Valuing the Corporation
Three approaches are commonly used in corporation valuation: the income approach, the assetbased approach, and the market approach.
Learning Objective

Distinguish between the income, assetbased, and market approaches for corporate valuation
Key Points
 Income approaches include Discount or capitalization rates, Capital Asset Pricing Model (CAPM), Modified Capital Asset Pricing Model, and Weighted average cost of capital ("WACC").
 The asset approach to business valuation is based on the principle of substitution: no rational investor will pay more for the business assets than the cost of procuring assets of similar economic utility.
 The market approach to business valuation is rooted in the economic principle of competition: in a free market the supply and demand forces will drive the price of business assets to a certain equilibrium.
Terms

net asset value
Net asset value (NAV) is the value of an entity's assets less the value of its liabilities, often in relation to openend or mutual funds, since shares of such funds registered with the U.S.

corporation
a group of individuals, created by law or under authority of law, having a continuous existence independent of the existences of its members, and powers and liabilities distinct from those of its members

discounted cash flow
In finance, discounted cash flow (DCF) analysis is a method of valuing a project, company, or asset using the concepts of the time value of money. All future cash flows are estimated and discounted to give their present values (PVs)â€“the sum of all future cash flows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cash flows in question.
Full Text
Corporation valuation is a process and a set of procedures used to estimate the economic value of an owner's interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to perfect the sale of a business. In addition to estimating the selling price of a business, the same valuation tools are often used by business appraisers to resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among business assets, establish a formula for estimating the value of partners' ownership interest for buysell agreements, and many other business and legal purposes.
Three different approaches are commonly used in business valuation: the income approach, the assetbased approach, and the market approach. Within each of these approaches, there are various techniques for determining the value of a business using the definition of value appropriate for the appraisal assignment. Generally, the income approach determines value by calculating the net present value of the benefit stream generated by the business (discounted cash flow); the assetbased approach determines value by adding the sum of the parts of the business (net asset value); and the market approach determines value by comparing the subject company to other companies in the same industry, of the same size, and/or within the same region.
1. Income approaches
 Discount or Capitalization Rates
A discount rate or capitalization rate is used to determine the present value of the expected returns of a business. The discount rate and capitalization rate are closely related to each other, but are distinguishable. Generally speaking, the discount rate or capitalization rate may be defined as the yield necessary to attract investors to a particular investment, given the risks associated with that investment.
 Capital Asset Pricing Model (CAPM)
The Capital Asset Pricing Model (CAPM) is one method of determining the appropriate discount rate in business valuations. The CAPM method originated from the Nobel Prize winning studies of Harry Markowitz, James Tobin, and William Sharpe. The CAPM method derives the discount rate by adding a risk premium to the riskfree rate. In this instance, however, the risk premium is derived by multiplying the equity risk premium times "beta," which is a measure of stock price volatility. Beta is published by various sources for particular industries and companies. Beta is associated with the systematic risks of an investment.
 Modified Capital Asset Pricing Model
The Cost of Equity (Ke) is computed by using the Modified Capital Asset Pricing Model
CAPM Model ke = Rf + B ( RmRf) + SCRP + CSRP Where: Rf = Risk free rate of return (Generally taken as 10year Government Bond Yield) B = Beta Value (Sensitivity of the stock returns to market returns) Ke = Cost of Equity Rm= Market Rate of Return SCRP = Small Company Risk Premium, CSRP= Company specific Risk premium
 Weighted Average Cost of Capital ("WACC")
The weighted average cost of capital is an approach used to determine a discount rate. The WACC method determines the subject company's actual cost of capital by calculating the weighted average of the company's cost of debt and cost of equity. The WACC must be applied to the subject company's net cash flow to total invested capital.
2. AssetBased Approaches
The value of assetbased analysis of a business is equal to the sum of its parts. That is the theory underlying the assetbased approaches to business valuation. The asset approach to business valuation is based on the principle of substitution: no rational investor will pay more for the business assets than the cost of procuring assets of similar economic utility. In contrast to the incomebased approaches, which require the valuation professional to make subjective judgments about capitalization or discount rates, the adjusted net book value method is relatively objective.
3. Market Approaches
