VALUATION CHECKS

BY ASWATH DAMODARAN
Damodaran’s 5 minute Valuation check

Ø You have made all the valuation spreadsheets and you got your first
result.

Ø But, how do you know your valuation is done right?

Ø It’s not whether your revenue growth rate is 15% or 14.92%. It’s not
whether your discount rate is 12% or 11.95%.

Ø Damodaran says valuation is a story about the business’ future. Good

stories are internally consistent. Damodaran suggests a quick check
across 3 crucial dimensions:

what are the growth rates

GROWTH
of your sales, profits and
cash flows?

Understand how these

dimensions interact. What if you find yourself with high
growth, low reinvestment, and low
Start-ups typically project high risk?
growth, requiring substantial
reinvestment and justifying a Two possibilities:
higher discount rate.
1. Reconsider your valuation;
there might be an error.
Conversely, mature companies VALUATION CHECK 2. Provide a compelling
may have lower growth and explanation. Uncover what sets
ACROSS 3 DIMENSIONS your story apart.
reinvestment needs, resulting in a
lower discount rate.

REINVESTMENT RISK

How much do you plan to reinvest to achieve your projected growth? Is your discount rate high, medium,
low?
Analyze capital expenditures, net working capital investments, and
even certain operating expenses. For instance, internally generated
intangibles in SAAS businesses often qualify as reinvestment.

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 WACC BUILDING
COMPONENTS
The risk-free rate is typically
represented by the yield on a Additional return investor Cost of debt should be
government bond (like the U.S. demands for investing in less adjusted for taxes since
Treasury bond) with a maturity developed country with its interest expenses are tax-
that matches the time horizon of specific economic, social and deductible, reducing the
the cash flows being discounted. geopolitical risks. company's taxable income.

The measure of the correlation

of return on investments in a The current costs of
certain industry in relation to the financing your business
return on investments in the operations in a long
market portfolio. term.

RISK-FREE EQUITY RISK REV.INDUSTRY SIZE COUNTRY SPECIFIC PRE-TAX COST TAS EFFECTS COST OF WEIGHTING WACC
SUB-TOTAL
RATE PREMIUM BETA EFFECTS PREMIUM RISK PERM. RISK PERM. OF DEBT DEBT EFFECTS

The excess return that an Risk premium related

investment in the stock to unique risks for
market provides over a risk- company you value in
free rate. This premium regard with its
Additional returns
compensates investors for processes such as Calculate
expected by investors for
taking on the higher risk of taking on the increased sales, human Corporate weightings
equity relative to risk-free risk of investing in resources, purchases, tax rate in a
assets like government operations, jurisdiction
smaller firms. This
bonds. In essence, the equity production, funding, where
premium compensates
risk premium is a measure of management and company
investors for the higher
the additional return volatility and potential others. operates in.
investors require to invest in illiquidity associated with
equities (stocks) instead of
company size.
risk-free securities.

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ROIC VS WACC
Cash 100 EBIT (1-t) ROIC > WACC
Equity 500 150 Value creation signal.
Company is earning
Loans 400 returns above what its
Lease 200 INVESTED investors expects based on
CAPITAL 1000 the risks associated with
investment. The company
ROE 30% > is creating the economic
ROIC = 150 / 1000 X 100 = 15%
KE value

ROIC 15%
> WACC 10.5%

WACC = 13.6 X 0.64 + 4.8 X 0.36 = 10.5

WEIGHTS E: 64%. D: 36%

COST OF
DEBT PRE
COST OF EQUITY COST OF DEBT TAX 6.5%
Ke 13.6 % 4.8%

TAX 25.5%

RISK FREE RATE RELEVERED EQUITY RISK RISK PREMIUM

3.88% + BETA 1.41 X PREMIUM 4.72 + 4%

UNLEVERED GEARING – TAX RATE MATURE RISK COUNTRY RISK

BETA – 0.93 56.4% 25.5% 3% 1%

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 HOW TO
MAXIMIZE VALUE OF
YOUR COMPANY BOJAN RADOJICIC

$ $ Avoid problems with

Increase revenue transferability
Ensure sales stability
Development organic and predictability of cash
and scalability
digital channels flows
Use tax incentives
Conversion rates
good trending
Decrease dependence from
Sales channels biggest customers Make sure you
diversification optimized free cash
Continuously improve
churn rate flow rate
Build financial history
Ensure trending of without anomalies
monthly revenues Increase amount of Ensure trending of
recurring revenues net income

