Tools Used in Asset-

Based Valuation
Module 7: Valuation and Concepts
Lecture/Content
• Tools Used in Asset-Based Valuation
• Financial Models in Going Concern Business Opportunities
• Steps in Developing Financial Models:
• Gather Historical Information and References
• Establish Drivers for Growth and Assumptions
• Determine the Reasonable Cost of Capital
• Execute the Formulae to Compute for the Value
• Make Scenarios and Sensitivity Analysis Based on the Results

• Components of Financial Model

• Summary
Tools Used in Asset-
Based Valuation
Tools Used in Asset-Based
Valuation
Valuation is a sensitive and meticulous task for every analyst and
investors. This activity must account for all drivers of growth and risks. It
was discussed that the value of the asset is an important representation of
the value of the firm, and effectively a good reference for the value of the
stake of the creditors and more importantly the investors or stockholders.
Since the process would require incorporation of a lot of factors, there are
tools that can be used to facilitate the calculation. These tools will enable
us to execute the formulae and fundamentals that are necessary to
determine the value and at the same time to determine the share from
the company.
It is always discussed what formula can be used to determine the value
but it is also important to know what are the sources of information that
can serve as reasonable inputs and estimates in order to quantify the
value that will be generated in the future.
Tools Used in Asset-Based
Valuation
Valuation can be calculated manually with the use of pen, paper or just
calculators. There are investors that uses multiples as ballpark figures. Ballpark
figures are quantitative drivers or multipliers that allow the investors to quickly
make an estimate or offer. Usual multiples used are P/E ratio or EBITDA
multiples.
The limitation of using ballpark figures is that these are mere estimates and
certain information where not included. Although ballpark figures and quick
computation are enough reference for risk seeking and risk neutral investors.
Then again, parties will still be negotiating for the amount acceptable between
them based on their risk and returns that they are recognizing.
Since there are a lot of limitation of ballpark figures, sanitary checks or
measures are needed to be administered. Financial ratios, multiples and
estimates are needed based on financial reports validated through due
diligence. Still, in practice, the most popular is the discounted cash flows.
Since discounted cash flows are heavily dependent on long-term projections,
electronic spreadsheets were used to develop financial models.
Tools Used in Asset-Based
Valuation
Financial Models are mathematical models designed to aid in coming up with
a recommended decision and at the same time can be used to validate the
assumptions made. Hence, it must be clear and auditable. It is like a financial
plan or quantification of strategies and operating plans of the enterprise,
which is used to facilitate the following:
• determination of asset value or enterprise value and equity value
• identification of risk
• development of scenarios and sensitivities

