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valuation of shares

Jyoti Aggarwal (COMPANY SECRETARY) (336 Points)

22 May 2010

Dear Frnds,

Pls advice me

Any clue on valuation of shares of a pvt ltd co under Discounted Cash Flow Method- method and fixation of discounting factor.

Pls rply on urgent basis....

Thanks & Regards

Jyoti Aggarwal

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4 Replies

laxman suthar (Asst. Manager Taxtation ) (329 Points)
Replied 23 May 2010

Share ownership in a private company is usually quite difficult to value due to the absence of a public market for the shares. Unlike public companies that have the price per share widely available, shareholders of private companies have to use a variety of methods to determine the approximate value of their shares. Some common methods of valuation include comparing valuation ratios, discounted cash flow analysis(DCF), net tangible assets, internal rate of return (IRR), and many others.

The most common method and easiest to implement is to compare valuation ratios for the private company versus ratios of a comparable public company. If you are able to find a company or group of companies of relatively the same size and similar business operations, then you can take the valuation multiples such as the price/earnings ratio and apply it to the private company.

For example, say your private company makes widgets and a similar-sized public company also makes widgets. Being a public company, you have access to that company's financial statements and valuation ratios. If the public company has a P/E ratio of 15, this means investors are willing to pay $15 for every $1 of the company's earnings per share. In this simplistic example, you may find it reasonable to apply that ratio to your own company. If your company had earnings of $2/share, you would multiply it by 15 and would get a share price of $30/share. If you own 10,000 shares, your equity stake would be worth approximately $300,000. You can do this for many types of ratios: book value, revenue, operating income, etc. Some methods use several types of ratios to calculate per-share values and an average of all the values would be taken to approximate equity value.

DCF analysis is also a popular method for equity valuation. This method utilizes the financial properties of the time-value of money by forecasting future free cash flow and discounting each cash flow by a certain discount rate to calculate its present value. This is more complex than a comparative analysis and its implementation requires many more assumptions and "educated guesses." Specifically, you have to forecast the future operating cash flows, the future capital expenditures, future growth rates and an appropriate discount rate

discounted cash flow tries to work out the value of a company today, based on projections of how much money it's going to make in the future. DCF analysis says that a company is worth all of the cash that it could make available to investors in the future. It is described as"discounted" cash flow because cash in the future is worth less than cash today

or example, let's say someone asked you to choose between receiving $100 today and receiving $100 in a year. Chances are you would take the money today, knowing that you could invest that $100 now and have more than $100 in a year's time. If you turn that thinking on its head, you are saying that the amount that you'd have in one year is worth $100 dollars today - or the discounted value is $100. Make the same calculation for all the cash you expect a company to produce in the future and you have a good measure of the company's value.

Valuation of private shares is often a common occurrence to settle shareholder disputes, when shareholders are seeking to exit the business, for inheritance and many other reasons. There are numerous businesses that specialize in equity valuations for private business and are frequently used for a professional opinion regarding the equity value in order to resolve the issues listed.