2 Market Approach: Guideline Merged or Acquired
3 Income Approach: Discounted Cash Flow Method
4 Asset Approach
The Guideline Publicly Traded Company
method is based on the premise that
the value of a business ownership
interest should be based on what astute
and rational capital market investors
would pay to own that interest. Capital
market ratios of guideline publicly
traded companies are used to estimate
the value of the subject interest.
This method is extremely variable,
depending on market conditions,
because it uses as the basis for the
valuation analysis current public
valuation multiples, which fluctuate
with changing market conditions.
However, it is almost always available
to use as a reference, assuming
public comparables are available.
The Market Approach: Guideline
Merged or Acquired Company Method
(guideline transaction) considers the
market value of business enterprises
similar to the subject company, as
observed in ( 1) the acquisition price of
either public or private companies, or
( 2) the trading price of publicly traded
companies. Market pricing multiples
are derived from the indicated market
value relative to various financial
metrics for those companies.
The multiples are applied to the
appropriate level of the subject
company’s financial metrics after
being adjusted for its investment
risk profile in relation to those of the
guideline companies. This method
always provides a strong indication of
what investors are willing to pay for
companies. However, in the economic
downturn, the number of transactions
available to use as comparables has
decreased dramatically and only
recently has begun to rise again.
The Income Approach: Discounted Cash
Flow Method (DCF) is used to estimate
value based on a projection of financial
performance over future periods of time.
The projected financial performance
includes analyses of revenue, expenses,
capital investment, residual value,
capital structure, and required rates of
return. Based on the results of these
analyses, a projection of economic
cash flow from business operations is
estimated for future periods of time.
The resulting cash flow projection is
discounted at an appropriate present
value discount rate to estimate the
present value of the future cash flow.
In addition to estimating the present
value of future economic cash flow
for a discrete period, the residual,
or terminal, value of the business
enterprise is estimated as of the end
of the discrete projection period. This
terminal value is also discounted
to estimate its present value.
The most significant issue with the
discounted cash flow approach is
determining the riskiness of the
cash flows themselves. In poor
market conditions, there will be more
scrutiny on how projected cash flows
line up to historical performance
and on the appropriateness of the
discount rate used on them.
continued on page 14