SALES DRIVERS FINANCIAL DRIVERS

$ Create potential to selling the product $ Build employee
across the globe morale and Ensure cultural alignment
engagement

Expand to the dynamic Improve workforce stability and

industry sustainability

Increase ability for workforce

Measure total addressable market trending replacement

Manage level and trending Decrease workforce

in customer acquisition fluctuation rates Build high-performers
costs expertise

MARKET DRIVERS HUMAN RESOURCES DRIVERS

$ $
Develop ESG level Enable potential Innovative
Minimize owner
influence on intellectual property technology & AI use
business transferability

Develop strong security

standards Increase IP
protection level
Increase overall business
sustainability Implement Industry
quality standards
Develop privacy protection
Possibility to replicate cost structure Improve cyber policies and standards
and resources security level

ORGANIZATIONAL DRIVERS TECH AND IP DRIVERS

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 VALUATION
METHODOLOGY
DCF
DCF estimates the intrinsic value based on the present value of the
expected cash flows, discounted at an appropriate discount rate that
WHEN TO APPLY
reflects the riskiness of those cash flows.
INCOME APPROACH For any company whose future
Cap of earnings income/cash flow can be
This approach is based projected with some level of
Method of determining the value of an company by calculating the
on the idea that the worth of its anticipated profits based on current earnings and expected certainty. Applied for growing
value of a company is future performance
companies with stabile sales and
directly related to its business model. Also used to
Excees earning method
ability to generate reflect both long term potential
Business valuation approach used to estimate the value of intangible and business risks.
income. assets, particularly goodwill.

Precedent transactions
Looking at the prices paid in past transactions for companies that are
similar to the one being valued. WHEN TO APPLY
MARKET APPROACH This approach is most applicable
Comparables company
This approach assumes when there are comparable
Valuing a company by examining the valuations of similar companies in transactions or market prices
that the value of a the same industry or sector.
available adn when valuator want
company is closely
to reflect the current sentiment of
related to the prices of Market price method the market. Also, good for
comparable companies Method assesses the value of an asset or liability based on its market companies that might not have
in the market. price or the current price it would fetch in the open market. positive cash flows

Net book value

NBV of an asset is the difference between its historical cost and its
accumulated depreciation. Used in accounting to reflect the asset's current WHEN TO APPLY
value on the company's balance sheet.

COST APPROACH Replacment costs Mostly for companies in

financial difficulties and
Refers to the cost of replacing an asset or an item at its current market companies with significant
This approach is based value.
amount of assets, but without
on the principle that
profit generating power or very
the value of a company low / negative renturn on
is equal to the sum of investments.
its assets. EXAMPLES

Type of business Maturity Assets Cash flow predictability Comparable data Method to consider

MRR model, stabile growth,

SaaS startup Scale up Intangible assets Not available DCF
expected churn etc..

Not reliable, this is pre- Berkus method, or

Tech startup Early stage No significant assets Not available
revenue stage replacement cost

Plant and equipment, Stabile revenues with stabile There is comparable Comparable
Manufacture Mature, public
brands growth rate companies data companies or DCF

Plant and equipment, Financial difficulties, losses, No comparable Net book value
Manufacture Mature, public
brands no significant revenues data method

Plant and equipment, Stabile revenues and cash Precedent Precedent

Wholesaler Mature
brands flows transactions transactions

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 VALUATION APPROACHES
INCOME VS COST VS MARKET
Category Income approach Cost approach Market approach

Company's value is Net book value = Company's value is

based on the present Assets - Total liabilities based on financial
1 DEFINITION value of income/cash metrics of comparable
flow generated in the companies/transactions
future

Discounted Cash Comparable

VALUATION Flows, Capitalized Net book value, companies, Precedent
2 Replacement costs
METHODS earnings, Excess transactions
earnings method

Very subjective, but Very objective, as it is Subjectivity limited to

SUBJECTIVITY/ choice of comparable
3 sensitivity analysis based on existing
OBJECTIVITY
can be applied companies and
historical data
transactions

ORIENTATION Future / High

4 Past / Low Present / Medium
/FLEXIBILIY
flexibility flexibility flexibility

For any company whose For companies with Companies for which
future income/cash flow significant amount of you can identify
5 FOR WHICH
COMPANIES? can be projected with assets, low revenue or comparable
some level of certainty profit generating power, transactions or
pre revenue stage companies

