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Valuation - The Essence of Corporate Finance

Valuation is an important process in corporate finance and it helps to determine the present value of assets. Both, assets and liabilities of a company can be valued. The process is important for all business owners, big and small, to know how much their company is worth. Valuation is needed for the purpose of analyzing investments, capital budgets, preparing financial reports etc.
Valuation is necessary so that if and when a company is put on the market, the buyer knows clearly how much are the company's management, capital structure, and assets are worth as well as what sort of future earnings prospects it presents. Valuation is also necessary from the purview of legal requirements for companies. Often, a company's assets need to be valued for the purpose of tax, accounting etc.
Increasing shareholder value is one of the key functions a manager needs to take care of. Valuation is an important step in decision making and assists managers in making important decisions. It provides an objective overview of the company's current market position to the managers. With its help managers can make both long and short term strategic decisions as well as plans with respect to capital investment, investment banking or other financial planning matters.
There are different ways in which valuation is done i.e. discounted cash flows, multiples based and options based valuation. Of these ways, one of the most commonly used methods is the discounted cash flow method. According to this method,
Value of an asset = Sum of the Present Value of All Future Cash Flow
  • Asset: Bonds, stocks, business, house, art, etc.
  • Present Value: It refers to the future value divided by (1 + discount rate) raised to the power of the time period.
  • All: Refers to the recurring as well as onetime cash flows, savings etc.
  • Future: Only future cash flows are considered. Past cash flows are not considered.
  • Cash Flow: Refers to the inflow and outflow of cash and not the net income.
The first step in the process is the estimation of future cash flow over a given period. The next step is to determine the growth rate after the forecast period. This future cash flow is then discounted to the present value. Interest and principal repayments, future selling price and dividends, free cash flow from the work, rental and/or any other income is used for discounting the future cash flow to its present value. Finally, the terminal cash flow is discounted to current value. The assumption made here is that there is continuous cash flow always. All the present values of assets are summed up to get the present value of cash flow over the forecasted period and the horizon value.
The process of valuation is based on fundamentals and not current market sentiment and hence, the valuation is objective and accurate. In this process, since the values of assets are calculated based on the cash flow it provides a real indication of value. Hence, valuation is an extremely important part of corporate finance and decision making.
For more details you can consult with our experts at CL King and Associates.
CL King provides investment banking, equity research, sales and trading, and investor services to corporations and institutions. Call at 518-447-8050 today and explore some best investment deals for you!

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