chapter, this method is not available at this time. So absent a PV valuation, other indications of value are the Revenue and EBITDA growth rates. The historical and projected Revenue and the EBITDAs for the Company with the Income Statement presented in Table 1-1 are shown in Table 1-2.
Table 1-2 Valuing a Company If the Industry Multiple Is Unknown
Assuming the forecast for Year n is accurate and using the data in Table 1-2, the Historical Compound Annual Growth Rate of Revenue, CAGRHR, is calculated with the assistance of Equation [1-17]:11
[1-17]
Substituting in Equation [1-17]
%CAGRHR = 7.2%
Similarly, the Forecasted Compound Annual Growth Rate of Revenue (CAGRFR) is calculated by using Equation [1-18].
[1-18]
Substituting in Equation [1-18]
%CAGRFR = 9.1%
Assuming the historical growth rate has been a steady 7.2 % and the projected Revenue growth rate of 9.1 % is credible, these growth rates can be helpful in estimating the Company's value to the extent they are reasonable proxies for an industry multiple. The historical growth rate is a fact. The question is: Is the projected growth rate believable? If it is forecasted to come about as a result of increased investment year by year in Sales and Marketing, Research and Development, Plant and Equipment, and Administration during the forecast period (implying that management intends to spur growth by investment) rather than grow Operating Expenses at a slower rate to increase the bottom line, then a growth rate of 9.1 % is realistic. On the other hand, it does represent a healthy increase and a prudent buyer would take this into account. Be that as it may, given the information at hand, the only conclusion that can be reached by applying this methodology is to assume the growth rates are indicative of a suitable multiple and that the multiple range in this case can be said to be a range of 7 to 9.
The average EBITDA for the period n – 2 to n is
And for the period n to n + 3, EBITDA is
Recalling Equation [1-16],
[1-16]Value = (EBITDA)(Industry Multiple) – Debt
The company doesn't have any debt or excess cash, hence the implied value is
Value = (EBITDA)(7 to 9) – 0 = (EBITDA)(7 to 9)
The EBITDA to use can get a little complicated depending on the buyer and what they are comfortable with. One way of coming up with an EBITDA is to assume the average of the Historical and Forecasted EBITDAs. Since the EBITDA proposed is the average of the two averages, one might be tempted to use an average of the multiple range (8). However, this company is very profitable and has demonstrated it can grow, and grow consistently, hence there is a strong argument for using the high end of the range. Hence:
or approximately $148 million using these assumptions.
However, as can be seen, the averaging method previously chosen yields an average EBITDA of $16,429,000, which is almost the same as the current year's EBITDA of $16,500,000, so one could argue that a value of $148 million is at the low end of the value range. If the average of the future EBITDAs were used and a multiple of 9 applied, the value would be closer to $168 million.
Value = (EBITDA)(9) = (18,625,000)(9) = $167,625,000
⧉ The Balance Sheet
The first thing to note about the Balance Sheet shown in Table 1-3 is by definition:
[1-19]Total Assets = Total Liabilities + Total Shareholders' Equity (TSHE)
or
[1-20]Total Assets = Total Liabilities + TSHE
Table 1-3 Basic Balance Sheet
If Equation [1-19] isn't satisfied, the Balance Sheet isn't balanced and there is something wrong with the numbers.
Following the model used when analyzing the Basic Income Statement, an inspection of the Balance Sheet in Table 1-3 results in a number of equations that describe the relationships between the various accounts.
[1-21]Total Assets = Total Current Liabilities + Net Fixed Assets
+ Net Intangible Assets
Current Assets consists of Cash, Accounts Receivable (money customers owe the company), and Inventory. Therefore:
[1-22]Current Assets = Cash + Accounts Receivable + Inventory
Similarly, Fixed Assets consists of Property, Plant, and Equipment (PP&E), which represent the fixed assets the Company needs to produce its deliverable, and Accumulated Depreciation, which represents how much of these assets have been expensed through the Income Statement as they wear out.
For example, if a hard asset is purchased for $5,000,000 and has an estimated useful life of 10 years, then the amount the asset would be depreciated each year would be $500,000 ($5,000,000/10)12 and after two years the accumulated depreciation for this asset would be $1,000,000 ($500,000 * 2).
All of this can be expressed as
[1-23]Net Fixed Assets = PP&E at Cost – Accumulated Depreciation
Intangible Assets includes such things as Goodwill, which is created when an Asset is purchased at a price in excess of its book value. Other Intangible Assets are such things as patents, non-competes, and customer lists if acquired as part of an M&A transaction.13
Again an example may be helpful. If a patent acquired as part of an acquisition of a company was valued at $3,000,000 and had 10 years remaining before expiring, it would be amortized at a rate of $300,000 ($3,000,000/10) per year for 10 years and at such time the accumulated amortization associated with the patent would be $3,000,000, leaving a net tangible value for this asset of zero.
Net Intangible Assets can be defined by Equation [1-24]:
[1-24]Net Intangible Assets
A lot has been said here about Fixed and Intangible Assets. Don't be concerned if it strikes you as being confusing. The purpose is to expose the reader to the terminology and nothing more. All of this will be discussed in more detail in subsequent chapters.