Finance planning and Finance analysis, Risk

SKILLS AND forecasting, Cost of Accounting / GAAP, analysis, Adjusting
6 RESOURCES
capital analysis, corporate law comparable
business and market companies data,
understaning Databases access

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FINANCIAL

DUE DILIGENCE PROCESS

1 PREPARATION AND PLANNING

Engagement setup Data Collection General business review

Define the şcope and specific areas and depth Make a list of requested documents and track Meet with key personnel of the target company
of the investigation. status of delivery to understand the business processes, financial
practices, and any unusual items.
Assemble a team of professionals with expertise Setup open questions on cloud and track status
in financial analysis, accounting, tax, etc. of delivery Understand business processes like sales,
purchase, payroll etc.
Make timeline framework and duties of team Organize data room, and collect and review
members. relevant financial documents, including financial Review business plan, business model, budgets
statements, tax returns, budgets, etc. etc.

ASSESMENT OF FINANCIAL FUNCTION EXAMINING CONTRACT AND

2 AND TEAM
3 AGREEMENTS

4 INTERNAL CONTROLS 6 FINANCIAL STATEMENTS REVIEW

REVIEW
Segregation of duties, Authorizations and
approvals process, Income statement review Balance sheet review
Automatic controls in system in the process of
Revenues structure analyzed (per product, Assets ownership documentation reviewed
revenue and cost recognition, reconciliation of
categories, business units etc.)
accounts PPE and IP registers reconciled with GL accounts
Gross margin analysis - movement in GM, GM
Closing procedures and checks and others Inventory structure review (materials, WIP, FG)
per products etc..

OPEX analysis – movements, variance, contract Assets impairment testing

5 ANALYTICAL PROCEDURES matches etc..
Balance reconciliations with debtors and
Accruals recognition and cut off test creditors
Analyze financial performance, Analyze trends
in KPIS and ratio numbers, Analyze actual vs Salaries analysis, industry benchmarks, taxes, Related parties relationships
historical vs budgeted figures employee benefits, owner compensation, stock
based compensation etc.. Commitments and contingencies
Review monthly movement in sold quantities,
revenues and margins and other analysis AP / AR ledger reconciled with GL accounts
Other analysis

7 FINALIZE REPORTING SET RESULTED FROM DUE DILIGENCE PROCESS

Quality of Net working

earnings Proof of cash Net debt
capital
Present normal and sustainable Present a movement in NWC and Present target’s net financial
Present a reconciliation procedure
level of operational earning to its main components, review of position and how target use dept.
results that's used to prove the
make sure that multiple-based DSO, DIO and DPO. Fair value of to create an earnings. Estimate
accuracy of the general ledger
price we pay for transaction is receivables: overdue, bad debt, how much additional debt
cash account. Present any unusual
fair. Usual subjects of payment terms, litigation, company can bear, and approach
or suspicious transactions, cash
adjustments : Revenues, Costs, balance structure. Compare financial leverage.
inflows and outflows analysis etc..
Net Working capital NWC/Revenue ration with
industry benchmark and peers.
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 VALUATION MODEL
MODEL TEMPLATE BY VALUATION MADE BY

