Valuation Terms by Category

 

Valuation Terms by Category

Valuation Terms by Category

Note: This table provides a general overview of valuation terms and their categories. Specific definitions and applications may vary depending on the valuation method, asset type, and industry.

CategoryTermDescription
Valuation MethodsDiscounted Cash Flow (DCF)Values a company based on the present value of its future cash flows.
Comparable Company Analysis (CCA)Compares a company to similar publicly traded companies to determine valuation.
Precedent TransactionsAnalyzes the sale prices of similar companies to determine valuation.
Asset-Based ValuationValues a company based on the fair market value of its assets.
Key Valuation MetricsEnterprise Value (EV)The total value of a company, including debt and preferred stock.
Equity ValueThe value of a company's common stock.
EBITDAEarnings Before Interest, Taxes, Depreciation, and Amortization.
RevenueThe total amount of income generated by a company.
Net IncomeA company's profit after all expenses and taxes.
Valuation RatiosEV/EBITDAEnterprise Value to EBITDA multiple.
P/E RatioPrice-to-Earnings ratio, comparing a company's stock price to its earnings per share.
PEG RatioPrice/Earnings to Growth ratio, considering earnings growth rate.
Discounting and Cash FlowWeighted Average Cost of Capital (WACC)The average cost of a company's financing.
Discount RateThe rate used to calculate the present value of future cash flows.
Terminal ValueThe estimated value of a company beyond the forecast period.
Financial AnalysisFree Cash Flow (FCF)Cash generated from operations after capital expenditures.
Working CapitalCurrent assets minus current liabilities.
Capital StructureThe mix of debt and equity financing a company uses.
Other TermsSynergiesIncreased value created by combining two companies.
GoodwillThe intangible asset representing the excess of purchase price over the fair value of net assets.
DilutionReduction in earnings per share due to issuing new shares.

Valuation Methods

MethodDescriptionKey InputsAdvantagesDisadvantages
Discounted Cash Flow (DCF)Values a company based on the present value of its future cash flows.Projected free cash flows, discount rate (WACC)Intrinsic value, flexibleRelies on future projections, sensitive to discount rate
Comparable Company Analysis (CCA)Compares a company to similar publicly traded companies to determine valuation multiples.Comparable companies, valuation multiples (EV/EBITDA, P/E, etc.)Relative valuation, market-basedComparability issues, market-driven valuation
Precedent TransactionsAnalyzes the sale prices of similar companies to determine valuation multiples.Recent transactions, valuation multiplesMarket-based, reflects control premiumLimited data availability, transaction-specific factors
Asset-Based ValuationValues a company based on the fair market value of its assets.Asset values, liabilitiesObjective valuation, suitable for asset-heavy companiesIgnores future earnings potential, subjective asset valuation

Let's Focus on a Specific Valuation Method: Discounted Cash Flow (DCF)

Key Components of a DCF Valuation

ComponentDescriptionFormula/Calculation
Free Cash Flow (FCF)Cash generated from operations after capital expenditures.Operating Cash Flow - Capital Expenditures
Discount Rate (WACC)Weighted Average Cost of Capital, reflecting the company's cost of financing.(E/V) * Cost of Equity + (D/V) * Cost of Debt * (1 - Tax Rate)
Terminal ValueThe estimated value of a company beyond the forecast period.Gordon Growth Model: FCF * (1+g) / (WACC - g)
Present Value of Cash FlowsThe current value of future cash flows.FCF / (1 + WACC)^t

Key Assumptions in DCF

AssumptionDescriptionImpact on Valuation
Revenue GrowthProjected increase in sales.Higher growth leads to higher valuation.
EBITDA MarginProfitability as a percentage of revenue.Higher margin leads to higher valuation.
Capital ExpendituresInvestments in long-term assets.Higher CapEx reduces FCF, lowering valuation.
Working CapitalCurrent assets minus current liabilities.Changes in working capital affect FCF.
Tax RateCorporate tax rate.Higher tax rate reduces FCF, lowering valuation.
WACCCost of capital.Higher WACC reduces present value, lowering valuation.
Terminal Growth RateExpected long-term growth rate.Higher growth rate increases terminal value, increasing valuation.

DCF Valuation: Key Components and Calculations

Free Cash Flow (FCF)

ComponentDescriptionFormula
Operating Cash FlowCash generated from normal business operationsNet Income + Depreciation + Amortization + Changes in Working Capital
Capital Expenditures (CapEx)Cash spent on acquiring or upgrading long-term assetsPurchase of Property, Plant, and Equipment
Free Cash Flow (FCF)Cash available for distribution to investorsOperating Cash Flow - Capital Expenditures

Discount Rate (Weighted Average Cost of Capital - WACC)

ComponentDescriptionFormula
Cost of EquityReturn expected by equity investorsRisk-Free Rate + Beta * Equity Risk Premium
Cost of DebtInterest rate paid on debtInterest Expense / Total Debt
Capital StructureProportion of debt and equity in the capitalDebt / (Debt + Equity)
Tax RateCorporate tax rateApplicable tax rate
WACCWeighted average cost of capital(E/V) * Cost of Equity + (D/V) * Cost of Debt * (1 - Tax Rate)

