Valuation Techniques in Financial Management

This document discusses various valuation techniques in financial management including price/earnings ratio, dividend valuation method, and discounted cash flow method. It explains how these techniques are used to determine the value of a company or investment. The document also provides a critical evaluation of each technique and discusses their advantages and disadvantages. It concludes by recommending the use of the discounted cash flow method for investment appraisal.

Financial Management

Question 2
a) Price/earnings ratio
The cost to-profit (P/E) proportion, which is equivalent to an organization's market cost
for every offer separated by its income per share (EPS), is the most generally utilized income
different. It gives a sign of how much speculators are happy to pay for an organization's profit
(LIHAWA, 2016). For instance, an organization whose P/E proportion is 15 is supposed to
sell for multiple times income and putting it in another way, financial specialists are eager to
pay $15 for each $1 of current or future profit. Organizations with high income development
prospects generally convey high P/E proportions in light of the fact that these organizations
are required to have the option to remunerate speculators with a faster and bigger profit for
their interest as profits, increment in share cost, or both.
MPS £3.89
EPS £0.21
P/E ratio of Aztec (A) 18.52
Distributable earnings £40.4
number of shares 147
EPS of trojan (B) £0.27
Value per share of Trojan (A * B) £5.0004
Total market value £735.06
Statement showing valuation using price earnings ratio
b) Dividend valuation method
The Gordon Growth Model is utilized by speculators to decide the connection among
valuation and return. Nonetheless, the model is just precise if certain conditions are met. The
Gordon Growth Model requires the accompanying suspicions: the organization has a steady
plan of action and the organization utilizes the entirety of its free income to deliver profits at
standard stretches (Affandy, 2019). The organization's profits are relied upon to develop at a
consistent rate and along with the same the organization's other presentation measurements,
(for example, earnings) are additionally expected to develop at the equivalent, stable rate as
its profits. The development rate is lower than the speculator's expected pace of return.

Current dividend (D) £0.13
Risk free rate of return (Rf) 5%
Return on the market (Rm) 11%
Beta (ß) 1.10%
As per CAPM, the required rate of return = Rf + (Rm-Rf) *ß
= 5% + (11% -5%) * 1.10%
Required rate of return (K) 5.07%
Growth rate 2%
Market price per share = D*(1+g) / (K-g)
= 0.13 * (1+2%) / (5.07% - 2%)
MPS £4.32
Total market value £635.04
Statement showing valuation using Dividend valuation method
c) Discounted cash flow method
The discounted cash flow (CF) strategy decides the business esteem by thinking about
anticipated monetary advantages, markdown rate and the terminal worth. The target of the
technique is to figure out what the normal monetary advantages stream is worth in present
day dollars, given the dangers related with claiming and working the private venture. As a
result of the technique's strong monetary hypothesis establishment, it is supported via
prepared speculators and business valuation experts (Ağca and Mozumdar, 2017). The
explanation is that this technique is very adaptable with the decision of the salary gauges that
can be utilized as its info. Key to the strategy's exactness, however, is a cautious match
between the pay measure, known as the income premise, and the discounting rate.
Discounted cash flow
Net operating profit £40.4
Add: depreciation 0
Add: change in working capital 0
Less: change in capital expenditure 0
Free cash flow £40.4
Discounting rate = WACC = 9%
PV of cash flow = Annual cash flow/discounting rate
Cash flow growth rate 2%
Market value per share = 40.4 / 9%
£448.89
Total market value £65986.67
Statement showing valuation using Discounted cash flow method