The market approach to business valuation is rooted in the economic principle of competition: that in a free market the supply and demand forces will drive the price of business assets to a certain equilibrium. Buyers would not pay more for the business, and the sellers will not accept less than the price of a comparable business enterprise. It is similar in many respects to the "comparable sales" method that is commonly used in real estate appraisal. The market price of the stocks of publicly traded companies engaged in the same or a similar line of business, whose shares are actively traded in a free and open market, can be a valid indicator of value when the transactions in which stocks are traded are sufficiently similar to permit meaningful comparison.
Key Term Reference
 Assets
 Appears in these related concepts: Secured vs. Unsecured Funding, Defining LongLived Assets, and Defining the Marketing Objectives
 Interest
 Appears in these related concepts: Interest Compounded Continuously, Accounting for Interest Earned and Principal at Maturity, and Tax Considerations
 Risk free rate
 Appears in these related concepts: Risk Adjusting the Discount Rate, The Cost of Debt, and FamaFrench ThreeFactor Model
 Stock
 Appears in these related concepts: Ownership Nature of Stock, Advantages of Private Financing, and Financial Instruments
 allocate
 Appears in these related concepts: Defining Strategic Planning, Depreciation, and Inputs to COGS
 analysis
 Appears in these related concepts: The Impact of External and Internal Factors on Strategy, Scenario Analysis, and Writing in Different Academic Disciplines
 asset
 Appears in these related concepts: Goodwill Impairment, Shifts in the Money Demand Curve, and Balance Sheets
 benefit
 Appears in these related concepts: Adding Value, Defining Price, and Childcare
 beta
 Appears in these related concepts: Announcements, News, and Returns, Defining the Security Market Line, and The Cost of Common Equity
 bond
 Appears in these related concepts: Factors Affecting the Price of a Bond, Current Maturities of LongTerm Debt, and Preferred Stock
 capital
 Appears in these related concepts: Temple Architecture in the Greek Orientalizing Period, Minoan Architecture, and The Acropolis
 capitalization
 Appears in these related concepts: The Relationship Between Present and Future Value, Cost of Interest During Construction, and Capital Letters
 cash flow
 Appears in these related concepts: Calculating the NPV, Interpreting the NPV, and Defining the Cash Flow Cycle
 cost of capital
 Appears in these related concepts: Advantages of the Payback Method, Calculating the IRR, and Cost of Capital Considerations
 debt
 Appears in these related concepts: Debt Utilization Ratios, Deficit Spending, the Public Debt, and Policy Making, and Collection from Delinquent Payables
 discount
 Appears in these related concepts: The Discount Rate, Par Value at Maturity, and Present Value, Multiple Flows
 discount rate
 Appears in these related concepts: Discounted Cash Flow Approach, The Discount Rate, and The Federal Reserve and the Financial Crisis of 2008
 equity
 Appears in these related concepts: Motivating and Compensating Salespeople, Civil Law and Criminal Law, and The Psychology of Employee Satisfaction
 expected return
 Appears in these related concepts: Expected Return, Types of Financial Decisions: Investment and Financing, and Arbitrage Pricing Theory
 investment
 Appears in these related concepts: Functions of Corporate Finance, The Role of the Financial System, and GDP Equation in Depth (C+I+G+X)
 investor
 Appears in these related concepts: Formation of the Corporation, Agency, and The United States Banking System
 net present value
 Appears in these related concepts: Other Considerations in Capital Budgeting, The Role of Financial Managers, and CostBenefit Analysis
 premium
 Appears in these related concepts: The Term Structure, Redeeming Before Maturity, and Health Insurance
 present value
 Appears in these related concepts: Capital Leases vs. Operating Leases, Calculating Values for Different Durations of Compounding Periods, and Present Value and the Time Value of Money
 return
 Appears in these related concepts: Dollar Returns, Comparing the Fields of Finance, Economics, and Accounting, and Disadvantages of the Payback Method
 risk
 Appears in these related concepts: The ExportImport Bank of the United States, Approaches to Assessing Risk, and Risks Involved in Capital Budgeting
 risk premium
 Appears in these related concepts: Understanding Future Stock Value, Measuring and Managing Risk, and The Value of Diversification
 sales
 Appears in these related concepts: Additional Funds Needed (AFN), Repurchasing Stock, and Seasoned Equity Offering
 systematic risk
 Appears in these related concepts: Measuring Risk, The Capital Asset Pricing Model, and Risk and Return Considerations
 systematic risks
 Appears in these related concepts: Impact of Diversification on Risk and Return: Unsystematic Risk, Expected Risk and Risk Premium, and Inflation Premium
 valuation
 Appears in these related concepts: Evaluating Financial Statements, Valuation of Intangible Assets, and Basic Components of Asset Valuation
 volatility
 Appears in these related concepts: Misleading Graphs, Historical Returns: Market Variability and Volatility, and BlackScholes Formula
 weighted average
 Appears in these related concepts: Average Cost Method, Market Reporting, and Expected Value
 yield
 Appears in these related concepts: Bonds Payable and Interest Expense, Stock Warrants, and Calculating the Yield of an Annuity
Sources
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