Q. Report on the valuation of Endess?
Ideally the valuation must be based upon the present value of incremental cash flows that result from the buy-in but in practice this data will rarely be available.
Method 1 acquires into account both earnings and assets and simply and illogically divides the value by two. You are suggesting purchasing the company as a going concern and the use of asset values is better suited to a liquidation or asset stripping situation. Nevertheless the realisable value of assets might be regarded as the minimum value of the company.
Occasionally asset values are used as it is argued that if existing managers leave the company assets are the main items being purchased. In your case as you are offering the management through a buy-in situation this argument has little relevance.
The earnings part of method is as well subject to criticism as
- Maintainable profits must be based upon expected future earnings not historic earnings and should be modified to incorporate items such as expected bad debts and changes in remuneration of directors.
- The number of years profit to utilize in the estimate is subjective. Depending on the selection of years and whether or not a higher weighting is given to years near to the current time significantly different valuations may result.
- Earnings valuations must be based upon post-tax profits not pre-tax profits.
- The capitalisation rate of 16% is subjective for an unlisted company. This imply a P/E ratio of 6.25 which may be realistic as the industry ratio for AIM companies is 8.333. The EVA approach considers that for some years higher than normal profits will be available and that these are being purchased in addition to the net assets of the business. Once another time all the problems of an asset valuation exist plus the problems of establishing a normal post-tax rate of return and estimating future earnings and agreeing the number of years of EVA to be purchased.
In both methods profits relatively than cash flows are being considered and no explicit allowance is made for the time value of money.