Analyzing Financial Evaluation Methods in Business Valuation

The assignment examines essential financial evaluation techniques such as the DuPont model and the capitalization of earnings method. The focus is on calculating Return on Equity (ROE) using the DuPont formula and assessing a company's value through capitalizing future earnings adjusted by growth rates. It aims to provide insights into these methodologies' practical applications, advantages, and potential drawbacks in business valuation.

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Project Head: Finance

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Que 1)
List which companies could use to Defense against takeovers and their
strength and weakness:
Sometimes, public companies takeover the private companies without their consent. It
is required for the comapny to take some steps to save itself from such issues. There is 2
times in which company could stop itself to takeover. First of before an offer and another is
after an offer.
Before an offer:
Financial condition:
The financial condition of a comapny must be in such a manner that comapny do not
require the help of other comapny. The strength of this is better position of the comapny and
the weakness of this is that the market is tough to manage the financial condition (Van der
Stede, 2001).
Market position:
Comapny must work over its market position to safe itself from the takeover. This
would help the company to position itself in a better manner and the weakness of this is
heavy competition in the market.
Directors:
The directors of the comapny must set strategies and positioning policies in such a
manner that the comapny is not required the help from others. This would help the company
to position itself in a better manner and the weakness of this is less professionalism.
After an offer:
Poison pill:
This defence system is related to shareholder’s right plans. In this, target companies
dilute its stock in such a manner that the bidder of the takeover could not obtain the
controlling stock without the massive expenses (Nobes and Parker, 2008).
This policy helps the company to position itself in a better manner and the weakness of
this is less professionalism.

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Why to stop takeover:
Takeovers are the process in which a public comapny buys the shares of the private
comapny and merge the comapny with its main business. The takeover is mainly stopped by
the private companies to retain their existence and assure that they could run their business
without the help of other companies.
Beneficiary of a takeover:
The main beneficiary of the takeovers is the shareholders of the company and the
clients associated with the companies (Radebaugh, Gray and Black, 2006).
Que 2)
Sunk Cost:
Sunk cost is the cost which has been incurred in the business and could not be
recovered now. Sunk cost is different from the future cost which a comapny could face like
inventory purchase decision. Sunk cost must not be considered while making a decision as
thus cost cannot changes the result of the decision.
Switching cost:
Switching cost is the cost which takes place due to changes in the brands, products or
suppliers of a product by the customers. Although, these costs are psychological, monetary,
time based and effort based cost. A switching cost could manifest from significant changes
and the time.
Strength and weakness:
a. Direct inspection of financial statements:
Direct inspection of final financial statement offers a great idea about the position and
the performance of the comapny, through investigating these reports, it become easy
for the stakeholders to make a better decision about the investment into the comapny.
Though, this process is time consuming and every stakeholder cannot understand the
concept of financial statements (Needles, Powers and Crosson, 2013).
b. Financial ratios:

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Financial ratios of a comapny offers a great idea about the liquidity, profitability
stability, capital structure etc of the comapny, through investigating these ratios, it
become easy for the stakeholders to make a better decision about the investment into
the comapny. Though, this process is less time consuming. And sometimes the
outcome of these ratios is manipulated (Horgren, 2009).
c. Earnings per share and price to earnings:
Price to earnings and earnings per shares offers a great idea about debt payment
positioning and the profitability positioning of the comapny, through investigating
these values, it become easy for the stakeholders to make a better decision about the
investment into the comapny. Though, this process is less time consuming but the
values could be changes and debenture policy of the comapny also affects the values
(Bierman, 2010).
d. Total return to investors:
Total return to investors offers a great idea about payment positioning of the
comapny, through investigating these values, it become easy for the stakeholders to
analyze the return of the comapny. Though, this process is less time consuming but
the values could be changes and debenture policy of the comapny also affects the
values.
Que 3)
DuPont formula:
DuPont analysis is a study which is used by the analyst and the investors to analyze
the position of the company in terms of the dividend payment. The formula of DuPont
analysis is as follows:
Mainly the DuPont is calculated in 3 steps which are as follows:
ROE = (net profit margin) *(asset turnover) * (Equity multiplier)
Net profit margin = net income / net sales
Total asset turnover = Net sales /Average total assets
Financial leverage = Total assets / total equity (Bierman, 2010)