ASWATH BOJAN
DAMODARAN RADOJICIC

INPUTS OUTPUTS
Country of incorporation0 United States Terminal
Industry (US) Retail (General) Base year 1 2 3 4 5 6 7 8 9 10 year
Industry (Global) Retail (General) Revenue growth rate 15.00% 15.00% 15.00% 15.00% 15.00% 12.78% 10.55% 8.33% 6.10% 3.88% 3.88%
Revenues $ 84,695
Revenues 84,695 97,399 112,009 128,811 148,132 170,352 192,116 212,388 230,076 244,120 253,591 263,431
Operating income or EBIT $ 22,365
Interest expense $ 656 EBIT (Operating) margin 26.41% 26.00% 24.86% 24.29% 23.71% 23.14% 22.63% 22.00% 22.00% 22.00% 22.00% 22.00%
Book value of equity $ 56,604
EBIT (Operating income) 22,365 25,324 27,842 31,283 35,128 39,424 43,475 46,725 50,617 53,706 55,790 57,955
Book value of debt $ 35,146
Cash and Marketable Securities $ 10,852 Tax rate 26.70% 26.70% 26.70% 26.70% 26.70% 26.70% 26.70% 26.70% 26.70% 26.70% 26.70% 26.70%
Number of shares outstanding 499.77 EBIT(1-t) 16,394 18,562 20,408 22,930 25,749 28,898 31,867 34,250 37,102 39,367 40,894 42,481
Current stock price $ 680.00
Effective tax rate 26.70% - Reinvestment 12,135 10,735 12,345 14,196 16,326 15,991 14,895 12,996 10,319 6,959 22,517
Marginal tax rate 28.00% FCFF 77,618 6,428 9,674 10,585 11,553 12,572 15,876 19,355 24,106 29,048 33,935 19,964
The value drivers below:
Cost of capital 8.00% 8.00% 8.00% 8.00% 8.00% 7.86% 7.73% 7.59% 7.46% 7.32% 7.32%
Revenue growth rate for next year 15.00%
Operating Margin for next year 26.00% Cumulated discount factor 0.9259 0.8573 0.7938 0.7350 0.6806 0.6310 0.5857 0.5444 0.5066 0.4720
Compounded annual revenue growth rate - years PV(FCFF) 5,952 8,294 8,403 8,492 8,556 10,017 11,336 13,123 14,716 16,019
2-5 15.00%
Target pre-tax operating margin (EBIT as % of
sales in year 10) 22.00%
Year of convergence 7.00 VALUATION HIGHLIGHTS
Sales to capital ratio (for computing
reinvestment) 1.05 Terminal cash flow 19,964
Market numbers
Riskfree rate - US T. Bond (10-year) 3.88%
Terminal cost of capital
Terminal value
7.32%
580,340
ESTIMATED MARKET
Initial cost of capital 8.00% PV(Terminal value) 273,947 VALUE/SHARE PRICE
PV (CF over next 10 years) 104,907

680.7 = 680
Sum of PV 378,854
Probability of failure = 5.00%
Proceeds if firm fails = 91,750
DIAGNOSTICS Value of operating assets = 364,499

Invested capital at start of valuation $ 80,898.00

- Debt
- Minority interests
35,146
0
569 601 680 772 815
Invested capital at end of valuation $ 207,794.18 + Cash 10,852 MARKET
Change in invested capital over 10 years $ 126,896.18 + Non-operating assets 0 PRICE
Change in EBIT*(1–t) (after-tax operating income) Value of equity 340,205
over 10 years $ 33,425.13 - Value of options 0
Marginal ROIC over 10 years 26.34% Value of equity in common stock 340,205
ROIC at end of valuation 19.68% Number of shares 500
Average WACC over the 10 years (compounded) 7.80% Estimated value /share 680.7
Price 680.0 MY VALUATION ZONE
Your calculated value as a percent of current price 100.85%
Price as % of value 99.16%

SUMMARY SENSITIVITY
WACC

$
680.72 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00%
After-Tax 8.00% 733.82 710.55 688.11 666.45 645.55 625.39 605.92 587.13 568.98
Change in Sales to Reinvestm Capital Implied
Year Operating FCFF 9.00% 739.64 716.16 693.51 671.66 650.58 630.23 610.59 591.63 573.32
Revenues Capital ent Invested ROC
Income
10.00% 745.45 721.77 698.92 676.87 655.60 635.07 615.26 596.13 577.66
TTM 16,394 80,898 20.26% 11.00% 751.27 727.37 704.32 682.08 660.63 639.92 619.93 600.63 582.00
1 18,562 12,704 1.36 9,334 9,228 90,232 20.57% 12.00% 757.09 732.98 709.73 687.30 665.65 644.76 624.60 605.13 586.34
2 20,408 14,610 1.36 10,735 9,674 100,967 20.21% 13.00% 762.90 738.59 715.13 692.51 670.67 649.60 629.27 609.63 590.68
3 22,930 16,801 1.36 12,345 10,585 113,312 20.24% 14.00% 768.72 744.19 720.54 697.72 675.70 654.45 633.94 614.14 595.02
4 25,749 19,322 1.36 14,196 11,553 127,508 20.19% 15.00% 774.53 749.80 725.95 702.93 680.72 659.29 638.61 618.64 599.36
5 28,898 22,220 1.36 16,326 12,572 143,834 20.09% 16.00% 780.35 755.41 731.35 708.14 685.75 664.14 643.28 623.14 603.70

