Business valuation is an assessment method which is used by an organization to arrive at the actual worth of the company. Usually, business valuation is done to arrive at the merger and acquisition decision. A company which is acquiring other company will be interested to know the actual worth of the company. This valuation is also used to calculate purchase consideration for the purchase of the company by acquiring the company. Therefore it is also important for an acquired company to conduct business valuation so that they are certain that purchase consideration decided by acquiring a company is appropriate as per the actual value of the company (MOHAMMAD, 2016).
Recently through press speculation we have noted that Asda is expected to make an offer to purchase B&M European Value Retail S.A for a purchase consideration of £4.4 billion. In such a situation there is a need of business valuation for both the companies i.e. Asda and B&M European Value Retail S.A. In this part of the report we will conduct a business valuation process with the help of two major business valuation methods i.e. asset-based approach and earing based approach.
In asset-based approach, the value of the business is calculated on the bases of the assets and liabilities which are used by a company in their business operations. This asset-based approach can be done in two manners-
In this approach, the assets and liabilities are valued at their book value. Book value means the value of which these assets and liabilities are recorded and presented in latest financial statements. In this method, we will calculate net asset value of the company. Net asset value can be defined as the value of total asset deducting outside liabilities of the company (Pinto et.al, 2015).
Following figures are taken form the balance sheet of the company-
Therefore total outside liabilities of the company are sum total of current liabilities and non-current liabilities i.e. 959,895,000.
Net asset value of the company= Total assets– outside liabilities
= 1,773,516,000- 959,895,000= 813,621,000
Value of business as per asset approach is £813,621,000.
In this approach, the value of assets and liabilities will be calculated on the basis of the current market value of the asset in market i.e. value receivable is an asset is immediately sold in the market. Usually, this value is relatively lower than the actual value of the asset as it is difficult to find an immediate buyer for commercial assets (Healy and Palepu, 2012).
In this assignment, market values of the assets are not given to us; therefore, we will assume that book value of the assets is equal to the market value of the asset. Hence valuation as per market value approach will be same as book value approach.
The disadvantage of asset value approach is that is only considered the existing value of the company. This method does not consider the expected growth and development of the company. This limitation is solved in earning based approach as it estimated that future cash inflows and then calculate the value of the business organization (ACCA, 2012).
In this approach of business valuation, the estimated value of the business is calculated by capitalizing the value average expected earnings of the business. This method is more appropriate as an acquiring company is always concerned about the performance of acquired company after its acquisition.
Limitation of this method is that this method is based on various estimations such as expected cash flows, capitalization rate, discount rate etc. Any deviation in these assumptions can have a vital impact on investment decision. Also, it is very difficult to assume the behaviors of business environment toward in future that can affect expected cash flows from the business (Wilson, 2012).
Different method of valuation can be used in earing based approach which are as follows-
In this approach, we will calculate the value of the business through an expected future dividend. In this method, we will capitalize the expected dividends of the company (Audretsch and Link, 2012).
Formula= expected divined/ cost of equity
= 0.047/ 23%= .204 per share
Total numbers of shares are 1,000,000,000
Therefore value of business is 204,000,000
Note- Expected dividend is calculated by adding the percentage increase in the dividend in the current year as compared to previous year to the dividend paid in a current year. Percentage increase in dividend in current year as compared to previous year is 21.875% (In previous year dividend paid was £32,000,000 whereas in current year dividend paid is £39,000,000)
Cost of equity=
= (.047/413) + 21.875%
= 23.00 %
In this method, future earnings of the company are capitalized to arrive at the value of the business. For proper estimation of the future earning we have arrived at the expected rate at which the revenue and profit after tax are expected to increase. For this purpose, we have averaged the past two-year growth rates in revenue of the company. This will help us in better estimation of expected future net profits after tax (Steiger, 2010).