It is similar to budget but the difference is that financial models are usually
longer in terms of the period, more conservative and designed to
determine the value and not the financing requirements of the firm.
Although nowadays, companies started to be more conservative in the
financial plan that they use, they also use financial models to enable them to
identify and incorporate the risks and facilitate the development of other
scenarios that win enable there to make the plan more implementable.
Financial Models in Going
Concern Business
Opportunities
Financial Models in Going Concern
Business Opportunities
Financial Modelling is a sophisticated and confidential
activity in a company or for an analyst. Information can
also be considered as competitive advantage of a
company or a person. Most of the companies hire
financial modellers to assist them in determining
the value of GCBOs or any opportunities. They also
have them to validate their ballpark estimate and may
also be used to determine their impairments. Most
financial modellers have extensive financial acumen and
vast knowledge and experience. Financial modellers
normally are economists, financial managers and
accountants. Management accountants are good
candidate for this role given their ability to understand
operational models and design long term financial
strategies.
Financial Models in Going Concern
Business Opportunities
In order to develop financial models, the following steps are needed
to be observed:
1. Gather historical and market information and references
2. Establish drivers for growth and assumptions
3. Determine the reasonable cost of capital
4. Execute the formulae to compute for the value
5. Make scenarios and sensitivity analysis based on the results
Steps in Developing
Financial Models
I. Gather Historical Information
and References
Historical information must be made available before the
financial model is to be constructed. Historical information
may be generated from, but not limited to the following:
audited financial statements, corporate disclosures,
contracts, and peer information.
Audited Financial Statements are the most ideal
reference for the historical performance of the company.
The components of the audited Financial Statements
enable the analyst or the financial modeller to assess the
future of the company based its past performance.
I. Gather Historical Information
and References
Statement of Income is used to determine the historical performance.
Statement of Financial Position is used to determine the book value of
the assets and the disclosed stakes of the debt and equity financiers.
Statement of Cash Flows illustrates how the company is historically
financing its operations and investments.
Statement of Changes in Stockholder’s Equity provides the
information on how much is the claim and dividend background of the
company.
One of the most important components of the financial statements
are the Notes to the Financial Statements. It provides the summary of
important disclosure that should be considered in the valuation. The
financial modeller must be able to quantify these disclosures and
more importantly, the risks involved.
I. Gather Historical Information
and References
Corporate disclosures are also key in developing the financial model.
Corporate disclosures provide more context for the future plans and
strategies of the company. This will enable the analysts or the financial
modellers to identify the risks about the GCBO and quantify them
accordingly. Since these are available to the public, it is the same
information that is known to others. The difference among the modellers are
their personal appreciation to risk and their client's appetite for risks.
Contracts are formal agreements between parties. In valuing the GCBOs, it is
important for the modeller to also know the existing contracts and the
covenants. Large accounting firms offer transaction advisory services to
assist their clients entering into new ventures. Due diligence is necessary to
verify any contingent liability and other legal risks surrounding that
opportunity and quantify it accordingly to have a more conservative value.
The modeller must be able to classify the probability of these from occurring.
But what is more important is to gather the information to have a reasonable
basis to quantify and incorporate it in the financial model.
I. Gather Historical Information
and References
Peer information and other public information are also essential inputs to the
financial model. Peer information provides more context and even supports the
risks identified or will be assumed in the valuation process Peers may be the other
analysts, industry experts and other consultants. Internal members of the
organization may also be considered as peers. However, the information sharing is
restricted by law since these are insider information and is not fair for the public.
Researches and studies can also be used as peer information. In the Philippines,
reliable sources could be the National Library and Philippine Institute on
Development Studies. Researches and studies shared through conventions and
forums will also be relevant inputs in the development of the financial model and
in valuation.
Collectively, the financial model must be able to filter the information that would
be necessary for the valuation. Relevance and reliability of information are
important. Not all information should be given consideration. Materiality is another
consideration Even if there are additional information gathered, there should be a
sense of materiality assessment involve. Note that projections remain to be
estimates. Therefore, only relevant cash flows should be considered in the
valuation.
II. Establish Drivers for Growth
and Assumptions
Once all relevant information were gathered and validated,
drivers and assumptions can be established by conducting
financial analysis. Drivers are suggested to be those
validated and is represented by authorities like government
or experts. Growth drivers are normally based on
population, since most of the businesses are consumer
goods.
If services, industry growth may be used as a driver. In the
Philippines, information is available from the Philippine
Statistics Authority. Because the government needs to be
transparent to its citizens. it fortunate that the information
can be found in the government website or is disclosed to
public through media with wider reach and scale.
II. Establish Drivers for Growth
and Assumptions

