value. This teaching note will explain you, on the one hand, how to analyze the market opinion, on the otherhand, how to forge your personal opinion on a company. It is divided into two parts: 1- Market opinion: multiples and comparables 2- Investor’s opinion: discounted cash flows 1/ MARKET OPINION: MULTIPLES & COMPARABLES It is important to understand the principles behind the method before you calculate the multiples, identify the comparables and actually use the figures to draw conclusions and takeactions. 1.1/ Principles Each company provides information and data to the business community on a regular basis (audited accounts every semester for listed firms). Financial statements tell you where the company stands at the end of the period (balance sheet), how much profit it generated out of sales during the period (profit & loss) and how this profit was transformed into cash and combinedwith external contributions (shareholders and financial creditors) to actually finance internal (capital expenditures) and external (acquisitions) growth (cash flow statement). It is reasonable to state that there is a relationship between, on the one hand, profitability and cash generated by the company, and, on the other hand, its value. Therefore, the method

Teaching Note Corporate Value –Dominique Jacquet – copyright – page 1 out of 11

confronts market values with those figures, among the accounting data, which provide information about the ability of the company to generate profits transformed into cash. You immediately understand why the quality of accounting information is key. The second section is about which ratios (multiples) are commonly calculated to confront market andbook figures. 1.2/ Calculating the “multiples” Multiples fall into two different categories, those which relate with the value of equity and those which deal with the enterprise value. Equity is the accumulated investment made by shareholders throughout the years and mainly consists in share capital and retained earnings. It is, then, natural to confront the value of equity with either the profitattributable to shareholders, or the investment realized by shareholders in the past. The market value of equity is calculated by multiplying the number of shares outstanding by the stock price and is named market capitalization. As earnings after taxes (EAT) represent the residual claim attributable to shareholders after each and every stakeholder has been remunerated, the first multiple, which...
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