Terminal Value

MethodDescriptionFormula
Gordon Growth ModelAssumes constant growth rate in perpetuityTerminal Value = FCF * (1 + g) / (WACC - g)
Exit Multiple MethodUses a multiple based on comparable companiesTerminal Value = EBITDA * Exit Multiple

Present Value of Cash Flows

ComponentDescriptionFormula
Discount FactorFactor used to calculate present value1 / (1 + WACC)^t
Present Value of FCFPresent value of each year's FCFFCF * Discount Factor
Present Value of Terminal ValuePresent value of the terminal valueTerminal Value * Discount Factor

Enterprise Value (EV)

ComponentDescriptionFormula
Enterprise ValueTotal value of a companyPresent Value of FCF + Present Value of Terminal Value

Detailed Breakdown of DCF Valuation Components

Free Cash Flow (FCF)

Detailed Components of Operating Cash Flow:

ComponentDescription
Net IncomeProfit after taxes
Depreciation and AmortizationNon-cash expenses
Changes in Working CapitalNet change in current assets and liabilities (Inventory, Accounts Receivable, Accounts Payable)

Detailed Components of Capital Expenditures:

ComponentDescription
Property, Plant, and Equipment (PP&E)Purchases of fixed assets
Other Capitalized ExpendituresInvestments in intangible assets (e.g., software development)

Discount Rate (WACC)

Detailed Components of Cost of Equity:

ComponentDescription
Risk-Free RateYield on a government bond with similar maturity
BetaMeasure of a stock's volatility relative to the market
Equity Risk PremiumExpected return on the market minus the risk-free rate

Detailed Components of Cost of Debt:

ComponentDescription
Interest ExpenseInterest paid on debt
Total DebtTotal amount of outstanding debt

Terminal Value

Detailed Assumptions for Gordon Growth Model:

AssumptionDescription
Perpetual Growth Rate (g)Assumed constant growth rate of FCF into perpetuity
Relationship to WACCg should be less than WACC for the formula to be valid

Detailed Considerations for Exit Multiple Method:

ConsiderationDescription
Comparable CompaniesSelection of similar companies for multiple comparison
Appropriate MultipleChoice of EBITDA, revenue, or other multiple
Terminal Year's EBITDA or RevenueProjected value for the terminal year

Present Value of Cash Flows

Detailed Calculation:

StepDescriptionFormula
1Project FCF for each year-
2Calculate discount factor for each year1 / (1 + WACC)^t
3Calculate present value of each year's FCFFCF * Discount Factor
4Calculate present value of terminal valueTerminal Value * Discount Factor
5Sum the present values of all cash flowsPV of FCFs + PV of Terminal Value
ComponentDescription
Equity ValueMarket value of the company's equity
Net DebtTotal debt minus cash and cash equivalents
Minority InterestValue of ownership in other companies
Preferred StockValue of preferred shares


ComponentDescriptionFormula/Calculation
Projected Royalty RevenueEstimated annual royalty income(Expected Licensee Sales) x (Royalty Rate)
Royalty RatePercentage of licensee revenue paid as royaltyBased on comparable licenses, industry standards, negotiation power
Revenue GrowthAnticipated growth in royalty revenueHistorical growth, market forecasts, industry trends
Patent LifeRemaining patent protection periodDetermined by patent office records
Expense GrowthProjected increase in costs associated with patent maintenance and enforcementHistorical data, industry benchmarks
Tax RateEffective tax rate applicable to royalty incomeBased on tax jurisdiction and relevant tax laws
Capital ExpendituresInvestments required to support patent exploitationResearch and development, marketing, sales
Working CapitalNet working capital requirementsInventory, accounts receivable, accounts payable
Free Cash Flow (FCF)Cash available for distribution to investorsOperating Cash Flow - Capital Expenditures - Taxes + Depreciation & Amortization
Discount RateReflects the risk associated with patent commercializationBased on industry risk premium, company-specific risk, risk-free rate
Terminal ValueValue of patent royalties beyond the forecast periodUsing a perpetuity growth model or terminal multiple
Present Value of FCFPresent value of projected free cash flowsUsing the discount rate to calculate the present value of each year's FCF
Patent ValueSum of the present value of FCF and terminal valuePresent Value of FCF + Terminal Value

ComponentDescriptionFormula/Calculation
Projected Royalty RevenueEstimated annual royalty income(Expected Licensee Sales) x (Royalty Rate)
Royalty RatePercentage of licensee revenue paid as royaltyBased on comparable licenses, industry standards, and negotiation power
Patent LifeRemaining patent protection periodDetermined by patent office records
Discount RateReflects the risk associated with patent commercializationBased on industry risk premium, company-specific risk, and risk-free rate
Terminal ValueValue of patent royalties beyond the forecast periodUsing a perpetuity growth model or terminal multiple
Present Value of RoyaltiesPresent value of projected royalty incomeUsing the discount rate to calculate the present value of each year's royalty
Patent ValueSum of the present value of royalties and terminal valuePresent Value of Royalties + Terminal Value