Valuation of Companies with a specific reference to Acquisition Valuation

The purpose of this dissertation is to examine the various valuation approaches and techniques used in valuing companies and identify what determines a company's value. The dissertation looks at two approaches of valuing companies viz. discounted cash flow valuation approach and the relative valuation approach. In the discounted cash flow valuation approach, we look at two cash flows measures viz. cash flows to equity and cash flows to the firm. In the cash flows to equity, we look at dividends and free cash flows to equity as a basis of valuation. The cash flows to the firm model looks at free cash flows to the firm, which unlike free cash flows to equity are before paying for a firm's financing needs. We discuss, analyse and appraise the various valuation models that are structured around these cash flow measures. By examining in detail all the steps involved in making projections of these cash flow measures for the purpose of valuation, we identify the factors that determine a company's value: the cash flow generating potential of the firm, growth in cash flows and riskiness associated with such cash flows. We use the case study of Compaq's merger with HP in 2002 as an example to demonstrate the computation of the various inputs that are utilised in determining value. We also discuss the relative valuation approach to valuation and discuss a few multiples that are used to value firms relative to the valuation of a set of comparable firms. We look beneath the hood and examine how these multiples are linked to a firm's fundamentals. This dissertation also looks at the specific issues involved with Acquisition Valuation. We apply all the valuation techniques examined by us to the case study of Compaq's merger with HP by valuing Compaq, as if it was not acquired and also value the combined firm (with and without the merger gains that accrue to the combined firm as a result of the merger). We highlight in our conclusions the subjectivity inherent in the valuation process and how valuation becomes a function of the assumptions we make about a company's growth, risk and cash flow generating potential