Valuation Methods Explained

Cost of debt adjusted for the tax effect of deductible interest where applicable.

Example: A 12% debt cost with a 30% tax rate gives an 8.4% after-tax cost under the simple formula.

After-Tax Cost of Debt describes cost of debt adjusted for the tax effect of deductible interest where applicable; the valuation forces an analyst to make the investment thesisA reasoned explanation of why an investment should produce an attractive return and what could invalidate that view. numerical: amount, timing, probability and discount rateThe rate used to convert future cash flows into present value. all enter the conclusion.

For example, a 12% debt cost with a 30% tax rate gives an 8.4% after-tax cost under the simple formula.

When reviewing After-Tax Cost of Debt, focus first on the assumptions that contribute most to value and on whether management has historically delivered similar forecasts.

The amount at which an asset or liability appears in financial statements.

Example: A machine's carrying value falls as depreciationThe systematic allocation of a tangible asset's cost over its useful life. accumulates.

Carrying Value is the amount at which an asset or liability appears in financial statements; small changes in growth, margins, terminal assumptions or required returnThe minimum expected return an investor demands for the time and risk involved. can produce large changes in the answer.

A machine's carrying value falls as depreciation accumulates.

For Carrying Value, audit the forecast, discount rate, terminal value, financing assumptions and treatment of inflationA sustained increase in the general price level, reducing the purchasing power of money. and currency; compare the result with market and asset-based evidence. Different methods answer different valuation questions and need not produce the same result.

Valuing a business using trading multiples of similar listed companies.

Example: The analyst applies peer EV/EBITDAEarnings before interest, tax, depreciation, and amortisation. multiples to the target's earnings.

Comparable-Company Analysis describes valuing a business using trading multiples of similar listed companies. The result from the valuation is not discovered in the market; it is produced by a model whose assumptions determine how future benefits are translated into today's money.

The analyst applies peer EV/EBITDA multiples to the target's earnings. The arithmetic is only the final step; the quality of the estimate depends on whether the projected cash flows and discount rate reflect the business risk.

For Comparable-Company Analysis, audit the forecast, discount rate, terminal value, financing assumptions and treatment of inflation and currency; compare the result with market and asset-based evidence. A model can be mathematically correct and economically wrong.

The effective rate a company pays or would pay on borrowed funds.

Example: The analyst uses the bond yield as a market estimate of debt cost.

Cost of Debt is the effective rate a company pays or would pay on borrowed funds; the valuation forces an analyst to make the investment thesis numerical: amount, timing, probability and discount rate all enter the conclusion.

The analyst uses the bond yield as a market estimate of debt cost. The arithmetic is only the final step; the quality of the estimate depends on whether the projected cash flows and discount rate reflect the business risk.

For Cost of Debt, audit the forecast, discount rate, terminal value, financing assumptions and treatment of inflation and currency; compare the result with market and asset-based evidence. A model can be mathematically correct and economically wrong.

The return required by equity investors for bearing ownership risk.

Example: A riskier company has a higher estimated cost of equity.

Cost of Equity is the return required by equity investors for bearing ownership risk; the valuation converts assumptions about cash flows, assets, growth, risk or required return into an estimate of value or project attractiveness.

A riskier company has a higher estimated cost of equity.

A sound use of Cost of Equity states the valuation date, perspective, forecast period and decision rule, and reconciles the output with comparable transactions or market prices; precision in the output does not reduce uncertainty in the forecast.

A valuation method that discounts expected future cash flows to present valueThe current worth of money expected in the future after applying a discount rate..

Example: The analyst forecasts ten years of cash flow and a terminal value.

Discounted Cash Flow is a valuation method that discounts expected future cash flows to present value. The result from the valuation is not discovered in the market; it is produced by a model whose assumptions determine how future benefits are translated into today's money.

The analyst forecasts ten years of cash flow and a terminal value.

Build Discounted Cash Flow from explicit cash-flow drivers, then run sensitivities for growth, margin, timing and required return; reject precision unsupported by the inputs.

A model valuing equity as the present value of expected future dividends.

Example: A mature utility is valued using forecast dividends and a required return.

DividendA payment made from a company's profits to eligible shareholders. Discount Model is a model valuing equity as the present value of expected future dividends. The result from the valuation is not discovered in the market; it is produced by a model whose assumptions determine how future benefits are translated into today's money.

A mature utility is valued using forecast dividends and a required return.

A sound use of Dividend Discount Model states the valuation date, perspective, forecast period and decision rule, and reconciles the output with comparable transactions or market prices.

After-tax operating profitProfit from core operations after operating expenses but before financing costs and tax. minus a charge for capital employed.