d. Critical evaluation of various valuation techniques
Price/earnings ratio
This ratio explains the comparison of MPS to the EPS. The EPS is calculated using
the last 4 quarters performance of the business. The greater proportion shows the greater
return prospect by the financial specialist with respect to the more prominent pay in the
coming years in contrast with low P/E proportion (Jitmaneeroj, 2018). The connection
between these two demonstrates what the market is willing to pay dependent on the current
degree of income and furthermore shows if the market is finished or underestimating the
organization. An ascent in the EPS prompts the ascent in the market esteem and the lower
income per share shows fall in MPS. This proportion is valuable in looking at the
organizations in a similar industry. Yet, the excessive cost winning proportions is viewed as
the dangerous speculations when contrasted with the lesser proportion and this is a result of
the explanation that rising proportion means high possibilities.
In the situation of M&A, it is very important to compare the ratios of the
organizations within the same industry. These ratios can be distorted by the company
depending upon the how company has accounted for the items and is based on the accounting
principles and practices which varies from country to country which adds another problem
(Köseoğlu and Almeany, 2020). In case of cyclical business entities, it requires a more
detailed investigation and the less PER would might mean low-priced that is all wrong
because it is precisely the wrong time to buy these types of firms. The EPS is determined
incorporates a great deal of noises and won't actual exhibition of the corporate. It additionally
disregards the effect of risk while focussing on value capitalization. This technique is utilized
generally with the end goal of valuation of speculation since it shows the normal cost of the
share dependent on the organization's profit. Consequently, every one of these issues
according to P/E proportion should be dealt carefully with utilizing it as it has immense effect
on the corporate decision taking process.
Dividend valuation method
This procedure is employed in making a decision about the overall assessment of a
stock which is then recognized with the market cost at which the offer cost is trading. The
main advantage of this method is the dividend tends to stay consistent over a time period.
Companies using this model, does not set up unnecessary high dividend expectation because
not meeting with the same affects the stock price later (Bruner, 2017). This method uses NPV

of the projected dividend for valuing the shares. It is derived by distributing dividend to be
paid in the subsequent time period divided by (cost of equity (Ke) less dividend growth rate
(GR). This approach is very easy to understand as it values the company’s stock deprived of
seeing the market conditions.
The major problem associated with the technique is that it is very difficult to forecast
precisely. This is additionally referred as DDC model. This practice can be applied in judging
the possible profit pay but this approach has certain disadvantages. It cannot evaluate those
stocks which does not convey dividend regardless of the fact that the investment increase
recognized from it. This is dependent upon the presumption that the estimation of the share
value is the ROI. For esteem figuring, it uses various assessments assumptions, such as,
development rate, required ROR (Trinh and Thao, 2017). For example, benefit yield does not
remain the same and changes with time, if any predictions are being made in the calculation
are to some degree in blunder will realize choosing the estimation of stock either overstated
or underestimated. It does not account for judging non-profitable factors, such as, brand
faithfulness, possession for valuable funds. This business valuation method is based upon the
suspicion that the profit development or the growth rate will remain consistent. It additionally
recognizes that the stock cost is exceptionally sensitive to the profit's pace of development
and also it can't outflank cost of equity (Ke) which isn't for every circumstance authentic.
Regardless, there were different undertakigs so as to defeat these issues yet it will join a great
deal of extra computations relating to projections and are additionally disposed to mistakes.
Another issue is that it overlooks the impact of stock buyback which can be named to be
absurdly conservative in the appraisal of stock worth.
Discounted cash flow method
This approach of valuation strategy decides the current approximation of the
advantage or the association subject to the estimation of cash it can create in future. It
depends upon the notion that the estimation of cash today is higher than what's to come. This
procedure is valuable in assessing the characteristics assessment of the affiliation. It requires
a lot of data subject to which worth is assessed of the stock (Cornell and Gerger, 2019). The
advantages of this system are that it contemplates all the critical business notion and it doesn't
need any vague affiliation. It is the good and appropriate technique for investigating the
M&A. It might be used in processing IRR and moreover allows compassion examination.

