Business Valuation
What’s an apple tree worth?
“Old Man and Apple Tree”
Consider the following valuations:
• Salvage
• Current production
• Future production
• Market price
• Book value
Balance Sheet
Time value of money
What is the value of $1?
Time value of money
Let’s say I offer you either
$500 today or $800 in three years.
Which is better?
Time value of money
Invest $500
10%
Balance
Year 1
Year 2
Year 3
$50.00
$55.00
$60.50
$550.00
$605.00
$665.50
$800 in 3 years is better than $500 today
(assuming a 10% rate for money)
Time value of money
Invest $500
20%
Balance
Year 1
Year 2
Year 3
$100.00
$120.00
$144.00
$600.00
$720.00
$864.00
$500 today is better than $800 in 3 years
(assuming a 20% rate for money)
Time value of money
Mathematically
$500 * (1+ .20)3 = $864
Time value of money
What if somebody offers you
$864 in three years. Or $1000.
What is it worth to you?
Time value of money
Discount
$864
Year 3
Year 2
Year 1
End of year
20%
Start of year
(divide by 1.20)
$864
$720
$600
$144
$120
$100
$720
$600
$500
$864 (discounted at 20% rate) = $500
Time value of money
Discount
$1000
Year 3
Year 2
Year 1
End of year
20%
Start of year
(divide by 1.20)
$1000
$833
$694
$167
$139
$115
$833
$694
$579
$1000 (discounted at 20% rate) = $579
Time value of money
Mathematically
$1000 / (1+ .20)3 = $578.70
“Old Man and Apple Tree”
Value of cash flows?
(from Class Notes)
Precision Tools
Net income
Depreciation
Bonuses
Net cash flow
Adjusted CF
$390,000
$250,000
$120,000
$760,000
$500,000
Discount rate
33%
Growth rate
8%
Capitalization rate 25%
(discount minus growth)
Cap multiplier
DCF
4
$2,000,000
Precision Tools
Comparables Method
Use P/E ratio
Company X
• Price = $4,000,000
• Adj Earnings = $520,000
Precision Tools
• Price = ??
• Adj Earnings = $760,000
4000
520
PT Price
=
760
Company X
• Price = $4,000,000
• Adj Earnings = $520,000
• P/E = 7.7
Precision Tools
• Price = P/E * Earnings
• Adj Earnings = $760,000
7.7*$760,000 = $5,850,000
PT Price = $5,850,000
Price-earnings ratio
Precision Tools
U.S. stock market
(average stock)
Price = $2,000,000
Earnings = $390,000
P/E = 5.13
Price = $36
Earnings = $1.80
P/E = 20
Irrationally exuberant?
Precision Tools