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Components:
Mainly, there are 3 main components of the DuPont analysis which is used to
calculate the ROE of the comapny which are as follows:
Profit margin
Financial leverage
Total asset turnover
All the above 3 components depict about the value of the ROE of the comapny; It is
required for the investors to analyze the ROE value before making an investment into the
comapny.
Comparison of ROA and ROE:
Return on assets and return on equity both are the important element of an
organization which is calculated to analyze the performance, efficiency and affectivity of a
comapny. This depicts that how the management team of the comapny manages the capital of
the shareholders. (Brown, Beekes and Verhoeven, 2011)
According to the DuPont analysis, the formula for the dividing the ROE into core
components explains the relationship among management efficiency and effectiveness of the
business.
ROE = (net income) / (total assets) * (total assets)/ (shareholder’s equity) (Kruth, 2013)
Thus according to the above analysis, it could be concluded that ROE and ROA are
quite different from each other and both the values are required by the managers of the
company to amke a better decision.
Que 4)
Weighted average cost of capital:
WACC is the weighted average cost of capital which is used to calculate the average
rate of return expects to recompense all the dissimilar investors. Weights are mainly the
fraction of every financing source in the target capital structure of the comapny.
WACC = ((E/V) * Re) + [((D/V) * Rd)*(1-T)]
E = Market value of the company's equity

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D = Market value of the company's debt
V = Total Market Value of the company (E + D)
Re = Cost of Equity
Rd = Cost of Debt
T= Tax Rate (Krantz, 2016)
A comapny is basically financed through the equity and debts. Because a comapny
might raise the funds through other sources as well but the main sources to enhancing the
funds are the debt and equity. It becomes essential for a comapny to analyze that how much
cost would company have to face in case of debt and equity funds (Garrison et al, 2010).
This analysis helps the comapny to reduce the level of the cost of the comapny and on
the basis of the WACC, comapny analyze that what would be the optimal capital structure of
the company. Further, it is analyzed that hoe expensive would it be for a comapny to enhance
the funds through buying the inventory, equipment and the building.
Component of WACC:
The main components of the WACC are the debt and equity and the tax rate, interest
rate of the debt, cost of debt and the cost of equity etc. all of these factors and elements of the
WACC helps the analyst to analyze the better result. The main components of the comapny
are:
E = Market value of the company's equity
D = Market value of the company's debt
V = Total Market Value of the company (E + D)
Re = Cost of Equity
Rd = Cost of Debt
T= Tax Rate (Deegan, 2013)
The above values are calculated on the basis of the market values of the debt, equity,
tax rate and the interest rate and growth rate of the security are also considered.
Que 5)
CAPM:

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CAPM is capital asset pricing model. This model is used by the financial analyst,
finance managers to analyze the cost of equity of the comapny. CAPM is a model which is
used to determine the required rate of return to make a better decision about the assets adding
into the well diversified portfolios. The formula of CAAPM is as follows:
E (Ri) = R (f) + Beta ( E (Rm) – (Rf)
This formula helps the comapny to analyze the expected return of the capital assets of
the comapny.
Components of CAPM:
The main components of the CAPM methods are as follows:
E (ri) = Expected return on capital assets
R f = Risk free rate
Bi = Beta
E (rm) – (rf) = market premium return
E (ri) – Rf = Risk premium (Brewer, Garrison and Noreen, 2005)
All of these components are helpful for the comapny to make a better decision about
the capital structure of the comapny and analyze that how would be the performance of the
comapny in term of the total cost of the comapny and the total return of the comapny. The
above given comports could be calculated through analyzing the financial statements of the
comapny and the industry’s performance in the company. The risk free rate is always same at
a particular time for all the companies (Lafond and Roychowdhury, 2008).
Earning capitalization method:
Capitalization of the earnings of a comapny is a tool to determine the organization’s value
and the net present value of all the expected future cash outflows of the company and cash
inflows of the comapny, the earning capitalization method is determined through considering
the future earnings and the capitalization rate of the comapny. It is an approach of income
valuation which determines about the business value and the current cash flows, annual rate
of return and expected value of the business.
Value = earnings in the future years / dividend – growth (Horgren, 2009)

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Components and their strength and weakness:
The main components of the earnings capitalization methods are the earnings of the
comapny, total dividend offered by the comapny to its shareholders, growth rate of the
comapny etc. these components are required to calculate the cost of equity of a comapny.
The main strength of these methods is their time and cost flexibility and the main
weakness is the manipulation of the results.

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References:
Bierman, H., (2010). An introduction to accounting and managerial finance: a merger of
equals. World Scientific.
Brewer, P.C., Garrison, R.H. and Noreen, E.W., (2005). Introduction to managerial
accounting. McGraw-Hill Irwin.
Brown, P., Beekes, W. and Verhoeven, P., (2011). Corporate governance, accountin
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Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., (2010). Managerial
accounting. Issues in Accounting Education, (25(4), pp.79(2-793.
Horngren, C.T., (2009). Cost accounting: A managerial emphasis, 13/e. Pearson Education
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Krantz, M. (2016). Fundamental Analysis for Dummies. John Wiley & Sons.
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Lafond, R. and Roychowdhury, S., (2008). Managerial ownership and accounting
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Madura, J. (2014). Financial Markets and Institutions. Cengage Learning.
Needles, B., Powers, M. and Crosson, S., (2013). Financial and managerial accounting.
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Nobes, C. and Parker, R.H., (2008). Comparative international accounting. Pearson
Education.
Radebaugh, L.H., Gray, S.J. and Black, E.L., (2006). International accounting and
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