This methodology is incredibly sensitive procedure which relies upon the presumption related
to unending development rate and the discounting rate.
In this procedure, any slight error will make the assessment change and the reasonable
worth decided won't be exact. This process capacities outstandingly fine in the condition of
having serious extent of certainty, however, the association's movement needs perceivability
which it makes trouble in foreseeing the business, costs related to business movement and
capital hypothesis. Deciding income for future years is annoying, doing it never-endingly
which is needed in DCF procedure, sometimes become inconceivable (Elnusa, 2020). This
technique is slanted to high misstep. The troublesome subject of this technique is that the
terminal worth contains all out worth, that is, 65-75% and a minor variety in the terminal year
will essentially impact the general valuation. This methodology isn't fitting for shorter term
undertakings as it revolves around creation of longer term value. It moreover relies upon
market demand, unforeseen impediment and some more. Also, assessing the future income
high, might realize selecting the investment that might not have the alternative to take care of
later on, influencing benefits.
Thus, from the above critical analysis of various valuation methods, it can be stated
that DCF method should be used by the company. Also, it should be used by the
professionals with expertise in the field of finance as they are very capable in creating
monetary structures and representations. It is the best suited method because it supports in
getting better and accurate results. Along with that proper care and focus needed in
forecasting and valuation because a small mistake will lead to inaccurate assessment which
can affect the performance and functioning of the corporates.
Question 3
1. Application of different investment appraisal techniques
a. The payback period (PBP)
It shows the measure of time period it will take to recuperate the cash that was
contributed at the beginning. It is actually the length of time at which the investment reaches
the point of no profit no loss (Gianakis, 2017). It is a very important technique; shorter the
period means more attractive investment. This helps business in taking speedy choices.

Compute the payback period (PBP)
Payback period (PBP)
3.79 years
͹ ͹͉ʹ ͷ ǡͲͲͲ
ሺ͉ ͺͷǡͲͲͲെ͉ ͳʹ ǡͷͲͲሻ݅݊ܫ݅݊ܫ݈ܽ݅ ݐݐݐݐݐݐݐݐݐݐݐݐݐݐ ͹ ͹ ͹͹͹͹݅݊ܫ݁ ݏ ݁ ݐ ݒݐ
ሺ  ݈ܽ݅ ݑݑݑݑݑݑݑݑݑݑݑݑݑݑ ͹͹ ͹͹ ͹ ݓ െ  ݈ܽ݅ ݑݑݑݑݑݑݑݑݑݑݑݑݑݑ݈ܽ݅ ݄ݏ  ͹ ͹͹͹ ͹ݑݐ ݓሻ
From the above it can be said that the company, Lovewell Limited is able to recover
its money in 3.79 years which is economically feasible for it as almost takes half of the
venture life of the machine and furthermore features the higher income later on.
b. The Accounting Rate of Return (ARR)
ARR is the percentage of earnings in return that is anticipated from the proposal in
comparison to the initial cost of investment. It is the investment evaluation metrics which is
utilized for determining the viability associated with the investment (Jordà and et.al, 2019).
This is mainly used for comparing the numerous investment proposals as it provides expected
return from each project. It is better to make an investment in obtaining machinery as the
return on investment is much higher then cost of capital, thus, it is recommended to invest in
the proposal.
Compute the average investment
Average investment
£158,125͹͹͹͹݅݊ܫ݅݊ܫ݈ܽ݅  ͹ ͹ ͹͹͹͹݅݊ܫ݁ ݏ ݁ ݐ ݒݐ͹͉͉͉͉͉͉͉͉͉͉͉͉͉͉ ͹ ͹͹ ͹ ͹݈ܽ݅݁ݑ ݒ
ʹ
͹ ͹͉ʹ ͷ ǡͲͲͲ͹ ሺ ͹ ͹͉ʹ ͷ ǡͲͲͲכ Ψͳͷ ሻ
ʹ͹͉͵ ͳ ǡʹ ͷͲ
ʹ

