Company valuation methods and their practical relevance

Abstract

The topic company valuation is one of the most significant areas of business administration but also one of the most controversial. In the literature there can be found a broad spectrum of methods and concepts for the valuation of companies with a difference in the complexity of its application. The aim of this master thesis is to give an overview of the topic company valuation and the existing valuation methods and to provide a better understanding, which methods are actually used in practice and what are the details that have to be considered. The methods of company valuation can be classified in three basic groups depending if they are focusing only on the values of the single components of the company, the company as one unit that is a compositions of its assets, or on something in between. The most common method used internationally and also the most practical relevance has the discounted cash flow method (DCF) with its three approaches. But typically not only one method is used but a combination of the DCF method and the multiple-based approach to validate the results is applied. Under the discounted cash flow method there exist three approaches, the WACC- (weighted average cost of capital), the APV- (adjusted present value), and the FtE- (flow to equity) approach. The individual variants of the DCF-method distinguish themselves basically in the manner of calculating the shareholder value directly (equity approach) or indirectly (entity approach), and how the tax advantage due to debt financing (tax shield) is used. The aim of all approaches is to determine the market value of the company respectively its equity and therefore estimating the present value of a company by discounting its future payments, the free cash flows (FCF). The estimation and forecasting of the free cash flows is done based on an analysis of the valuation object, it-s historical performance, and the market environment. In order to perform the calculation of the discounted cash flows it is necessary to determine the costs of equity based on the capital asset pricing model and the costs of debt. The multiple-based approaches are using the known market prices of other companies to calculate multiples that are then taken to valuate the object company. There is the possibility to either taking the market price of stock exchange listed companies or using the market price of recently acquired comparable companies. For the selection of comparable companies or transactions it is important that they share the same characteristics as the valuation object.