How to perform business value analysis?
Question:
Answer:
can i understand u more detail? cos ur question seems vy broad. how about ROIC, ROE?
This is a very easy two-step answer.
1. Buy a copy of Brealey Meyers (the definitive text on corporate finance).
2. Read it.
DCF modeling - (Discounted Cash Flow). If you can calculate a net present value or you are familiar with how to calculate payments on a loan, then this won't be too much of stretch.
A DCF model works like this:
1) Estimate the cash flow the business is expected to generate on an annual basis from now to eternity (usually people just model the first five years and assume some constant rate of growth like 3% for all of the following years).
2) Pick a discount rate. This should represent a risk-free interest rate (like on 10yr treasury bonds) + some risk premium based on the risk of the business and your confidence in your cash flow projections. The higher the risk (or lower your confidence), the higher the discount rate over the 10 yr treasury bond rate. A very stable business might have a discount rate of 10%. A risky business might have a rate of 20%. For small mom-and-pop businesses you should use 50% to 100%.
3) Calculate the NPV (net present value) of your future cash flows with your discount rate. You probably should calculate it with a couple of discount rates to a range. The NPV of future cash flows is the value of the business.
On calculating NPV: Google it. It's a simple process.
Example - This is an example of a three-year business and a 10% discount rate.
Discount rate = 10%
Cash flow projections:
Cash flow Present Value of Cash Flow
Yr 0 $100 $100
Yr 1 $150 $136
Yr 2 $200 $165
NPV = $100 + $136 + $165 = $401, So I wouldn't spend more than $401 on this business.
This is THE model to use to value a business. But, business valuation is more of an art. Projecting cash flows and picking a discount rate is a very subjective process that people like Warren Buffett are very good at. The stock market does this as well. WB is very good at figuring out when the market has it wrong.
I hope this helps.
More Questions & Answers...