Compute the accounting rate of return
(ARR)
Accounting rate of return
ARR 45.85%
ሺ  ݈ܽ݅ ݑݑݑݑݑݑݑݑݑݑݑݑݑݑ݈ܽ݅ ݄ݏ  ͹ ݓ െ  ݈ܽ݅ ݑݑݑݑݑݑݑݑݑݑݑݑݑݑ݈ܽ݅ ݄ݏ  ͹ ͹͹͹ ͹ݑݐ ݓሻ͹ ͹ ͹͹͹͹ ݁ ݈݁ܽ݅ ͹ ͹ ͹͹͹͹݅݊ܫ݁ ݏ ݁ ݐ ݒݐ
ሺ͉ ͺͷǡͲͲͲെ͉ ͳʹ ǡͷͲͲሻ͉
ͳͷͺ ǡͳʹ ͷ
͹ ͹͉ʹ ǡͲͲͲ͉
ͳͷͺǡͳʹ ͷ
It is suggested to put resources into procuring new machine in light of the fact that the
get back from it is a lot higher in contrast with cost of capital, accordingly, it is prescribed to
put resources into the proposition, thus, it is recommended to invest in the proposal.
c. The Net Present Value
It is the investment appraisal technique which represents the relation between the PV
of cash inflows and PV of cash outflow over the life of the asset (Bajura, 2019). It is used for
determining the profits associated with the projected investment. The positive NPV indicates
that investment can be made as projected earnings exceeds the anticipated cost.
Calculating NPV
Cost £2,75,000
Life 6 years
Cost of capital 12%
Net annual inflow Annual cash flow-Annual cash outflow
(£85000-£12500)
£72500
Net present value Present value of cash inflows- Present value of cash
outflows

Year Cash flow Amount
in £
Present value
factor @12%
Present
value
(PV) in £
0 Outflow (cost) -2,75,000 1 -2,75,000
1 Net annual cash inflows 72500 0.893 64732.14
2 Net annual cash inflows 72500 0.797 57796.56
3 Net annual cash inflows 72500 0.712 51604.07
4 Net annual cash inflows 72500 0.636 46075.06
5 Net annual cash inflows 72500 0.567 41138.45
6 Net annual cash inflows 72500 0.507 36730.76
6 Scrap value 41,250 0.507 20898.53
Net present
value £43,976
Since, the NPV is £43976 which indicates that the company can make an investment
in buying the asset because the earnings from it exceeds the cost and it is assumed that it will
be profitable. Thus, it is feasible enough to invest.
d. The Internal Rate of Return
This approach of capital budgeting is utilized in assessing the profits in association to
the respected investment (Crain and Law, 2018). IRR is basically a discounting rate which
makes NPV of the project equal to zero. It is important for businesses to look at IRR for
taking decisions in relation to the business expansion and growth prospects.
Computing the IRR using trial and error method
Year Cash flow Amount
in £
Present value
factor @15%
Present
value
(PV) in £
0 Outflow (cost) -2,75,000 1 -2,75,000
1 Net annual cash inflows 72500 0.87 63043.48
2 Net annual cash inflows 72500 0.756 54820.42
3 Net annual cash inflows 72500 0.658 47669.93
4 Net annual cash inflows 72500 0.572 41452.11
5 Net annual cash inflows 72500 0.497 36045.31
6 Net annual cash inflows 72500 0.432 31343.75
6 Scrap value 41,250 0.432 17833.51
NPV £17,209

Year Cash flow Amount
in £
PV factor
@18%
Present
value
(PV) in £
0 Outflow (cost) -2,75,000 1 -2,75,000
1 Net annual cash inflows 72500 0.847 61440.68
2 Net annual cash inflows 72500 0.718 52068.37
3 Net annual cash inflows 72500 0.609 44125.74
4 Net annual cash inflows 72500 0.516 37394.69
5 Net annual cash inflows 72500 0.437 31690.42
6 Net annual cash inflows 72500 0.37 26856.29
6 Scrap value 41,250 0.37 15280.3
NPV £-6,144
IRR
17.18%െͳͷ ͹ ͹ ͹ ௧͹ ͹ ͹ ͹ ͹ ͹௦௧ ͹ ͹͹ ͹௩௨͉ ଵହΨ͹ ͹ ௧͹ ͹ ͹ ͹ ͹ ͹௦௧ ͹ ͹͹ ͹௩௨͉ ଵହΨି ͹ ͹ ௧͹ ͹ ͹ ͹ ͹ ͹௦௧ ͹ ͹͹ ͹௩௨͉ ଵ଼ Ψ
*(18-15)െͳͷ ͹ ͹ ͹ ͹ ͹ଵଶଽ͹ ͹ ͹ ͹ଵଶଽି  ሺି ͹ ଵସସሻ
*3െͳͷ ͹ ͹ ͹ ͹ ͹ଵଶଽ
ଶଷଷହଷ
*3
From the above it can be said that it is beneficial for the company to purchase the new
machine which is based on the complete evaluation carried out above. The IRR is 17.18%
which is approximately 17% more than the expense of capital of 12% which isn't a lot higher
and will be unable to enhance the speculation. In any case, at that point as well, it is practical
to make a venture the new hardware.
2. Advantages and limitations of various types of investment appraisal techniques
The Payback Period
It alludes to the amount of time takes to create the cash as to from the speculation
made. It marks as the earn back the original investment point in the cash flow. It is
determined by dividing starting investment with income created. The significant preferred
position of this method is that it is the basic and easy to ascertain & provides data on the
threat in relation with the investment (Chandra, 2020). This is a good approach which is used
in measuring the liquidity. While on the other side, this technique ignores the time estimation
of cash (time factor) and besides it is continuously determined about the liquidness and not
profit. It also ignores the cash generating external to the PB time frame which might lead to

