How to Value a Company in 3 Easy Steps – Valuing a Business Valuation Methods Capital Budgeting

How to Value a Company in 3 Easy Steps – Valuing a Business Valuation Methods Capital Budgeting


How to Value a Company in 3 Easy Steps, How
to Value a Business – Valuing a Business Valuation Methods Capital
Budgeting Welcome back to our second part of Capital
Budgeting, which is Valuing a Business. Brought to you by MBABULLSHIT.COM. Before this video,
you should first understand present value, net present value, basic capital budgeting,
and the weighted average cost of capital, or the WACC. If you don’t understand these
concepts yet, I recommend that you watch my other free videos on these topics above. Let’s
get down to it! When we say valuing a business, we’re actually
trying to answer the question “How much is the business worth?” If you remember,
here is a store, an existing business. Maybe you want to buy this store from its owner.
Before you buy from him, you have to find out how much is the business worth? Here is
where financial managers and accountants have different philosophies. For most accountants,
the way they would value a business is they look at the price of the assets – shelves,
building, uniform – and then they look at the price of the liabilities or the debt (maybe
they owe money to the bank) and then they come out with something called “owner’s
equity” and that’s how they value the business. The amount of owner’s equity is
how much the business is worth. However, for financial managers, we don’t
care about the asset value or the owner’s equity. We don’t care if this shelf costs
$1M or if the business building is worth a lot, usually. What we do care about is the
present value of the free cash flows. This is another way of saying how much the store
actually earns. If the store, for example, has $10,000 worth of shelf and equipment,
but it only earns $5 a year then the store is not worth much. Even if the assets are
worth a lot, the fact that it earns such a small amount means that it’s a bad business
and that it’s worth little. Most financial managers put a heavier importance on the earnings
of the business instead of the assets of the business. One way of representing these earnings
is by looking at the free cash flow. The way we value a business is we look at
the present value of the free cash flow plus the present value of its horizon value. Don’t
worry if you don’t understand these terms yet. You will see in a while.
How to compute the “free cash flow” will be discussed in another video. For this video,
I will just give you the amount or the figure of this business’ free cash flow so you
can understand the concept quickly. For example, this store has free cash flow
earnings of: Year 1: $10,000
Year 2: $12,000 Year 3: $11,000
Year 4: $13,000 This is given. In more advanced problems,
you would have to compute this yourself, but I will discuss that in another video. Let’s
assume that these are the free cash flows of the store. And then I give you the following
information: Horizon year is Year 3, which means this (referring
to Year 3: $11,000). You might be wondering what the heck is a horizon year? Horizon means
you look into the future. However, most people make the mistake of thinking that the horizon
year is the last year of information that you are given in the problem. Do not do that.
Year 4 is not the horizon year. Usually, your professor will say that the horizon year is
1 year before the last year. Remember to always read the problem carefully and look at what
the professor says is the horizon year. In our case, it’s Year 3. If you’re wondering
why we need to know the horizon year, you’ll know in a short time later. I’ll show you
why it is important. And we know that the weighted average cost
of capital is 10%. In more advanced problems, you would have to compute the WACC by yourself.
If you don’t know how to compute this, you can watch the other video about WACC. The
other piece of information that is given is the estimated free cash flow long term average growth of 5% per year.
For Year 4, Year 5, Year 6, Year 7, the free cash flow will grow 5% year. It doesn’t
mean that it will grow exactly 5% per year. It just means that, on the average, it will
grow 5% per year. How do we compute or value the business? We
need to look at 2 formulas. Remember, I said we have to look at the present value of the
free cash flows. To do that, we use this formula: Don’t panic. I know it looks scary and complicated,
but I will show you how easy it is.

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About the Author: Oren Garnes

67 Comments

  1. Success for Managers is: Time to help my own people realize who they can be, not just what they can do.

  2. Helpful video. I may be wrong but according to my professor the horizon value is the terminal value and therefore the last year.

  3. Both can be correct, it all depends on whether the people involved believe in the "cash basis" of accounting or the "accrual basis" of accounting. Naturally if you have a lot of accrued income for your biz, you'd try to use the accrual basis when trying to sell your biz to a buyer; vice versa if your company has a lot of FCF. It's like Romney prefers to talk about Obama's past 4 years as a basis for election, while Obama prefers to talk about Romney's mistakes as a basis. 🙂

  4. How many years you go back depends on you or your professor, but I generally the longer, the better; unless there was a major "change" in the company.

  5. Good video, very informative. My channel is dedicated to value investing and value investors should be valuing businesses as if it were their own. Check out my channel if you have time. Great work though, keep it up!

  6. Yup, how much your business worth is a fundamental question that any small business owner should be able to answer. However, 75% of small business owners have no clue about their business value. This is a problem that our team at BizEquity is trying to help solve. Check us out, google and see BizEquity!

    Thanks,
    JJ
    Market Analyst, BizEquity

  7. where I can the next video , I want to complete the amazing lesson I have seen ever ..
    Thank you very very very much man:)

  8. Hi, just click on my username so you can see my youtube channel with all my youtube videos, Cheers

  9. You will be off a little depending what you put as your horizontal value. To play it safe, you wanna use the first year of consistency growth pattern in FCF as your horizontal point. In this problem they were trying to test you on the definition of horizontal value. If you valuate a company in real life the horizontal value will always be the last year.

  10. @Poutineville: There'd be many different ways of valuing it, such as based on its projected future/expected profit… much like Facebook or Amazon is highly valued despite not being profitable yet, because people are expecting them to make a certain amount of profit in the future.

  11. hi, MBAbullshitDotCom….Could you make it APV(adjust present value) simply…Hope to see APV one online….

  12. i dont understand why all other years are excluded in making a prognosis for future growth. Wouldnt it be more accurate to take all years into account as well as other prognostic factors. However i think this method only applies to a certain kind of business. For example if you value a pharmaceutical company that are not profitable yet and were just about to launch a new medication that would take the world by storm it would still not be worth anything.

  13. I have watched a lot of your videos and they are very helpful. I have question how do I know when to include the number 1 when calculating percentages and why?

  14. are the FCF for year 1-3 projections? or are they the actual free cash flows. If they are the actual cash flows does that mean year 4 is the projection? meaning any year after the "horizontal year" is purely projection?

  15. OMG, again, I'm back on your videos. This was the second concept I did pretty poorly in. THIS made it SO much easier! My text blows. Thank you!!!!!!!!!!

  16. Shouldn't year four FCF of $13000 include the 5% growth rate before dividing it with wacc minus growth rate?

  17. This is good training and can give a business owner a sense of timing for the sale. Most businesses are sold below market value due to not understanding the true value of the business. Ultimately, the true value of a business is what an informed and willing buyer will pay for it. There are strategies which allow businesses to be sold quickly and for maximum profit by creating a competitive environment forcing buyers to compete against each other and driving up the sale price for your business.

  18. How do you valuate a small business that doesnt exist yet nor has any financial data to go based on? Or is this not even a possibility (valuating a business that does not exist yet?)

  19. I read a book called how to buy any business. It says in the book just a handful of calculations to price, evaluate, offer price is all that's needed to invest in businesses. Your videos are great, but do I really need all this info to be successful s a business investor ?? Again, great videos !

  20. Value of a business based on stock
    1,000,000 stocks @ $50 a share= $50,000,000 business value
    Investment value
    Investor puts $50,000 into company= $50,000 business value
    Asset value (not the stuff inside the building but the building itself)
    Building costs $125,000= $125,000 business value
    All the above is ignoring legal costs and liquid asset costs

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