connectcode .net barcode sdk PART ONE Business Valuation in Software

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PART ONE Business Valuation
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A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 [1] Based on Abrams regression of the SBBI-2002 Yearbook 1938-2001 results
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TABLE
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Discount Rates According to Firm Value
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Mkt Cap 12/31/01 FMV 10,000,000,000 1,000,000,000 100,000,000 50,000,000 35,388,037 25,000,000 20,000,000 10,000,000 5,000,000 3,000,000 1,000,000 500,000 250,000 125,000 100,000 50,000 25,000
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Discount Rate [1] 137% 160% 182% 189% 192% 196% 198% 205% 212% 217% 228% 235% 241% 248% 250% 257% 264%
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ample, $10 billion firms averaged a 137 percent (B5) rate of return over the 64 years, while $1 billion firms experienced a 16 percent (B6) average return The difference between the two size groups is 23 percent That difference extends to smaller firms too When we go down in size by another factor of 10, ie, from $1 billion firms to $100 million firms, the discount rate increases another 23 percent, to 182 percent (B7)22 A $10 million firm had average returns of 182% 23% 205% (B12)
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It is actually 227 percent Using one decimal point is simpler; however, it causes an apparent, but not real rounding error
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CHAPTER 5 Discounting to Present Value
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Similarly, reducing firm size by one-half increased the average rate of return by 07 percent You can see this by looking at the $20 million firms, which had an average return of 198 percent (B11), while $10 million and $5 million firms had average returns of 205 (B12) and 212 percent (B13) Of the various firm sizes, $35,388,037 (A9) is the average size of the 10th decile, which is the smallest of the publicly traded firms The discount rates for all firm sizes below that (B10 through B21) are my extrapolations of the results from the publicly traded stocks Most privately held firms are smaller than $354 million in FMV Therefore, it was necessary to extrapolate the results to forecast discount rates for smaller firms, which accounts for rows 10 through 21 in the table23
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Circularity of the Calculation
While publicly held firms have an objective stock price, which is the FMV in Table 54, privately held firms do not Therefore, it s possible to choose a discount rate that is inconsistent with the value of your firm, and it is imperative to ascertain that the assumed discount rate used in the Discounted Cash Flow Method is consistent with the value calculated If not, you must update the discount rate in order to force consistency in the assumption and the result This is necessary because we must first estimate a value of the firm in order to calculate a discount rate, which we use to calculate the value of the firm! This is circular reasoning and is only valid if the assumption is consistent with the result, as mentioned above Table 54 provides guidance, so your initial guess is likely to be close to the correct discount rate, and the iterations are done semiautomatically with our valuation software, with clear instructions on how to ensure the consistency of the discount rate
All extrapolations are never as empirically sound as interpolations However, the results are intuitively appealing
PART ONE Business Valuation
Adjustments to the Discount Rate
The discount rates in Table 54 represent the average rate of return for the average publicly held firm in each size (value) category However, not all firms are average If your firm is likely to differ in any material way from the average publicly held firm in your size category, you should make adjustments to the discount rate Note the following common situations that imply making adjustments to the discount rate: Very high or very low financial leverage The use of debt as part of the financing of a business is called financial leverage The two most common quantitative measures of financial leverage are Debt-to-Total Assets ratio, which is interest-bearing debt divided by total assets, and the Debt-to-Equity ratio, which is interest-bearing debt divided by the book value of equity Most publicly held firms have a middling level of leverage, which often varies by industry If your firm has an unusually high or low level of debt, it is appropriate to increase or decrease the discount rate to reflect that Most commonly, I add or subtract 1 to 2 percent for unusual leverage, although I might make a larger adjustment for extremes, eg, for a firm that is 90 percent or more debt financed However, if your firm has very high leverage, you will likely need to use Invested Capital Method to value the firm, which is much more complicated and beyond the scope of this book Depth of management, One of the obvious changes that occur in comparing very large firms to medium and small firms is that the quantity and quality of management tends to decline with the reduction in firm size Billion dollar firms have hordes of MBAs from the best business schools, while small firms are often managed by a founder with no specific education in business management Nevertheless, you should have a sense for how strong the management is in your firm compared to other firms of your size If a preliminary DCF shows a valuation of $1 million, you should compare your firm to
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