Valuation

Kunal Jana 1011214094 2012-14 Shanti Business School

A Project Proposal Submitted to Shanti Business School as part of Grand Project to be undertaken in this Institute

25th July, 2013

Under guidance of: PROF. RAVIRAJ GOHIL Designation: ASSISTANT PROFESSOR

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Index

Sr No 1 2 3 4 5 6 7

Particulars Valuation-Introduction Automobile Sector- Introduction Research Objective Literature Review Research Methodology Limitations Bibliography

Pg No 3-5 6-13 14 15-16 17 17 18

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Introduction
VALUATION OF FIRMS Whenever people talk about equity investments, one must have come across the word "Valuation". In financial parlance, Valuation means how much a company is worth of. Talking about equity investments, one should have an understanding of valuation. Valuation means the intrinsic worth of the company. There are various methods through which one can measure the intrinsic worth of a company. This section is aimed at providing a basic understanding of these methods of valuation. According to Investopedia, Business Valuation is, The process of determining the economic value of a business or company. Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership and divorce proceedings. Often times, owners will turn to professional business valuators for an objective estimate of the business value. Valuation is very important for everyone, be it the businessman himself, the creditors or the shareholders. The main objective of a business should be to increase the value of its company so that the value disbursed to the shareholders also increase, and thus companies need valuation. The Creditors are the one who provide the companies and businesses with debt and its very important for them to know whether they will be able to get the interests and the principal amounts, and valuation of a company helps them to determine whether they should lend or not. Valuation holds great importance for the shareholders, a company can show a good performance in the market by a number of ways, but valuation protects the shareholders from getting fooled by the short term performance by showing them the larger picture, because through valuation not only we evaluate the past and present , we also forecast the future, and thus after properly valuing a company, and getting answers of a few questions such as: whether it will have stable cash flow, what is the return that can be expected out of it etc, a shareholder should think of investing in a company.

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Intrinsic Valuation

Cash flow methods Residual Income method Dividend Discount Model

Relative Valuation

Based on multiples like EBITDA, P/B ratio, etc.

Net Asset Valuation: NAV or Book value is one of the most commonly used methods of valuation. As the name suggests, it is the net value of all the assets of the company. If you divide it by the number of outstanding shares, you get the NAV per share. One way to calculate NAV is to divide the net worth of the company by the total number of outstanding shares. Say, a companys share capital is Rs. 100 crores (10 crores shares of Rs. 10 each) and its reserves and surplus is another Rs. 100 crores. Net worth of the company would be Rs. 200 crores (equity and reserves) and NAV would be Rs. 20 per share (Rs. 200 crores divided by 10 crores outstanding shares). NAV can also be calculated by adding all the assets and subtracting all the outside liabilities from them. This will again boil down to net worth only. One can use any of the two methods to find out NAV. One can compare the NAV with the going market price while taking investment decisions. Discounted Cash Flow: DCF is the most widely used technique to value a company. It takes into consideration the cash flows arising to the company and also the time value of money. Thats why, it is so popular. What actually happens in this is, the cash flows are calculated for a particular period of time (the time period is fixed taking into consideration various factors). These cash flows are discounted to the present at the cost of capital of the company. These discounted cash flows are then divided by the total number of outstanding shares to get the intrinsic worth per share.

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There are two types of Cash Flow: Free Cash Flow to the Firm: FCFF is a metric used to determine a firm's financial health and profitability by measuring how much cash is available for all claim holders in the firm (debt holders and share holders) after all taxes and needs for reinvestment have been met. FCFF- {Net Income + Non Cash Charges + Interest (1-t) + Preference Dividend}-{Capital Expenditure + Working Capital Expenditure} Positive FCFF implies that there is sufficient cash to either service debt (through interest payments or principal repayments) and / or service the equity holders (through dividends or share repurchases). On the other hand, negative FCFF means that the firm has not generated sufficient revenue to cover its costs and will have to raise more cash, either through issuing more debt or selling more equity. According to Investopedia, FCFF is, This is a measurement of a company's profitability after all expenses and reinvestments. It's one of the many benchmarks used to compare and analyze financial health. A positive value would indicate that the firm has cash left after expenses. A negative value, on the other hand, would indicate that the firm has not generated enough revenue to cover its costs and investment activities. In that instance, an investor should dig deeper to assess why this is happening - it could be a sign that the company may have some deeper problems. Free Cash Flow to the Equity: FCFE is a measure used to determine how much cash is available to pay to a company's equity shareholders after accounting for all expenses, reinvestment, and debt repayment. FCFE is commonly used to gauge the health of companies. Positive FCFE indicates what can be paid out to equity holders (as a dividend or repurchased stock) without harming the firm's operations or growth opportunities while negative FCFE, it implies that the firm must issue new equity to raise cash. FCFE: FCFF Interest (1-t) - Preference Dividend + Net Borrowings According to Investopedia, FCFE is, This is a measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment. FCFE is often used by analysts in an attempt to determine the value of a company. This alternative method of valuation gained popularity as the dividend discount model's usefulness became increasingly questionable.