Example: Positive EVA means operations earned more than the required cost of capital.

Economic Value Added describes after-tax operating profit minus a charge for capital employed. The result from the valuation is not discovered in the market; it is produced by a model whose assumptions determine how future benefits are translated into today's money.

Positive EVA means operations earned more than the required cost of capital.

A sound use of Economic Value Added states the valuation date, perspective, forecast period and decision rule, and reconciles the output with comparable transactions or market prices; precision in the output does not reduce uncertainty in the forecast.

A terminal-value method applying a valuation multiple to a future financial measure.

Example: The analyst applies eight times year-five EBITDA.

Exit Multiple Method is a terminal-value method applying a valuation multiple to a future financial measure; small changes in growth, margins, terminal assumptions or required return can produce large changes in the answer.

The analyst applies eight times year-five EBITDA. The arithmetic is only the final step; the quality of the estimate depends on whether the projected cash flows and discount rate reflect the business risk.

For Exit Multiple Method, audit the forecast, discount rate, terminal value, financing assumptions and treatment of inflation and currency; compare the result with market and asset-based evidence. Terminal assumptions often account for most of the estimated value.

An estimate of an asset's appropriate value under specified assumptions or accounting standards.

Example: The valuation model produces a fair value of ₦75 per share.

Fair Value is an estimate of an asset's appropriate value under specified assumptions or accounting standards; small changes in growth, margins, terminal assumptions or required return can produce large changes in the answer.

The valuation model produces a fair value of ₦75 per share. The arithmetic is only the final step; the quality of the estimate depends on whether the projected cash flows and discount rate reflect the business risk.

A sound use of Fair Value states the valuation date, perspective, forecast period and decision rule, and reconciles the output with comparable transactions or market prices; different methods answer different valuation questions and need not produce the same result.

The value of a business assuming it continues operating rather than being liquidated.

Example: A profitable brand is worth more as an operating company than as separate assets.

Going-Concern Value is the value of a business assuming it continues operating rather than being liquidated. The result from the valuation is not discovered in the market; it is produced by a model whose assumptions determine how future benefits are translated into today's money.

A profitable brand is worth more as an operating company than as separate assets.

For Going-Concern Value, audit the forecast, discount rate, terminal value, financing assumptions and treatment of inflation and currency; compare the result with market and asset-based evidence. Precision in the output does not reduce uncertainty in the forecast.

A constant-growth dividend model dividing next-period dividend by required return minus growth.

Example: A stable company with long-run dividend growth is valued using the Gordon model.

Gordon Growth Model is a constant-growth dividend model dividing next-period dividend by required return minus growth; the valuation forces an analyst to make the investment thesis numerical: amount, timing, probability and discount rate all enter the conclusion.

A stable company with long-run dividend growth is valued using the Gordon model.

Build Gordon Growth Model from explicit cash-flow drivers, then run sensitivities for growth, margin, timing and required return; reject precision unsupported by the inputs. Different methods answer different valuation questions and need not produce the same result.

An estimate of an asset's underlying economic worth based on expected cash flows, assets, or earning power.

Example: The analyst estimates intrinsic value above the current market price.

Intrinsic Value is an estimate of an asset's underlying economic worth based on expected cash flows, assets, or earning power; the valuation forces an analyst to make the investment thesis numerical: amount, timing, probability and discount rate all enter the conclusion.

The analyst estimates intrinsic value above the current market price.

For Intrinsic Value, audit the forecast, discount rate, terminal value, financing assumptions and treatment of inflation and currency; compare the result with market and asset-based evidence. Precision in the output does not reduce uncertainty in the forecast.

The estimated net amount available if assets are sold and liabilities paid.

Example: A distressed investorA person or organisation that commits capital with the expectation of a financial return. compares the share priceThe market price at which one share is quoted or traded. with liquidationThe process of selling an entity's assets, paying creditors, and distributing any remainder to owners. value.

Liquidation Value is the estimated net amount available if assets are sold and liabilities paid; the valuation forces an analyst to make the investment thesis numerical: amount, timing, probability and discount rate all enter the conclusion.

A distressed investor compares the share price with liquidation value. For Liquidation Value, a downside case and a sensitivity table reveal which assumption actually drives the result.

Build Liquidation Value from explicit cash-flow drivers, then run sensitivities for growth, margin, timing and required return; reject precision unsupported by the inputs. A model can be mathematically correct and economically wrong.

The price at which an asset could trade in the market at a given time.

Example: A listed share's market value changes throughout the trading day.

Market Value is the price at which an asset could trade in the market at a given time; small changes in growth, margins, terminal assumptions or required return can produce large changes in the answer.