deluding of data. Other problem of it is that it favours smaller PBP without taking into
account the general existence or the useful life of the venture. It cannot draw any distinction
in between the projects having equal PBP. One more important fact is, it does not consider
residual amount pertaining to the asset after the conclusion of the plan.
The Accounting Rate of Return
It is an expected arrival on the speculation that is communicated in rate. The rate is
judged by dividing the yearly operating benefit by the average amount invested in the project.
More the ARR, it is well on the way to be beneficial. It is very simple to be used. It includes
only operating earnings which is utilized by lenders and speculators for judging the
presentation of the organization (Namanda, 2017). In any case, this method does not signify
time estimation of cash and spotlights on the working pay instead of cash flowing inward and
along with that it doesn't remain constant till the useful life of the project which brings it
looks alluring at once and unwanted at another. This strategy can't be used in contrasting the
undertakings along with the distinctive life of each (Tirumalsety and Gurtoo, 2019). The time
and the pattern of the cash flowing inward is completely ignored and doesn't speak of
weakness and cost increments. It likewise doesn't signify riches and execution. In regard to it
generally made useful in shorter undertakings. In this way, it is required to be used
cautiously.
The Net Present Value (NPV)
NPV strategy is the most often utilized investment evaluation approach or the
technique. It is essentially the assessment of future money inflow over the life of the
undertaking or hypothesis which is restricted to the current worth. It helps in assessing the
assessment of the enthusiasm as to pay and efficiency. NPV mirrors the time assessment of
money on record to all the livelihoods over the life of the speculation and also speaks to the
arranging and different patterns of the salary. It checks the absolute complete assets of the
firm which may result concerning the changes in relationship with the venture (Ghiyasi,
2018). Not in any way like IRR, NPV technique doesn't expect that the return will be further
reinvested. This methodology helps in seeing whether the specific undertaking will have the
decision to make enough compensation that will outflank the expense of the venture. The
positive outcome of the NPV of the venture can be attempted and the other one can't to be
incorporated. This technique is helpful if there should be an occurrence of choosing only one

proposal from the multiples, by approximating the benefit of every task and later selecting the
extremely valuable investment.
But this technique suffers from certain drawbacks. Calculating the net present value is
an intricate cycle and deciding the limiting rate is actually very important for ascertaining
present worth. Therefore, the COC is accounts for various factors which aids in guaranteeing
maximum fairness (Diao, Dutta and Zhu, 2020). It includes inflation and other risk factors.
Under the situation of mutually exclusive ventures, there are chances that NPV will give
deluding results. There is no defined guidelines for determining the NPV and is dependent
upon the willingness of the administrations which may cause inaccurate return. Shorter life
investment plans with the greater NPV might not be able to boost the EPS and the ROE and
probably will not be able to work in the favour or expectation of the entity’s stakeholders.
The Internal Rate of Return (IRR)
It is basically the rate, under which the net PV of the proposal becomes equal to the 0.
It is employed to gauge and look at the development pace of diverse undertakings and
venture plans and the method is the regular mode which is used to select which project
produce more noteworthy yields. IRR provides precise ROR to every solo project in
distinction with the expense of project. It provides a plan to the stakeholders which involves
the expected return in association with the undertaking. This technique besides mirrors the
time assessment of money and assistants in making a decision about definite return and
moreover it is hard to register and understand.
This system aids in expanding the benefit and stakeholder's prosperity. This strategy
likewise has some limitations. If the CF pattern is unconventional it might give multiple IRR
resulting into misleading figures. It rests on the possibility that cost of acquiring and loaning
is the same. It is completely established on assessment and prerequisites for experimentation
approach and disregards economies of scale (Van Wee and Priemus, 2017). It requires the
assessed cost of capital for making any decision. Extra requirement is that it acknowledges
that all the livelihoods can be placed into the market at the pace of IRR and on the off chance
that the typical movement of return in excessively removed from the IRR then the benefit is
not legitimate.