Following are some of the data relevant for calculation of business value of the company-
|
Particular |
2017 |
2016 |
2015 |
2014 |
|
Sales |
2,430,660 |
2,035,285 |
1,646,824 |
1,351,236 |
|
NPAT(A) |
144,033 |
125,800 |
39,863 |
(19,415) |
|
Depreciation(B) |
25,221 |
19,726 |
14,847 |
10,162 |
|
Taxes (C) |
38,885 |
28,745 |
21,852 |
5,096 |
|
Cash inflows (A+B) |
169254 |
145526 |
54710 |
(14319) |
Average increase in revenue= 21.62 (we have not included 2014as there is a loss in that year)
Therefore average future net profit after tax in future years is 144033+ 21.62%= 175172
Value of business= 175172000/ 17.7%= 1,024,397,660
Note- Calculation of capitalization rate-
Net profit/ capital employed = 144033000/ 813,621,000 = 17.7%
This method of business valuation is similar to that of PV of future earnings but in this method cash flows are used instead of net profit after tax. This is a better and accurate representation of company valuation as non-cash expenses are excluded in this method.
Similar to above method,
Value of business= Average expected cash inflows/ capitalisation rate
= 199,846,000/ 17.7% = 1,129,073,446
Note-
Average expected cash inflow= 169254+ 21.62% = 199846 i.e. 199,846,000
Part C- Source of finance
B&M European Value Retail has recently issued 4.125% senior secured notes worth £250,000,000. Internet on these notes will be payable to the investors on half yearly basis on February 1 and August 1 of each year. The first installment of interest will be payable on 1 August 2017. Senior secured debt is a source of finance for the company which is required to be paid in priority as compared to other debt instruments in case of liquidation of a company. Junior debt, preferred stock, and shareholders will be paid after senior debt holders in the mentioned order. Senior debt can also be of two types i.e. senior secured debt and senior unsecured debt. Senior secured debts are secured by a collateral asset whereas senior unsecured debts are not secured by any asset of the company. Senior debts issued by B&M are secured (Peirson, et.al, 2014).
Investors in this debt instrument are allowed to redeem the noted totally or in parts after 1 February 2019. In such cases, the investor will get the amount which is mentioned in the investment offer letter. Investors also had an option to redeem these notes before 1st February 2019 but hey will be entitled to get 100% of the invested amount in addition to accrued interest. The due date of these senior secured notes is 1st February 2022. These notes are issued on a precondition that the investors who have redeemed the notes prior to its due date may be required to repurchase the notes at a price equal to 101% of its original purchase price.
B&M have also given the manner in which the amount realized from such debt instrument will be used. The proceeds from this debt instrument together with proceeds from new term loan will be used to repay two existing term loan of £ 440 million. The new term loan will be of £300 million and balance amount will be brought in the business.
Interest-bearing loans and borrowing of the company has increased from £435142000 in the financial year ending 2016 to £ 543,725,000 in the financial year ending 2017. Therefore there is an aggregate increase of £108,583,000 with a percentage increase of 25% in interest-bearing loans and borrowings. Hence we can say that debt component of the company has increased by 25% in the financial year 2017 as compared to 2016. As a result of such increase, debt to equity ratio of the company has also increased from .63 in the financial year 2016 as compared to .69 in the financial year 2017.
In many ways, the issue of senior secured debt is beneficial to the company and in other ways it has created some limitations for the company. Issuing of debt has not diluted the ownership of the company. This is a good sign for the company as dilution of ownership results in more interference in the management of the company which can make management process difficult. Another advantage of issuing debt as a source of finance is that it will be tax deductible and tax benefits will be available on interest paid on these loans. The proceeds of the issue of debt are used by the company for payment of the term loans. Therefore the capital structure of the company has not changed substantially (Storey and Greene, 2010).
