Sample Business Studies Essays on Valuation

Valuation is an important process for entrepreneurs who frequently attempt to establish a fair value for their companies. Without accurate valuation, business owners may conceive unrealistic ideas of how much their business are worth. The broad array of valuation methods aim to assess all the aspects of a company. The area that is usually assessed include the economic worth of equipment, inventory, assets, and anything that possesses economic value. The valuation process also examines projected revenues and competitive price. Enterprise owners and investors often attempt to establish a fair value for their companies to determine their sale price when decide to exit from a given sector. Valuing a business also enables investors to make the right investment decisions.

The most common approach used to value projects and businesses is Adjusted Present Value (APV).  Rich et al. describes APV as the net present value or an investment adjusted to accommodate interest and tax benefits with equity being the only source financing (85). In other words, Adjusted Present Value method is used to objectively evaluate a company that finances projects or capital investment through owner’s equity. Additionally, Rich et al. mention that the APV method of valuation is typically utilized to assess transactions of massive proportions, for instance, a controlling stake from a bank loan (87). Hence, APV method is invariably preferred because it can be utilized in diverse business cases so long as the influence of financial policies on the cost of a project or investment can be determined.

There are notable differences between net and adjusted present value. Foremost, APV typically utilizes an owner’s equity that is used during the valuation process while Net Present Value (NPV) does not. Rich et al. affirm that NPV is used to objectively appraise a project or investment by calculating the cash flow from company assets and discount (92). The NPV model uses a weighted average cost of capital treated as the discount rate to arrive at the final valuation results. Furthermore, a business analyst does not need to calculate the present value to evaluate an investment using APV because financing is based on shareholders’ equity. Orsag et al. posit that APV is used to calculate cash flows from project or business assets and discount their value based on the cost of equity in the company (75). Furthermore, APV calculations take into account the varied tax shield like deductible interests. Overall, the two methods tend to use different sets of data and assumptions to rule if the investment is viable.

The Internal Rate of Return (IRR) is another business valuation model. It describes the discount rate at which the net present value of an investment is equal to zero. It implies that the present value of all expected cash flows associated with the ambitious project or investment is directly proportional to the initial investment. Additionally, Orsag et al. reveal the method of discounted cash flows forms the basis of IRR method of valuation (73). The method has widely been utilized in budgeting capital investments and supports the execution of investment decisions by potential investors. Moreover, investment decisions follow the rule that if the IRR is greater than the discount rate of cash flows, the project or investment is of value and should be engaged in. if the IRR is less than the discount rate of cash flow, the project or investment is of no value therefore should be rejected (Orsag et al. 74). Notably, the primary advantage of IRR model of valuation is its apparent simplicity because it is expressed as a percentage. The disadvantage is that it assumes that investors can reinvest incremental cash flow at the same rate as the IRR which an impossible action.

Discounting Cash Flow (DCF) is another model worth mentioning. DCF essentially attempts to determine free cash flows and accurately identify terminal value of a project or investment. It also determines the subsequent discounting of investment results attained ostensibly based on the discount rate applied. Orsag et al. mention that DCF model has widely been used to perform valuations because it is coherent and inexpensive owing to it primarily depending on the activities involved in a business or project (76). Additionally, the DCF model assists in evaluating economic viability of enterprise processes, such as production expansion and re-equipping large business mergers and acquisitions. The economic determination is part of the valuation process. The DCF model has never been disputed because its calculation logic is accessible, understandable, and can be idealized.

Conclusion

The valuation of investments or projects is a common practice in the business sector. It is paramount for investors to examine the viability of investments or projects before committing funds to buy, merge, or amalgamate business entities. Business analysts and investors can utilize one or more of the popular valuation models including DCF, IRR, APV and NPV. The APV method is preferred to the others because it allows investors to establish whether including more debts in a business directly increases its value. APV is suited for the analysis of projects and investments in which debt is repaid within a fixed schedule. Investors base their investment decisions on the result of calculations yielded by the different valuation models. The chosen valuation model should be able to yield accurate results.

 

 

Works Cited

Orsag, Silvije and McClure, Kenneth. “Modified Net Present Value as a Useful Tool for Synergy Valuation in Business Combinations.” UTMS Journal of Economics, Vol. 4, No. 2, 2013, pp. 71-77.

Rich, Steven, Rose, John and Delaney, Charles. “Net Present Value Analysis in Finance and Real Estate: A Clash of Methodologies.” Journal of Real Estate Portfolio Management, Vol. 24, No. 1, 2018, pp. 83-94.