Valuation

In an M&A deal, the seller will always try to sell for the highest price and the buyers will always wish to buy the company at the lowest price. Thus each company values the target company differently. However, there are definitive measurements for the value of a company that can be used to help out in the process

Types of Valuation

The measurement used will often depend on the circumstances and the type of deal or required analysis. Below are listed some valuation methods used in an investment bank.

Discounted Cash Flow

Discounted Cash Flow (DCF) is a valuation method that estimates the value of a company based on its expected future cash flows. The underlying principle that backs this method is that the value of money today is worth more than the same amount of money in the future, this is due to the time value of money and potential risks or crises.

First, you have to calculate the present and expected cash flows of the compnay. Cash flow is the amount of money that flows in and out of the company in a given time period, usually a year. This is done through calculating expected revenues, expenses and taxes as well as any other relevant factors.

Then, you find the discount rate, which the the rate of interest provided by the central bank. This rate represents the return an investor would expect from an investment with similar risk and characteristics. It takes into account the rate of inflation, interest rates and risk profile of the invesment.

Finally, you use the above information to calculate the discounted cash flow which brings the value of the company back to its present value. This involves dividing each future cash flow by (1 + discount rate) to the power of the respective time period. Once you sum up all the present values of the future cash flows you get the net present value (NPV).

This is the equation for calculating the DCF where:

PV = Present Value of Cash Flows

CF = Cash in that time period

r = Discount Rate

n = Number of time periods into the future

P/E Ratio

The price-to-earnings ratio is a simple, commonly used calculation to value companies and then compare them. It takes the market price of a company's shares and compares it to its earnings per share (EPS).

P/E Ratio = Market Price per Share / Earnings per Share (EPS)

Market Price per Share = Current market price of one share of the company's stock

Earnings per Share (EPS) = EPS is the company's net income divided by the number of outstanding shares of its stock (EPS = Net income/Number of Outstanding Shares)

EBITDA

The EBITDA multiple is a valuation metric that compares the enterprise value of a company to its EBITDA.

EBITDA Multiple = Enterprise Value / EBITDA

Enterprise Value = Total value of a company, including its equity value, debt, and cash equivalents

(Enterprise Value = Market Capitalisation + Total Debt - Cash and Cash Equivalents)

EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortisation

Further breaking down EBITDA:

Earnings = Company's net income

Before: EBITDA is a measure of profitability "before" taking into account certain expenses.

Interest: Interest expenses are the costs associated with borrowing money

Taxes: Income taxes, both federal and state are excluded because they are considered financial expenses

Depreciation: Depreciation is a non-cash accounting expense that reflects the gradual decrease in the value of tangible assets over time.

Amortisation: Amortisation is similar to depreciation but pertains to intangible assets

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