Limitation of issuing secured debt in this situation is that the issues instrument are a high yielding instrument and interest payable on these instruments is higher than the term loan that is repaid. Hence the interest in the current year will be higher as compared to interest cost in a previous year. Also, the issued debt is required to be repaid in preference to any other loans and borrowings of the company (Tarantin Junior and Valle, 2015).
The main objective of the company for raising the finance was the repayment of following two term loans amounting 440 million in total. This could have been done by the company by issuing any of the following sources of finance instead of issuing senior secured debt notes.
Equity financing
B&M could have issued common stock of the company worth amount £250,000,000. Equity financing is one of the efficient manners to acquire finance and expansion of the company. The advantage of equity financing is that there is no compulsion on payment of dividend to the shareholders of the company. The company can issue dividend and bonus shares for the shareholders one company is making good profits. Equity investors always have good intentions for growth and development of the company whereas, in case of debt financing, investors are only concerned with their interest and principal payments.
There are some limitations of raising finance through equity financing such as the process of equity financing is higher and it is also a lengthy process. A company has to go through a long process from issuing issue letter to collecting money from shareholders (Robb and Robinson, 2014).
Retained earnings
Retained earnings are a most efficient internal source of financing for a company. At the end of the financial year 2017, the company has £204,077,000. Therefore company could have used £200,000,000 and balance amount could have been raised through issue of the new term loan. In the financial year 2017, company has already issued term loan of 300 million pounds. Therefore company could have raised 200 million pounds through equity financing and 350 million pounds through term loans (Anandarajan et.al, 2012).
The advantage of retained earnings is the company is required to incur any additional cost in raising finance. But the disadvantage of this method of that there will be a decrease in future dividend distributed to the shareholders.
In the financial year 2017, B&M has taken a term loan of 300 million pounds in addition to the issue of senior secured debt notes. The interest rate on the term loan is lower as compared to senior secured debt loan. The company could have taken a total of 550 million in form of term loan bank or financial institution. In both cases, the company is required to present a collateral asset as security against the loan. The benefit in case of the term loan is lower interest rate as compared to senior secured debt (DeAngelo et.al, 2011).
References
Anandarajan, M., Anandarajan, A. and Srinivasan, C.A. eds., 2012. Business intelligence techniques: a perspective from accounting and finance. Springer Science & Business Media.
Audretsch, D.B. and Link, A.N., 2012. Valuing an entrepreneurial enterprise. Small Business Economics, 38(2), pp.139-145.
DeAngelo, H., DeAngelo, L. and Whited, T.M., 2011. Capital structure dynamics and transitory debt. Journal of Financial Economics, 99(2), pp.235-261.
Healy, P.M. and Palepu, K.G., 2012. Business analysis valuation: Using financial statements. Cengage Learning.
Kornberger, Martin, Lise Justesen, Anders Koed Madsen, and Jan Mouritsen, eds. Making things valuable. Oxford University Press, USA, 2015.
MOHAMMAD, A.N, 2016. Valuation Tools for Determining the Value of Assets: A Literature Review. International Journal of Academic Research in Accounting, Finance and Management Sciences
Peirson, G., Brown, R., Easton, S. and Howard, P., 2014. Business finance. McGraw-Hill Education Australia.
Pinto, J.E., Henry, E., Robinson, T.R. and Stowe, J.D., 2015. Equity asset valuation. John Wiley & Sons.
Robb, A.M. and Robinson, D.T., 2014. The capital structure decisions of new firms. The Review of Financial Studies, 27(1), pp.153-179.
Steiger, F. 2010, The Validity of Company Valuation Using Discounted Cash Flow Methods.
Storey, D.J. and Greene, F.J., 2010. Small business and entrepreneurship. Financial Times/Prentice Hall.
Tarantin Junior, W. and Valle, M.R.D., 2015. Capital structure: the role of the funding sources on which Brazilian listed companies are based. Revista Contabilidade & Finanças, 26(69), pp.331-344.
Wilson, A., 2012. Business valuation: theory and practice. Deloitte transaction services.
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