For other economic factors, drivers, and estimates, Bangko Sentral ng

Pilipinas and National Economic and Development Authority are also
other agencies that can be relied into. Certain statistical information can
also be found from the websites or research of the Local Government and
National Government Agencies. Research organizations may also be used
however strong validation and evaluation needs to be done to isolate any
form of biases that may affect the value.
II. Establish Drivers for Growth
and Assumptions
The usual growth indicators used are: inflation, population growth,
GNP or GDP growth. In economics, the inflation is the result of the
movement of prices from a year to another. This is calculated by
comparing the movement of the price of the basket of commodities
from a year to another or a period to another. Inflation is computed
using this formula:
II. Establish Drivers for Growth
and Assumptions
The consumer price index represents the price of the
basket of commodities for a particular period. In financial
modelling, you need the inflation to be used as driver for
certain operating and capital expenditures. There are two
ways to calculate the value: (1) nominal and (2) real.
Nominal financial models are already in current
prices meaning the prices stated in the model already
assumes that the prices grew or decline, in the case of
inflation or deflation respectively. Some uses the headline
inflation to determine the current price. Real financial
model, on the other hand, does not include the
effect of changes in prices, but rather preserve the
price of operating expenses and capital
expenditures, as if no changes in prices occur. If the
financial model is in real prices the cost of capital should
II. Establish Drivers for Growth
and Assumptions
With the given equation, to illustrate, that in year 2019
the CPI is 151 meaning the cost of the basket is Php151.
In year 2020, the CPI published is Php155. Obviously the
price of the basket grew, hence, inflation is on n the other
hand, if the CPI expected to be 2.64% [(155/151 )-1 x
100%]. On the other hand, the CPI published for 2020 is
Php149, then it will be a deflation or decrease in prices at
1.32% [(149/151) - 1 x 100% ].
To illustrate its application, supposed you are projecting
for how much is the communication costs for 2021 when
the cost in 2020 is Php5 Million. Given the calculated
inflation of 2.64%, the communication costs to be
incorporated in the financial model is Php5.132 Million.
II. Establish Drivers for Growth
and Assumptions
Other indicator is population growth rate. Population growth rate is
factored in to serve as a growth driver the demand of the product,
particularly for the merchandising or manufacturing business. The
services sector may use the growth rate in the businesses or the
industry or sector that they are going to serve. The formula to
calculate for the population growth rate is similar with the inflation,
except that the input is the population count of a particular segment
in a particular year.
To illustrate, suppose that population in Barangay A in 2019 is
25,200. The survey is conducted in 2020 and the population is
26,460. Using the formula of inflation to calculate for population
growth rate:
II. Establish Drivers for Growth
and Assumptions
To illustrate the application, assuming that the estimated consumption of
pandesal in Barangay A is 5 pcs average per head. If you are going to project
the number of pandesal to be sold in 2021, it will be 138,915 units computed as
follows:
Current pandesal sold (26,460 x 5) 132,300
Increase in pandesal (26,400 x 5% x 5) 6,615
Total estimated pandesal 138,915
Financial ratios may be used as tools to determine the growth drivers and
assumptions. Trend analysis will also help you establish the trajectory of growth
pattern. The financial modeller must assess whether the company can sustain
the pattern otherwise it is conservative to assume a less aggressive growth.
Normally the weighted growth pattern will be considered in the long term
financial perspective. It must be assessed whether the average year on year
growth will be sustained or may be surpassed.
II. Establish Drivers for Growth
and Assumptions
To illustrate, PUP Company's historical production grows 10% per year.
It is expected that in the next five years the probability are as follows:
Scenario Rate Probability
A 5% 10%
B 10% 40%
C 15% 50%
With the given information, the weighted average growth rate to be
used is 11.5% computed as follows:
Probability Weighted (1)
Scenario
Rate (1) (2) x (2)
A 5% 10% 0.50%
B 10% 40% 4.00%
C 15% 50% 7.50%
Total 12.00%
In this situation, the financial modeller can safely us the 12% for
projecting sales moving forward. Hence, if the sales for this year was
reported to 8,500 units, then under the average sales computed will
result to 9,520 units sold.
III. Determine the Reasonable Cost
of Capital
In determining the reasonable cost of capital, the financial modeller
must be able to use the appropriate parameters for the company.
Generally, cost of debt and cost of equity are weighted to determine
the cost of capital reasonable for the valuation. The Weighted
Average Cost of Capital (WACC) can be used determine the
appropriate cost of capital by weighing the portion of the asset was
funded through equity and debt.

