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 Discounted Cashflow Analysis: Does Achieving the Forecast Affect Implied Value?
During the first quarter of 2005, Woodward completed a fair market valuation of the common equity of a growing manufacturing client in connection with a company-sponsored offer to purchase stock owned by unaffiliated investors. As part of the valuation process, Woodward performed discounted cash flow analyses, using management’s forecasts and a 19% all-equity company cost of capital, discounting forecasted cashflows to present value as of March 31, 2005. The client contacted Woodward in April 2006 with a question: Because the company’s financial results for the fiscal year ended December 31, 2005 exactly matched the forecasted results included in Woodward’s discounted cashflow analyses, would the value of its equity increase by 19% as of March 31, 2006, assuming all other factors remained constant, including forecasted results? What do you think?
April 2006
Market-to-Book Analysis Market-to-Book Analysis is used within comparable company analysis to calculate the equity of a business relative to its tangible and intangible assets, net of liabilities. In assessing the value implied through a Market-to-Book analysis, we note practitioners often misunderstand the denominator in this calculation. Within the numerator, “Market” refers to the market value of the company being analyzed. “Book” is an accounting term that refers the company’s balance sheet. Book Value is calculated as a company’s total assets minus total liabilities, also known as book equity, shareholders’ equity or book value. It is not calculated by subtracting liabilities from a company’s market value of equity. If the incorrect “Book” calculation is used, the resulting ratio is flawed. Instead of measuring a company’s equity value relative to its net assets, the incorrect calculation generates a circular result, comparing equity value to another, adjusted equity value. Accordingly, to correctly determine a Market-to-Book ratio for the purpose of comparable valuation analyses, the accounting measure of book value must be used. Comparable company analysis Comparable company analysis is one of the standard, accepted methodologies for assessing implied value of a business or business unit. In this methodology a set of “comparable” publicly traded companies and their key financial statistics: revenues, EBIT, EBITDA, net income and book value are determined. We denote “comparable” in quotations, because rarely is any business directly comparable to another in terms of financial size, location, product mix and/or strategy. By comparing these statistics to each “comparable” company’s market and enterprise values, as appropriate, we determine valuation ratios or multiples for each company and then apply these ratios to the financial results of the business or business unit being valued. October 2005
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