Company valuation in 10 minutes …
You do not always have enough time to run a full blown company valuation. On the occasions that you are in a hurry, you may take a quick EVA approach. Whilst we all appreciate that transaction valuation is more complex than this and requires more extensive financial modelling and transaction structuring experience, such a quick EVA assessment of indicative value is very helpful during brainstorming and ‘what next’ types of meetings.
We know that company value equals value of equity plus value of debt (interest bearing); while in normal (non-distressed situations) value of the debt equals to its nominal book value, in corporate transactions the variable is then value of equity.
When valuing a business you may get company / equity value
-
equal; or
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higher; or
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lower than is its book value.
So let’s start:
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Analyze normalized EBIT – Earnings before interest and tax that the company can sustainably generate; (Points 01,02,03 of Sample table bellow.)
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Take the company’s book value of equity and add interest bearing bank debt to get capital employed (or book value of company). You may adjust it by adding other operating assets and subtracting non-operating items; (04,05,06)
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Calculate WACC- weighted average cost of capital or how much the capital employed costs – take cost of equity (expected return on equity) add cost of debt (interest rate), both weighted by its respective share in the capital employed prior to the addition; (07,08,09)
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Calculate ROCE – return on capital employed, which is a division of EBIT over the capital employed; (02,04,10)
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Subtract WACC from ROCE and multiply the result by capital employed to arrive to EVA – economic value added; (07,10,11)
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Divide EVA by WACC and add the result to capital employed to get indicative company value; (11,07,04)
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Subtract the interest bearing debt to arrive at indicative value of equity; (12,13,14)
|
Sample |
Indicative value of the company to its book value |
|||
|
Equal |
Higher |
Lower |
||
|
01 |
Normalized Revenue |
175.00 |
175.00 |
175.00 |
|
02 |
Normalized EBIT |
15.85 |
26.25 |
8.75 |
|
03 |
EBIT (Margin) |
9.06% |
15.00% |
5.00% |
|
04 |
Capital Employed |
149.00 |
149.00 |
149.00 |
|
05 |
Book Value of Equity |
84.00 |
84.00 |
84.00 |
|
06 |
Interest Bearing Debt |
65.00 |
65.00 |
65.00 |
|
07 |
WACC |
10.64% |
10.64% |
10.64% |
|
08 |
Cost of Equity |
15.00% |
15.00% |
15.00% |
|
09 |
Cost of Interest Bearing Debt |
5.00% |
5.00% |
5.00% |
|
10 |
ROCE |
10.64% |
17.62% |
5.87% |
|
11 |
EVA |
0.00 |
10.40 |
-7.10 |
|
12 |
Indicative Fair Company Value |
149.00 |
246.77 |
82.26 |
|
13 |
Indicative Fair Value of Equity |
84.00 |
181.77 |
17.26 |
|
14 |
Interest Bearing Debt |
65.00 |
65.00 |
65.00 |
Indicative value of the company equity is to its book value
1. equal when ROCE equals WACC or simply said when EBIT equals cost of capital
2. higher when the difference between ROCE and WACC is positive
3. lower when the difference between ROCE and WACC is negative
Please Note
Please note that accounting for taxes, you may use NOPAT – net operating profit after tax instead of EBIT as well as tax adjusted WACC instead of just WACC. In case of low CAPEX requirements going forward you may use EBITDA instead of EBIT. The most accurate item to include in the computation is unleveraged free cash flows anyway, which accounts for taxes, CAPEX, working and other capital requirements. In order to get and indicative value of a company you may even shorten the calculation and just divide WACC over EBIT, which is by the way also the mathematic-financial construct behind valuation multiples (e.g. division by 10% returns the same results as if you mulitpled the numerator by 10). The EVA however is an excellent indicator that helps determine which direction you would like to go to improve the company future valuation – focus on the increase in EBIT, or on the decrease in capital employed, or combination of both…