Approach


Discounted Cash Flow Method

Enterprise value as present value of expected future free cash flows

Definition

The value of a company is determined by the gain it can generate in the future as a result of its available success factors as of the valuation date, e.g. its products, market position, internal organisation, innovative strength, employees, and management. Provided that only financial objectives are pursued, the corporate value is derived solely from its capacity to generate financial surpluses for shareholders.

Fundamental approach

eValuation is based on the discounted cash flow method, which is characterised by a two-step approach. As a first step, the company's overall market value (i.e. enterprise value) is derived as the sum of the present values of all future financial surpluses (free cash flows) available to capital providers (i.e. equity investors and debt holders). As a second step, the market value of debt is deducted from the overall enterprise value in order to determine the market value of equity.

Derivation of the free cash flows

With eValuation, the free cash flows are derived using the "indirect method", which is based on the planned income statement and the projected balance sheet of the company to be valued.

The starting point for the determination of the free cash flows are the forecasted EBIT of the budgeted financial years. First, corporate taxes are subtracted from EBIT under the assumption that the company is debt-free. Second, to determine the free cash flows available to equity investors and debt holders, non-cash earnings and expenses are eliminated. Accordingly, capital expenditures are included while amortisation and depreciation are removed. Further changes not affecting the net income must also be taken into account, e.g. changes in net working capital. 

Multiple Method

Enterprise value as relation of market values and income measures

Definition

In terms of methodology, multiple-based valuation is the simplest process for valuing a company.The assumption is that the value of a company can be derived from observable market values of peer companies. Due to the minimal effort associated with its application, it is frequently used for an initial indication of value. 

Fundamental approach

A distinction is made between transaction and trading multiples. Transaction multiples are based on the acquisition prices paid for companies while trading multiples are based on the market capitalisation of companies listed on the stock market. The multiples are derived as the ratio of the market values and various income statement variables of these companies such as revenues, EBIT, EBITDA. To establish the enterprise value, the derived multiple is multiplied with the appropriate income statement variable of the object under valuation.

Derivation of the multiples

The eValuation multiple-based valuation is based on trading EBITDA multiples. Industry-specific multiples supplied by a financial information provider are the basis for our calculations. These industry-specific multiples are determined based on forward-looking variables (EBITDA analyst estimates, reference date + 1 year).

Should the field of activities of the company to be valued encompass more than one industry or if it is not possible to unequivocally assign it to one industry, eValuation offers the option of selecting up to three industries and weighting them. It is advisable to use the sales volumes generated in each industry for instance as a point of reference for the weighting.

Benchmark Analysis

Industry-specific comparison of key financial indicators

Fundamental approach

The eValuation benchmark analysis is a comparative industry-specific analysis of financial indicators. It is based on a financial information provider's data pool which is continuously updated and includes companies located around the world and from a wide range of industries. 

Descriptive graphs are used for each financial indicator to indicate whether the company should be classified below, at, or above the market level for the industry-specific benchmark analysis. These diagrams allow the company's strengths and possible potential for optimisation to be identified at a glance.

Financial indicators

The eValuation benchmark analysis includes the following financial indicators: EBITDA and EBIT margins, return on investment (ROI) and return on equity (ROE), cash conversion cycle, days inventory outstanding, days sales and days payable outstanding, liquidity ratio, gearing ratio and interest coverage.

Industry selection

Should the field of activities of the company encompass more than one industry or if it is not possible to unequivocally assign it to one industry, up to three different industries can be selected and weighted.

In order for the industry affiliation to be as specific as possible, your options are broken down hierarchically into sectors, industries, and sub-industries. For example, the Industrial sector includes the Transport industry. In turn, that industry is broken down into the sub-industries air cargo transport, air passenger transport, maritime cargo transport, maritime passenger transport, etc.

Cost of Capital

Discounted cash flow method with weighted average cost of capital

Determination of the cost of capital

The WACC (weighted average cost of capital) is the tax adjusted opportunity cost of capital that we use to determine the present value of the planned free cash flows. The cost of equity and the cost of debt are weighted respectively with the equity ratio and debt ratio and used as a basis for the interest rate. The WACC specifies the minimum interest rate which must be generated from the object under valuation in order not to place the equity investors and debt holders in a less favourable position than if they had invested in the next best alternative. eValuation derives the cost of capital in euros (EUR) and US dollars (USD).

Cost of equity

Method
The cost of equity is derived using the capital asset pricing model (CAPM), which is based on the portfolio theory. This is a theoretical capital market model based on attainable returns from a portfolio of company shares listed on the capital market and adjusted to reflect the risk structure of the object under valuation. In this context, a differentiation is made between the risk-free interest rate and the components of the risk premium (market risk premium and beta factor).

Risk-free rate
The starting point for determining the risk-free rate is a yield curve derived taking into account the current interest rate level and the term structure of interest rates as published by the federal banks (in EUR based on data from the Deutsche Bundesbank and in USD based on data from the Federal Reserve Bank of the United States of America). The data on the term structure of interest rate are estimates on the basis of the observed yields of (virtually) risk-free coupon bonds. The derived yield curve illustrates the relationship between interest rates and maturities, much like the one which would apply to zero-coupon bonds without credit default risk.

Beta factor
In order to derive the beta factor, a peer group is set up according to the industry specified in eValuation. The median of the indebted (raw) beta factors of the companies in the respective industry group is derived when calculating the beta factors. This approach analyses weekly returns over a period of two years (104 data points), which are derived from rate data supplied by the financial information provider S&P Capital IQ. The MSCI World Index with rate data translated into EUR or USD, respectively, is utilised as the benchmark index.

Market risk premium
The market risk premium forecast for the future can be estimated by means of the historical difference between the returns of risk-prone securities, for example on the basis of a stock market index, and the returns of (virtually) risk-free capital market investments. Empirical analyses of the capital markets are used as a basis in this context.

Country risk premium
In practice, country risks and particularly the associated default risk are often not reflected adequately when forecasting financial surpluses. Therefore, they must be included in the risk-adjusted capitalisation interest rate. If necessary, a country-specific risk premium according to the list compiled by Prof. Damodaran (New York University) is applied as a country risk premium. This risk premium is then taken into account both for the cost of equity and the cost of debt.

Cost of debt

Risk-free rate
The same interest rate is used as when calculating the cost of equity.

Credit spread
The credit spread with an equivalent term is derived based on the ratings which are observable on the capital market or the credit model scores for the respective industry peer group (median) which are supplied by a financial information provider (effective interest method).

Tax shield
The allowable tax deduction for interest on debt ("tax shield") must be considered when calculating the weighted average cost of capital. 

Equity & debt ratio

The cost of equity and cost of debt are weighted using the market values of equity and debt.

According to the definition of a company's (net) indebtedness, pension provisions are also included in addition to financial debts, and all cash and cash equivalents are subtracted when determining the level of net debt.