WACC may also include other sources of finances like Preferred Stock
and Retained Earnings.
III. Determine the Reasonable Cost
of Capital
The cost of equity may be derived using Capital Asset Pricing Model
or CAPM. The formula used is as follows:

To illustrate, the risk free rate is 5% while the market return is roving
around at 11.91 %, the beta is 1.5. The cost of equity is 15.365% [5%
+ 1.5 (11.91% - 5%)]. If the prospect can be purchased by purely
equity alone, the cost of capital is 15.365% already. However, if there
will be portioned raised through debt it should be weighted
accordingly to determine the reasonable cost of capital for the project
and to be used for discounting.
III. Determine the Reasonable Cost
of Capital
The cost of debt can be computed by adding debt premium over the risk-free rate.

To illustrate, the risk free rate 5% and in order to borrow in an industry a premium
was considered to be about 6%. Given the foregoing, the cost of the debt is 11%
(5% +6%). Now, assuming that the share of financing is 30% equity and 70% debt
and the tax rate is 30%. The weighted average cost of capital will be computed as:

The WACC is 10%. Observe that tax was considered in the picture to factor in that
the interest incurred or cost of debt is tax deductible, hence, there is tax benefit
from it. You may also note that the cost of equity is higher than cost of debt, this is
because cost of equity are more risk s compared to cost of debt, which is fixed.
IV. Execute the Formulae to
Compute for the Value
Normally in Financial Modelling, DCF is used to calculate for the
value. Since most information already available in financial model, it
can be easier to use other capital budgeting techniques like Internal
Rate Return, Profitability Index etc.
To demonstrate, Cyrus Company’s last year EBITDA reported was
Php50 Million. Historically, their sales grew by 12% every year. The
plan of the company is to purchase an asset within the year with cost
of Php150 Million to enable 12% growth in the succeeding years.
Terminal cash flow was estimated to be Php250 Million. The
outstanding total liabilities of the company is Php100 Million. If the
interest rate is 5.5% per year. Corporate taxes to be paid is 30% of
the EBITDA. Using the 10% WACC, the Equity Value is Php63 Million.
IV. Execute the Formulae to
Compute for the Value
IV. Execute the Formulae to
Compute for the Value
With the results, if the company has 1
Million shares, then the share price is
valued at Php63 per share. Enterprise
Value is the value of the company or the
asset for this case, calculated as present
value of the cash flows to be generated
in the future. Theoretically, Asset =
Liabilities + Equity. Hence, if you
subtract the liability from the Enterprise
Value it will now be the value
stockholder from the cash flows which
remaining for the claims of the equity
stockholder from the cash flows which
known to be Equity Value. Using the
electronic spreadsheet like Microsoft
Excel, certain valuation tools or capital
budgeting techniques can easily be
calculated like Net Present Value and
Internal Rate of Return. Using the given
information, the spreadsheet can be
presented as:
V. Make Scenarios and Sensitivity
Analysis Based on the Results
The advantage of having a financial model is that you can easily tweak the given information
and get the results immediately. For instance, in the previous illustration the cost of capital
used is 10%. How about if you find that cost of capital will be 1 2% or 1 5%, what will be the
Enterprise Value.
If this is the case, we need to design the financial model to accommodate this through the use
of Data Table feature in Microsoft Excel. First, design a table where the values will be inputted.
V. Make Scenarios and Sensitivity
Analysis Based on the Results
Next, select the table we prepared by highlighting cells C17 to D19
and you go to DATA Tab and go to “What If” Analysis then select
“Data Table”.

Data Table Dialogue box will appear and will ask you to enter the
inputs. Since the table we are doing provides for a columnar input,
then we’ll input C17 in the COLUMN INPUT and click OK.
V. Make Scenarios and Sensitivity
Analysis Based on the Results
Then the results will now be shown to you in the table.