For example, a listed share's market value changes throughout the trading day.

When reviewing Market Value, focus first on the assumptions that contribute most to value and on whether management has historically delivered similar forecasts.

A terminal-value method assuming cash flow grows at a constant rate indefinitely.

Example: Year-six cash flow is capitalised using the discount rate minus long-term growth.

Perpetuity Growth Method is a terminal-value method assuming cash flow grows at a constant rate indefinitely; the valuation converts assumptions about cash flows, assets, growth, risk or required return into an estimate of value or project attractiveness.

Year-six cash flow is capitalised using the discount rate minus long-term growth.

Build Perpetuity Growth Method from explicit cash-flow drivers, then run sensitivities for growth, margin, timing and required return; reject precision unsupported by the inputs. A model can be mathematically correct and economically wrong.

Valuing a business using prices paid in comparable past acquisitions.

Example: Recent bank takeovers provide reference acquisitionThe purchase of control or ownership of a company or business. multiples.

Precedent-Transaction Analysis describes valuing a business using prices paid in comparable past acquisitions; the valuation converts assumptions about cash flows, assets, growth, risk or required return into an estimate of value or project attractiveness.

For example, recent bank takeovers provide reference acquisition multiples. For Precedent-Transaction Analysis, a downside case and a sensitivity table reveal which assumption actually drives the result.

Build Precedent-Transaction Analysis from explicit cash-flow drivers, then run sensitivities for growth, margin, timing and required return; reject precision unsupported by the inputs. Also compare Sum-of-the-Parts Valuation, defined here as valuing separate business segments independently and adding them together, net of central claims.

The current cost of replacing an asset with one of similar utility.

Example: Building a comparable factory today would cost ₦30 billion.

Replacement Cost is the current cost of replacing an asset with one of similar utility; the valuation forces an analyst to make the investment thesis numerical: amount, timing, probability and discount rate all enter the conclusion.

For example, building a comparable factory today would cost ₦30 billion.

For Replacement Cost, audit the forecast, discount rate, terminal value, financing assumptions and treatment of inflation and currency; compare the result with market and asset-based evidence. Terminal assumptions often account for most of the estimated value.

A model valuing equity as book valueThe accounting value of shareholders' equity. plus the present value of future profit above the required return on equity.

Example: A bank's value reflects book equity and expected excess returns.

Residual Income Model is a model valuing equity as book value plus the present value of future profit above the required return on equity. The result from the valuation is not discovered in the market; it is produced by a model whose assumptions determine how future benefits are translated into today's money.

A bank's value reflects book equity and expected excess returns.

When reviewing Residual Income Model, focus first on the assumptions that contribute most to value and on whether management has historically delivered similar forecasts.

Valuing separate business segments independently and adding them together, net of central claims.

Example: A conglomerate's banking, telecom, and propertyLand and buildings held for use, rent, development, or capital appreciation. divisions receive different multiples.

Sum-of-the-Parts Valuation describes valuing separate business segments independently and adding them together, net of central claims. The result from the valuation is not discovered in the market; it is produced by a model whose assumptions determine how future benefits are translated into today's money.

A conglomerate's banking, telecom, and property divisions receive different multiples. The arithmetic is only the final step; the quality of the estimate depends on whether the projected cash flows and discount rate reflect the business risk.

A sound use of Sum-of-the-Parts Valuation states the valuation date, perspective, forecast period and decision rule, and reconciles the output with comparable transactions or market prices; a model can be mathematically correct and economically wrong.

The estimated value of cash flows beyond an explicit forecast period.

Example: Most of the DCF value comes from operations after year five.

Terminal Value is the estimated value of cash flows beyond an explicit forecast period; the valuation converts assumptions about cash flows, assets, growth, risk or required return into an estimate of value or project attractiveness.

Most of the DCF value comes from operations after year five.

A sound use of Terminal Value states the valuation date, perspective, forecast period and decision rule, and reconciles the output with comparable transactions or market prices.

The blended required return of debt and equity capital, weighted by their market values.

Example: A company uses a 14% WACC to evaluate operating projects.

Weighted Average Cost of Capital is the blended required return of debt and equity capital, weighted by their market values; small changes in growth, margins, terminal assumptions or required return can produce large changes in the answer.

A company uses a 14% WACC to evaluate operating projects. The arithmetic is only the final step; the quality of the estimate depends on whether the projected cash flows and discount rate reflect the business risk.

For Weighted Average Cost of Capital, audit the forecast, discount rate, terminal value, financing assumptions and treatment of inflation and currency; compare the result with market and asset-based evidence. Terminal assumptions often account for most of the estimated value.