What are Market-based valuations? and example of them?
The ‘going rate’ method: the simple current market price for a particular type of firm, Eg sale price = sale prices of similar firms.
Revenue multiplier method: an industry multiple to give and indicative purchase price. Eg sale price = (turnover)*(standard industry multiple)
what are asset based valuations? examples of them?
- Book value method: price is set by calculating the net worth of the firm’s assets using book values. Eg sale price = tangible assets +
- intangible assets - liabilities
- Adjusted book value method: same concept as book value method but now the value of assets and liabilities are adjusted to better represent their current (true) values.
- Liquidation value method: the value of the net assets of the business assuming that the business is no longer a going concern and thus the business is only worth whatever the net assets are worth.
- Replacement value method: the price that would be paid for the business of the tangible assets of the business were valued at their current replacement cost.
what are earning based valuations/ examples of them?
ROI method: based on the notion that the investor requires a certain minimum rate of return if he/she is to invest in the new business. Eg maximum sale price = net annual profit/ ROI
- Discounted cash flow method: a more complex version of ROI method, annual net cash flows are estimated for the future and then discounted to give a current value of the
- business. The discount rate is the required rate of return. Eg, value = (sum of) (CFt/(1+r)t) + (terminal value/(1+r)t)
Which is the best method for determining the purchase price or sale price of a business?
Why? (Your answer should include both an (abbreviated) discussion of the strengths and weaknesses of each method, and a consideration of what constitutes the best purchasing price from the perspectives of both the buyer and seller.)
- No one method is the idea method for identify the appropriate price, some methods are less perfect than others. From the buyers point of view the best method is the method that gives the lowest
- price, for the sellers the best method is the method that gives the highest sale price.
- Market based evaluations are straight forward
- and easy to understand but fail to take into account individual circumstances of the business, don’t give proper consideration to returns/assets being acquired, often market price or industry multiple may not exist.
- Asset based evaluations are relatively easy
- to understand, attempt to taking into account individual circumstances of the business and can be useful is the buyer is simply interested in acquiring the businesses assets. But there can be difficulty correctly valuing assets and
- liabilities and this method may not provide a true value of the business.
- Earning based evaluations is the most theoretically correct approach, given that it
- gives the most accurate measure of the true value of the business being purchased however it is difficult to use in practice.
Why do most business sales
come down to a process of negotiation?
Because the buyer wants the lowest price and the seller wants the highest possible price. Negotiation seeks to achieve a fair price for both parties.