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đ´ How to Value a Company in 3 Easy Steps - Valuing a Business Valuation Methods Capital Budgeting - YouTube
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How to Value a Company in 3 Easy Steps, How
to Value a Business
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- Valuing a Business Valuation Methods Capital
Budgeting
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Welcome back to our second part of Capital
Budgeting, which is Valuing a Business.
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Brought to you by MBABULLSHIT.COM.
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Before this video, you should first understand
present value, net present value, basic capital
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budgeting, and the weighted average cost of
capital, or the WACC.
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If you donât understand these concepts yet,
I recommend that you watch my other free videos
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on these topics above.
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Letâs get down to it!
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When we say valuing a business, weâre actually
trying to answer the question âHow much
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is the business worth?â
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If you remember, here is a store, an existing
business.
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Maybe you want to buy this store from its
owner.
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Before you buy from him, you have to find
out how much is the business worth?
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Here is where financial managers and accountants
have different philosophies.
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For most accountants, the way they would value
a business is they look at the price of the
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assets â shelves, building, uniform â and
then they look at the price of the liabilities
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or the debt (maybe they owe money to the bank)
and then they come out with something called
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âownerâs equityâ and thatâs how they
value the business.
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The amount of ownerâs equity is how much
the business is worth.
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However, for financial managers, we donât
care about the asset value or the ownerâs
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equity.
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We donât care if this shelf costs $1M or
if the business building is worth a lot, usually.
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What we do care about is the present value
of the free cash flows.
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This is another way of saying how much the
store actually earns.
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If the store, for example, has $10,000 worth
of shelf and equipment, but it only earns
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$5 a year then the store is not worth much.
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Even if the assets are worth a lot, the fact
that it earns such a small amount means that
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itâs a bad business and that itâs worth
little.
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Most financial managers put a heavier importance
on the earnings of the business instead of
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the assets of the business.
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One way of representing these earnings is
by looking at the free cash flow.
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The way we value a business is we look at
the present value of the free cash flow plus
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the present value of its horizon value.
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Donât worry if you donât understand these
terms yet.
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You will see in a while.
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How to compute the âfree cash flowâ will
be discussed in another video.
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For this video, I will just give you the amount
or the figure of this businessâ free cash
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flow so you can understand the concept quickly.
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For example, this store has free cash flow
earnings of:
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Year 1: $10,000
Year 2: $12,000
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Year 3: $11,000
Year 4: $13,000
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This is given.
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In more advanced problems, you would have
to compute this yourself, but I will discuss
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that in another video.
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Letâs assume that these are the free cash
flows of the store.
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And then I give you the following information:
Horizon year is Year 3, which means this (referring
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to Year 3: $11,000).
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You might be wondering what the heck is a
horizon year?
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Horizon means you look into the future.
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However, most people make the mistake of thinking
that the horizon year is the last year of
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information that you are given in the problem.
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Do not do that.
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Year 4 is not the horizon year.
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Usually, your professor will say that the
horizon year is 1 year before the last year.
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Remember to always read the problem carefully
and look at what the professor says is the
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horizon year.
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In our case, itâs Year 3.
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If youâre wondering why we need to know
the horizon year, youâll know in a short
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time later.
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Iâll show you why it is important.
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And we know that the weighted average cost
of capital is 10%.
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In more advanced problems, you would have
to compute the WACC by yourself.
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If you donât know how to compute this, you
can watch the other video about WACC.
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The other piece of information that is given
is the estimated free cash flow long term
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average growth of 5% per year.
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For Year 4, Year 5, Year 6, Year 7, the free
cash flow will grow 5% year.
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It doesnât mean that it will grow exactly
5% per year.
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It just means that, on the average, it will
grow 5% per year.
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How do we compute or value the business?
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We need to look at 2 formulas.
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Remember, I said we have to look at the present
value of the free cash flows.
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To do that, we use this formula:
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Donât panic.
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I know it looks scary and complicated, but
I will show you how easy it is.
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