Explain various valuation methods in mergers and acquisitions

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Generally, there are two ways for a valuation of a company namely, liquidation value and going concern way. Companies prefer going concern way of valuation. If a company wants to eliminate a targeted company or wants to remove it from the market, the company goes for valuation.

Some of the methods of valuations are as follows −

  • Price − Earnings Ratio (P/E Ratio)

It compares a company's current share price to earnings per share. Investors prefer high P/E Ratio, because of high earnings.

P/E Ratio tells about investors willing to pay per dollar of earnings. It can be easily manipulated.

P/E ratio is useful in comparison with other companies in the same sector or historical P/E Ratio.

  • Enterprise value to sales ratio

This ratio measures a company's enterprise value to its sales. Investors prefer lower enterprise value to sales ratio because this ratio tells about the estimated price (to buy) at which company sales.

Negative enterprise value to sales ratio, indicates the company is having more cash than its market capitalization and debt.

Enterprise value to sales ratio is a more accurate method than the price to sales valuation method. Higher enterprise value to sales ratio tells that the sales could increase in future and lower enterprise value to sales ratio tells that the future sales are not attractive.

  • Book value

It is the best method, if a company is not having intangible assets and assets like those that brand value; trade secrets etc. or its value is ignored.

Book value depends on accounting practices used by the company.

  • Liquidation value

Companies having financial distress or having uncertain futures use this method.

Liquidation is the value of sale of assets at a particular time.

Value fluctuates with appraisers. Some appraisers will ignore the value of intangible assets. Some of the factors considered while liquidation are physical condition, age of an assets etc.

  • Market value

Market value is calculated by multiplying stock price by outstanding shares or it can be calculated by multiplying price per bond to number of bonds outstanding.

While in mergers and acquisitions, a company selling its equity will get control premium, which is the amount, where equity will get more price than its normal price

  • Replacement cost method

This method is used at the basic level in the merger process to sell at price of equipment, staffing cost and eliminates acquired companies. This method is least effective or often used in industry.

  • Discounted cash flow method

This method estimates enterprise value. This can be done by estimating future cash flows over a period of time and forecasts free cash flows and terminal value to present value.

This is the most valued method in enterprise value. Quality of assumptions must be considered, while calculating the free cash flows, terminal values etc. in valuation.

Updated on 19-Jul-2021 10:06:51