REFERENCES
Books and Journals
Affandy, C., 2019. STOCK VALUATION MENGGUNAKAN DIVIDEND DISCOUNTED
MODEL (DDM) DALAM PENGAMBILAN KEPUTUSAN INVESTASI PADA
BANK PEMBANGUNAN DAERAH YANG TERDAFTAR DI BURSA EFEK
INDONESIA. The Manager Review, 1(1).
Ağca, Ş. and Mozumdar, A., 2017. Investment–cash flow sensitivity: fact or fiction?. Journal
of Financial & Quantitative Analysis, 52.
Bajura, T., 2019. Modern methods of valuation of investments’ economic efficiency in the
agricultural business.
Bruner, R. F., 2017. Choosing Among Different Valuation Approaches. Darden Business
Publishing Cases.
Chandra, P., 2020. Fundamentals of Financial Management|. McGraw-Hill Education.
Cornell, B. and Gerger, R., 2019. Consistent Treatment of Inflation in Discounted Cash Flow
Valuation. Available at SSRN 3435615.
Diao, X., Dutta, S. and Zhu, P. C., 2020. Investing in Emerging Markets. Equity Markets,
Valuation, and Analysis.
Elnusa, T., 2020, February. Valuation analysis of skill based asset company: Acquisition by
PT. In Understanding Digital Industry: Proceedings of the Conference on Managing
Digital Industry, Technology and Entrepreneurship (CoMDITE 2019), July 10-11,
2019, Bandung, Indonesia(p. 54). Routledge.
Ghiyasi, M., 2018. Performance assessment and capital budgeting based on
performance. Benchmarking: An International Journal.
Gianakis, G. A., 2017. Strategic Planning and Capital Budgeting: A Primer. Handbook of
Debt Management. p.207.
Jitmaneeroj, B., 2018. A latent variable analysis of corporate social responsibility and firm
value. Managerial Finance.
Jordà, Ò. and et.al, 2019. The rate of return on everything, 1870–2015. The Quarterly
Journal of Economics. 134(3). pp.1225-1298.
Köseoğlu, S. D. and Almeany, S. S. A., 2020. Introduction to Business Valuation.
In Valuation Challenges and Solutions in Contemporary Businesses (pp. 1-23). IGI
Global.
LIHAWA, EA, 2016. PRICE-EARNINGS RATIO, DIVIDEND YIELD, AND MARKETTO-
BOOK RATIO TO PREDICT STOCK RETURN (Doctoral dissertation,
AIRLANGGA UNIVERSITY).
Namanda, M., 2017. Capital Budgeting, Net Present Value and other Business Decision
Making Tools. GRIN Verlag.
Tirumalsety, R. and Gurtoo, A., 2019. Financial sources, capital structure and performance of
social enterprises: empirical evidence from India. Journal of Sustainable Finance &
Investment. pp.1-20.
Trinh, T. H. and Thao, L. T. N., 2017. Corporate valuation modeling for strategic financial
decisions. Asian Economic and Financial Review. 7(12). p.1153.
Van Wee, B. and Priemus, H., 2017. Megaproject decision making and
management. Flyvbjerg, B.(eds.). The Oxford Handbook of Megaproject
Management. pp.118-136.

Crain, N. and Law, K., 2018. The bright side of fair value accounting: Evidence from private
company valuation. Available at SSRN 3040396.