BUSINESS VALUATION MODELS
This paper deals with the basic theory underlying valuation models. It begins by discussing such concepts as free cash flow, cost of capital, and expected growth rates, as they are basic to an understanding of valuation theory.
The ultimate goal of a corporate manager is to maximize the wealth of shareholders. Shareholders wealth is the value of the firm 's collective assets. To maximize the shareholders wealth, in general, is equivalent to maximizing the value of the firm. Therefore, it is imperative that the corporate officers know how to determine the value of the firm.
Determining the value of a company is a difficult task, since there are various definitions of "value", depending on the needs and usage of different users.
"Value" can be considered from two different perspectives. The first is market value, which reflects what investors are willing to pay for a firm, which can be determined simply by multiplying the price per share by the number of shares outstanding. Financial economists often argue that the stock market is efficient, and therefore, the market value of the firm should be the price the firm would bring if sold in the market today.
Although the stock market as a whole is considered to be efficient, many financial analysts feel that individual stocks and firms are seldom fairly valued. Therefore, a second method, which is based on the present value of expected cash flows, or what we call intrinsic financial value, has been suggested.
Under efficient market hypothesis, we expect the market value to reflect the intrinsic financial value. However, in recent years, valuation of most firms in mergers and acquisitions, have resulted in errors, and undervaluation of the companies. As a result, these two values have not been the same, and the focus of this paper will be on the techniques of determining the intrinsic financial value.
THE BASICS OF INTRINSIC FINANCIAL VALUE:...