? How to Value a Company in 3 Easy Steps – Valuing a Business Valuation Methods Capital Budgeting

? How to Value a Company in 3 Easy Steps – Valuing a Business Valuation Methods Capital Budgeting


How to Value a Company in 3 Easy Steps, How
to Value a Business – Valuing a Business Valuation Methods Capital
Budgeting Welcome back to our second part of Capital
Budgeting, which is Valuing a Business. Brought to you by MBABULLSHIT.COM. Before this video,
you should first understand present value, net present value, basic capital budgeting,
and the weighted average cost of capital, or the WACC. If you don’t understand these
concepts yet, I recommend that you watch my other free videos on these topics above. Let’s
get down to it! When we say valuing a business, we’re actually
trying to answer the question “How much is the business worth?” If you remember,
here is a store, an existing business. Maybe you want to buy this store from its owner.
Before you buy from him, you have to find out how much is the business worth? Here is
where financial managers and accountants have different philosophies. For most accountants,
the way they would value a business is they look at the price of the assets – shelves,
building, uniform – and then they look at the price of the liabilities or the debt (maybe
they owe money to the bank) and then they come out with something called “owner’s
equity” and that’s how they value the business. The amount of owner’s equity is
how much the business is worth. However, for financial managers, we don’t
care about the asset value or the owner’s equity. We don’t care if this shelf costs
$1M or if the business building is worth a lot, usually. What we do care about is the
present value of the free cash flows. This is another way of saying how much the store
actually earns. If the store, for example, has $10,000 worth of shelf and equipment,
but it only earns $5 a year then the store is not worth much. Even if the assets are
worth a lot, the fact that it earns such a small amount means that it’s a bad business
and that it’s worth little. Most financial managers put a heavier importance on the earnings
of the business instead of the assets of the business. One way of representing these earnings
is by looking at the free cash flow. The way we value a business is we look at
the present value of the free cash flow plus the present value of its horizon value. Don’t
worry if you don’t understand these terms yet. You will see in a while.
How to compute the “free cash flow” will be discussed in another video. For this video,
I will just give you the amount or the figure of this business’ free cash flow so you
can understand the concept quickly. For example, this store has free cash flow
earnings of: Year 1: $10,000
Year 2: $12,000 Year 3: $11,000
Year 4: $13,000 This is given. In more advanced problems,
you would have to compute this yourself, but I will discuss that in another video. Let’s
assume that these are the free cash flows of the store. And then I give you the following
information: Horizon year is Year 3, which means this (referring
to Year 3: $11,000). You might be wondering what the heck is a horizon year? Horizon means
you look into the future. However, most people make the mistake of thinking that the horizon
year is the last year of information that you are given in the problem. Do not do that.
Year 4 is not the horizon year. Usually, your professor will say that the horizon year is
1 year before the last year. Remember to always read the problem carefully and look at what
the professor says is the horizon year. In our case, it’s Year 3. If you’re wondering
why we need to know the horizon year, you’ll know in a short time later. I’ll show you
why it is important. And we know that the weighted average cost
of capital is 10%. In more advanced problems, you would have to compute the WACC by yourself.
If you don’t know how to compute this, you can watch the other video about WACC. The
other piece of information that is given is the estimated free cash flow long term average growth of 5% per year.
For Year 4, Year 5, Year 6, Year 7, the free cash flow will grow 5% year. It doesn’t
mean that it will grow exactly 5% per year. It just means that, on the average, it will
grow 5% per year. How do we compute or value the business? We
need to look at 2 formulas. Remember, I said we have to look at the present value of the
free cash flows. To do that, we use this formula: Don’t panic. I know it looks scary and complicated,
but I will show you how easy it is.

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