connectcode .net barcode sdk PART ONE Business Valuation in Software

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PART ONE Business Valuation
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Congratulations! You have just performed your first business valuation! You could have stopped after the fourth step, so you could have done this in one or two minutes once you have a forecast of economic net income and the Payout Ratio
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Shortcut Midyear Gordon Model Formula
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As you have seen in Table 61, most small businesses should require rates of return of 23 to 26 percent The square root of one plus those two numbers are 111 and 112, respectively For mathematical ease, we can approximate the midyear correction for small business as being about 10 percent We can then use Equation 64 as a quick-and-dirty Gordon Model formula approximation: FMV 11 1 r g CFt
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(64)
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In other words, this approximation formula for midyear cash flows is 10 percent larger than the End-of-Year GMM The approximation works over a wide range of firms, with fairly little error While we do not use Equation 64 in this chapter, we will make use of it later in the book
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VALUATION WHEN A FIRM IS NOT MATURE
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The foregoing valuation is fine for an already mature firm If it will take, let s say, five years to reach maturity, first you will need to discount the first five years of cash flows to present value, as you learned in 5 Then you will forecast Year Six economic cash flow, determine the appropriate GMM given your forecast of constant growth in cash flows and your best initial estimate of the value of the firm and multiply your tentative GMM times Year Six economic cash flow The result of that multiplication is the present value of the Years Six to infinity cash flows as of the end of Year Five Then you will discount that back five years to present value as of time zero (now), and add the present value of Years One through Five cash flows This becomes a tentative FMV of your company You will need to go through the iteration process to make sure that the
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TABLE
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Gordon Model Multiples
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Section 1 [1] 2% 73 64 57 55 53 53 51 50 49 47 45 44 43 43 42 41 43 44 45 47 45 44 45 47 46 48 50 49 49 47 46 47 49 52 49 51 53 51 53 56 59 56 54 53 51 51 49 48 52 55 57 61 54 56 59 63 55 58 61 65 69 67 64 62 59 57 55 54 53 52 50 56 59 62 66 70 58 61 64 69 73 60 63 67 71 76 82 78 75 74 71 68 66 62 60 58 56 56 54 53 68 72 77 83 90 98 78 84 91 100 110 123 1% 0% 1% 2% 3% 4% 5% 6% 139 108 89 84 80 79 76 73 70 66 64 61 59 59 57 55
Section 2: GMMs (Midyear) Constant Growth Rate g 7% 160 120 97 92 87 85 81 78 75 70 68 65 63 62 60 58 8% 188 135 106 100 94 93 88 84 81 75 72 69 66 66 63 61
Mkt Cap
Return
$10,000,000,000
137%
1,000,000,000
160%
100,000,000
182%
50,000,000
189%
25,000,000
196%
20,000,000
198%
10,000,000
205%
5,000,000
212%
3,000,000
217%
1,000,000
228%
500,000
235%
250,000
241%
125,000
248%
100,000
250%
50,000
257%
25,000
264%
[1] Section 1 is the same as Table 54
PART ONE Business Valuation
value assumed and the value calculated are consistent Don t worry too much about the iterations, because the valuation spreadsheet that you can download from my Web site automates this process for you We will present and explain this software in 7 For example, suppose your firm plans to retain all net income for the first five years of operations The first year in which you forecast dividends (whether explicit dividends or implicit dividends in the form of excess compensation) is in Year Six, for $1 million After that you expect 6 percent growth in cash flows forever The valuation steps are as follows: 1 Assume a FMV of $1 million The GMM is 66 (Table 6-1, L16) 2 Multiply $1 million 66 $66 million That is the tentative FMV as of the end of Year Five for the forecast cash flows from Years Six to infinity 3 Discount five years back to present value today Note, here we do not use a midyear present value factor We discount exactly five years The present value factor at a discount rate of 228 percent (B16) is 036, ie, (1/12285) 036 We multiply $66 million 036 $24 million (rounded) 4 The calculated value is closer to an FMV of $3 million than it is to the $1 million, so we need to do one more iteration The GMM for $3 million is 70 (L15)6 Then, $1 million 70 $70 million Multiplying this by the present value factor of 036, the second iteration valuation is $25 million (rounded), which is consistent with the FMV that we assumed and the 70 GMM Thus, we can stop with a valuation of $25 million
If you want to be sophisticated, you could choose a GMM of 69 This would be reasonable, since the GMM for a $24 million firm should be between the 66 GMM for $1 million firms and the 70 for $3 million firms, and closer to the GMM of 70 of the $3 million firms
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