Teaching Note on “Corporate Value”
When you ask the question “what is the value of a company?”, the answer is quite often: “the price somebody’s ready to pay for it”. This answer looks reasonable, but is useless when it comes to set up the conditions of an IPO or take an investment or divestment decision. The price paid by anybody is the result of a transaction. In any transaction, there is a buyer and a seller. If the transaction price is, say, $100, it means that both parties agreed to exchange the asset against this amount of money. But, if the buyer is happy to pay $100 for the asset, it means that he or she is convinced that the “true” value of the asset is more. The same for the seller, who is convinced that the “true” value is less than $100. Thus, a transaction may happen and produce a transaction price if there is a disagreement on the value. If both, buyer and seller, are convinced that the value is $100, none of them is going to pay transaction fees in order to make a zero-NPV investment. As a consequence, in order to make any decision involving an asset, you need two opinions: the market opinion tells you at which price the asset is offered, your personal opinion tells you if it’s worth the price. Consider an investment, say buy a machine to save costs. You will actually approve the investment if the value of the machine (cash flows discounted at the cost of capital) exceeds its cost, the difference between these two figures being named the Net Present Value. This teaching note will explain you, on the one hand, how to analyze the market opinion, on the other hand, how to forge your personal opinion on a company. It is divided into two parts: 1- Market opinion: multiples and comparables 2- Investor’s opinion: discounted cash flows 1/ MARKET OPINION: MULTIPLES & COMPARABLES It is important to understand the principles behind the method before you calculate the multiples, identify the comparables and actually use the figures to draw conclusions and take