6 31,867 21,764 1.36 15,991 15,876 159,825 19.94% 17.00% 786.17 761.02 736.76 713.35 690.77 668.98 647.94 627.64 608.03
18.00% 791.98 766.62 742.16 718.56 695.80 673.82 652.61 632.14 612.37
7 34,250 20,272 1.36 14,895 19,355 174,720 19.60%
19.00% 797.80 772.23 747.57 723.78 700.82 678.67 657.28 636.64 616.71
8 37,102 17,688 1.36 12,996 24,106 187,716 19.76%
20.00% 803.62 777.84 752.97 728.99 705.84 683.51 661.95 641.14 621.05
9 39,367 14,044 1.36 10,319 29,048 198,034 19.88%
21.00% 809.43 783.45 758.38 734.20 710.87 688.35 666.62 645.64 625.39
10 40,894 9,472 1.36 6,959 33,935 204,994 19.95%
22.00% 815.25 789.05 763.79 739.41 715.89 693.20 671.29 650.14 629.73

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 DCF VS COMPARABLE VS PRECEDENT
VALUATION COMPANIES TRANSACTIONS

CONCEPT

DCF valuation estimates the intrinsic Valuing a company by examining the

Looking at the prices paid in past
value based on the present value of valuations of similar companies in
transactions for companies that are
the expected future cash, discounted the same industry or sector.
similar to the one being valued, and
at an appropriate discount rate that Comparing financial metrics and
then calculating valuation based on
reflects the riskiness of those cash ratios with comparable Calculate
most applicable multiple
flows. value based on reasonable multiple

WHEN TO USE EACH METHOD

When there are reasonable and reliable When there are well-established When considering M&A or when you
cash flow projections available, with companies in the same sector or want to see what acquirers have
excellent foundation in proven industry with publicly available financial historically paid for similar companies.
historical figures. data and valuations, and any differences Used when it comes to the law suites
can be reliable adjusted.

STRENGTHS

Focuses on the future cash flows that a Quick and easy to implement. Reflects real-world data on what
business is expected to generate. Based on real-time market data. acquirers have paid.
allows for sensitivity analysis, which Useful when there are many comparable Incorporates a control premium, which
enables investors to test the impact of publicly traded companies. It's a is the premium an acquirer typically
changes in assumptions and inputs on commonly used and widely accepted pays over the market price to obtain
the valuation. method control of a company.

WEAKNESSES

Highly sensitive to assumptions Assumes that market valuations are Relevant transaction data may not
about growth rates and discount correct. always be available.
rates. Difficult to find truly comparable Past transactions may not reflect
May not be suitable for companies companies. current market conditions.
with unpredictable or non-existent Subjective in selecting which Like comps, selecting truly comparable
cash flows comparable and which multiples to use. transactions can be subjective.

CALCULATION EXAMPLE – SIMPLIFIED

COMPARABLE COMPANIES METHOD PRECEDENT TRANSACTIONS METHOD

Precedent transactions

Price

Acqusition
prices

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 FROM FCFF TO EQUITY VALUE IN

VALUATIONS
Value creation signal. Company is earning returns above what its Value creation signal. Company is earning returns above what its
investors expects based on the risks associated with investment. investors expects based on the risks associated with investment.
The company is creating the economic value The company is creating the economic value

Valuation Results

Value creation signal. Value creation signal.

Company is earning returns
PV(FCFF in projected period) 267.995
Company is earning returns
above what its investors Terminal cash flow 79.106 above what its investors
Terminal cost of capital 7,00%
Terminal value 1.582.122
PV(Terminal value) 663.782

Sum of PV 931.777
Probability of failure 5,00%
Value creation signal. Value creation signal.
Company is earning returns
Proceeds if firm fails 283.823
Company is earning returns
above what its investors Value of operating assets = 899.379 above what its investors
- Debt 27.679
- Minority interests 100
+ Cash 113.762
+ Non-operating assets 50
Value creation signal. Value creation signal.
Company is earning returns
Value of equity 985.412
Company is earning returns
above what its investors - Value of options 100 above what its investors
Value of equity in common stock 985.312

Value creation signal. Company is Value creation signal. Company is Value creation signal. Company is
earning returns above what its earning returns above what its earning returns above what its
investors expects based on the risks investors expects based on the risks investors expects based on the risks
associated with investment. The associated with investment. The associated with investment. The
company is creating the economic company is creating the economic company is creating the economic
value value value

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