Unit 6: Valuation
In its most basic form, the value of a corporation is its book value. The balance sheet records what the company owns (assets) and what it owes (liabilities). The difference is the book value of the firm. Consider that a company has decided to close its doors. All of the assets are liquidated and turned into cash. Then, the company uses the cash to pay all its liabilities. If any money is left, it belongs to the owners as owner's equity (OE). This is fundamentally the accounting equation:
A (assets) – L (liabilities) = OE (owner's equity)
Completing this unit should take you approximately 4 hours.
Upon successful completion of this unit, you will be able to:
- recognize the importance of increasing firm value;
- calculate various measures of corporate value; and
- apply value creation methodologies to business decisions.
6.1: Corporate Valuation
There are many reasons we want to determine the value of a corporation. It is essential in determining the cost of a share of stock and whether we will invest in this company. It is a significant factor if the company wants to be acquired. The business' priority is to create value for its owners/shareholders. Through various valuation methods, we can evaluate how well the business is doing in meeting these priorities.
We can use three methodologies to determine the value of a corporation. They include an income, an asset-based, and a market approach to valuation. After you read, you will be able to explain the various approaches to valuation.
6.2: Value-Based Management
Recognizing the importance of creating and increasing the value of a corporation for the benefit of all stakeholders, it is only reasonable that management should make investment decisions based on the potential value increase they should generate. This concept is referred to as value-based management.
Earlier, we discussed the need for management to make decisions that improve the firm's financial performance. The dividends paid and the potential for future dividends are indicators of performance. After you read, you will be able to explain the dividend discount model and how it is used in stock valuations.
Growing a business to produce favorable results for shareholders requires detailed and actionable strategies. One strategy for growth involves the area of M&A activity. Read this section to explore some of the options available to a firm.
A firm will make investments that will generate additional revenue and cash flows in the future. To analyze the potential benefits of these investments, the company recognizes the impact of time on the value of money, especially when the money or cash flows will occur in the future. This section discusses the effects of time on these investments.
6.3: Economic Value Added (EVA) and Market Value Added (MVA)
Whether you own a business or are considering growing your business by buying another company, you will want to be able to know what it is worth or the value of the business.
As you can see, the decisions you make on how much debt and how much of your own money (equity) you use to operate the business determine just how risky your business is. This is of great interest to people you want to borrow money from (lenders, investors) and your ownership interest in the business. The enterprise value is a way to consider if your debt to equity ratio decisions are increasing or decreasing your business's value.
If you have incorporated your business, the Market Value of Equity, also known as the firm's market capitalization, is equal to the price of a share of stock times the number of shares outstanding. If you haven't incorporated and are operating as a partnership or sole proprietor, the market value of equity is equal to the firm's book value (owner's equity).
Generally, a firm's enterprise value is the amount someone might be willing to pay for the company if it were available today. This value is based solely on the company's balance sheet. If you were looking to sell the business, a buyer would get the equity that exists in the company, would have to take on responsibility for the debt, and would get any cash that you have on hand. This value is the equity position of the current owner, plus any liabilities they must assume.
This article gives a brief overview of Market Value Added (MVA) and Economic Value Added (EVA).
The balance sheet in a company's financial package is, in brief, a summary of everything the firm owns and the total of what they owe. The difference is Owner's Equity, and shareholders are very interested in the trend of this account. The value of assets is determined by evaluating the book value and the market value. Read this chapter to learn more, and pay particular attention to the market value vs. book value section.
Companies can create value for their shareholders by paying cash dividends. There are also other methods for addressing the value of a share of stock. Read this chapter, which discusses some of these methods.
Read this article. You must be able to explain how market value added (MVA) is an element of shareholder value.
Study Session
This study session is an excellent way to review what you've learned so far and is presented by the professor who created the course. Watch this as you work through the unit and prepare for the final exam.
We also recommend reviewing this Study Guide before taking the Unit 6 Assessment.
Unit 6 Assessment
- Receive a grade
Take this assessment to see how well you understood this unit.
- This assessment does not count towards your grade. It is just for practice!
- You will see the correct answers when you submit your answers. Use this to help you study for the final exam!
- You can take this assessment as many times as you want, whenever you want.