It will be easier for you to determine which value to use. Since, in our
example the outstanding debt is Php100 Million then you have to play
in the range of Php19.86 to Php63 per share.
V. Make Scenarios and Sensitivity
Analysis Based on the Results
The scenarios will be developed based on the set of possible
occurrences like level of operating expense, mode of operations,
capital expenditure development period etc. Emerging trend is
having a Risk Based
Valuation, wherein major systematic risk are incorporate such as
climate change, war, economic sabotage, pandemic etc.
Sensitivity Analysis is almost similar with Scenario Modelling. The
difference is that sensitivity analysis will have to select a driver or
few drivers, ceteris paribus, and check the degree of change it will
cause to the results. Sensitivity analysis is a useful exercise in
developing ballpark estimates.
Components of Financial
Model
Components of Financial Model
As described in the earlier part of this chapter, a financial model
should be understandable, printable and auditable. The financial
model should be designed in a way that the investor or the client of
the analysts or the proponent themselves can understand the
dynamics and follow the drivers to enable them to have a better
appreciation and sound judgment of the results. Please bear in mind
that the results of the financial models are just guide for the investors
or even sellers of investment to determine the reasonable value.
As a quick guide in developing a financial model, the following
components are recommended, particularly when using Microsoft
Excel:
Title Page
This provides an overview of the project being valued or assessed.
This includes also necessary information to secure the proprietary
rights of the modeller or the firm he or she is working with. It may
also include data cut-off to serve as a guide to the readers.
Components of Financial Model
Data Key Results
This sheet summarizes the result of the study. This will serve as
the dashboard to enable the modellers to analyze the results and
to facilitate the reader’s appreciation on the results of the project.
This also facilitates preparation of pertinent reports.
This also contains the valuation results, scenarios, and sensitivity
analysis. Graphs can also be found in this sheet.
Assumption Sheet
This sheet summarizes the assumption used in the model. This is
normally an input sheet where all inputs should be made. The
information that can be found in this sheet must be linked to all
the output sheets like pro-forma financial statements, supporting
schedules and data key results.
Components of Financial Model
Pro-forma Financial Statements
This presents the 3 components of the financial statements namely:
Statement of Comprehensive Income, Statement of Financial Position
and Statement of Cash Flows. In this sheet, you can also find some key
financial ratios particularly those that has to do with financial
performance and efficiency ratios.
Some modellers also find it convenient to have their valuation
computation be done in this sheet since the inputs of cash flows are
already available here.
Supporting Schedules
This is like a subsidiary ledger which provides supporting computation to
the components of the pro-forma financial statements. There is no limit
for the supporting schedules. The only challenge is that the electronic
financial models consume large amount of data because of the
supporting schedule.
Summary
Summary
Calculating for the value of the asset has a lot of complication since
there are a lot of consideration involved. Hence, the tools are made
available to facilitate the determination of the reasonable value of
the equity based on the value of its assets.
The approach could be manual or electronic/computer-assisted.
Manual approach or the conventional approval simply uses pen,
paper and calculator using ballpark figures. Electronic or computer-
assisted may be done using electronic spreadsheets or applications
designed to calculate equity value.
Financial Modelling is a sophisticated and confidential activity in a
company or for an analyst. Information can also be considered as a
competitive advantage of a company or a person.
Summary
In order to develop financial models, the following steps need to be
observed:
i. Gather Historical Information and References
ii. Establish Drivers for Growth and Assumptions
iii. Determine the Reasonable Cost of Capital
iv. Execute the Formulae to Compute for the Value
v. Make Scenarios and Sensitivity Analysis Based on the Results
Financial models should be understandable, printable and
auditable. Suggested components of the financial models are: title
page, data key results, assumption sheet, pro-forma financial
statements, and supporting schedules.
End of Discussion