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Conceptual Framework Of Valuation

Conceptual Framework of Valuation
Estimating the worth of an asset or a security or a business is termed as "valuation". Any investor would be interested in knowing the value of a business before purchasing a major portion of the assets or a security. The task of valuation involves not only the estimating the values of the existing plant and equipment, machinery, furniture & fittings etc., but also of intangible assets like patents, copyrights, good will etc. The process of valuation would also include any unrecorded contingent liabilities so that the purchaser is totally aware of the entire business assets and liabilities as on a particular date. The valuation process is thus influenced and affected by subjective considerations. The following concepts of valuation are generally used to help the finance manager arrive at a more accurate valuation, reducing the element of subjectivity to the maximum possible extent.

  • Book value - Book value is the accounting record value of assets that is shown in the balance sheet. It is usually the purchase cost of an asset less the accumulated depreciation on it. It may not reflect the sale value or the fair value of the asset. This valuation is based on the going concern principle of accounting. It is the total book value of all the assets that are valuable excluding the fictitious assets, minus the external liabilities. It is otherwise known as the net worth.

  • Market value - Market value is the value at which an asset or a security of a company can be sold in the market. Market value can be applied to tangible assets only because intangible assets cannot be sold generally. The total market value of all the outstanding equity shares as quoted in the stock market can be referred as the market value of a business. Market value can be ascertained for listed corporates only.

  • Intrinsic/Economic value - The present value of all the incremental future cash flows can be termed as the intrinsic value. The present value is arrived by discounting the incremental cash flows at an appropriate discount rate. The maximum price at which a business can be acquired is the economic value.

  • Liquidation value - This represents the price at which each individual asset can be sold in the event of liquidation of business. It is valued after subtracting all the external liabilities. The liquidation value would generally be the least.

  • Replacement value - It is the cost of purchasing or replacing a new asset which is of equal utility to the business. It is generally applied to tangible assets like equipment, plant etc.

  • Salvage value - Salvage value, also called as the scrap or residual value is the sale value of an old asset after its usage.

  • Valuation of goodwill - Valuation of goodwill is one of the toughest as goodwill is non-monetary. A business is said to have a real goodwill if it can earn a higher rate of return on an investment when compared with its competitor having the same risk. When the firm earns super profits, goodwill results. It can be valued as the present value of all the future expected super profits for ā€˜nā€™ number of years. It is very useful in merger and acquisition decisions.

  • Fair value - fair value is based on all of the valuations explained above. Particularly, it is the average of the market value, book value and the intrinsic value.

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