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Automobile Sector in India

The Automobile industry in India is one of the larger markets in the world and has been one of the fastest growing globally. India's passenger car and commercial vehicle manufacturing industry is the sixth largest in the world, with an annual production of more than 3.9 million units in 2011. According to recent reports, India overtook Brazil and became the sixth largest passenger vehicle producer in the world (beating such old and new auto makers as Belgium, United Kingdom, Italy, Canada, Mexico, Russia, Spain, France, and Brazil), grew 16 to 18 per cent to sell around three million units in the course of 2011-12. In 2009, India emerged as Asia's fourth largest exporter of passenger cars, behind Japan, South Korea, and Thailand. In 2010, India beat Thailand to become Asia's third largest exporter of passenger cars. As of 2010, India is home to 40 million passenger vehicles. More than 3.7 million automotive vehicles were produced in India in 2010 (an increase of 33.9%), making the country the second (after China) fastest growing automobile market in the world in that year. According to the Society of Indian Automobile Manufacturers, annual vehicle sales are projected to increase to 4 million by 2015, no longer 5 million as previously projected. The Automobile Sector is divided into 4 segments two wheelers (mopeds, scooters, motorcycles, electric two-wheelers), passenger vehicles (passenger cars, utility vehicles, multipurpose vehicles), commercial vehicles (light and medium-heavy vehicles), and three wheelers (passenger carriers and good carriers). The world standings for the Indian automobile sector, as per the Confederation of Indian Industry, are as follows:

Largest three-wheeler market Second largest two-wheeler market Tenth largest passenger car market Fourth largest tractor market Fifth largest commercial vehicle market Fifth largest bus and truck segment

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Key Statistics The production of passenger vehicles in India was recorded at 3.23 million in 2012-13 and is expected to grow at a compound annual growth rate (CAGR) of 13 per cent during 2012-2021, as per data published by Automotive Component Manufacturers Association of India (ACMA). Passenger car sales stood at 1.89 million units in 2012-13. Additionally, share of luxury cars to the total passenger car market of India is expected to increase to four per cent by 2020. The total number of passenger cars in India is likely to touch around 8 million units by 2020, as per Mr. Boris Fitz, Director, Sales and Network Development, Mercedes-Benz India. The industry produced 1.74 million vehicles in May 2013. The export of passenger vehicles and three- wheelers grew by 7.34 percent and 26.53 percent respectively during the April-May 2013, as per data released by Society of Indian Automobile Manufacturers (SIAM). Furthermore, the amount of cumulative FDI inflow into the Indian automobile industry during April 2000 to April 2013 was worth US$ 8.32 million, amounting to 4 per cent of the total FDI inflows (in terms of US$), as per data published by Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce. The auto sector reported a robust growth rate of 26 percent in the last two years (2010-2012). The BSE AUTO Index outperformed the benchmark Nifty by 79%, 12% and 19% in FY10, FY11 and FY12, respectively. Society of Indian Automobile Manufacturers (SIAM) has estimated that in FY2014, Passenger Vehicles will grow by around 5-7%, Commercial Vehicles will grow by around 11-13% and 3 wheelers will grow by around 6-8% and the overall industry will increase by around 7-8%.

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Major Developments & Investments

Nissan Motor India Pvt Ltd is expecting to sell over 60 per cent more units this year on the back of the launch of its upgraded small car - Nissan Micra Daimler India Commercial Vehicles (DICV) exported its first lot of 64 Fuso trucks manufactured at its Oragadam plant in Chennai Mahindra USA, a subsidiary of Mahindra and Mahindra (M&M), will set up an assembly and distribution centre, expanding one of the four tractor facilities in North America, by January 2014 The Japan-based automobile manufacturer Isuzu Motors' local subsidiary Isuzu Motors India has entered into an agreement with Hindustan Motors (HM) for contract manufacturing of Isuzu SUVs and pickup trucks A year after introducing the popular 'MINI' range of cars in India, luxury car maker BMW has started local production of 'MINI Countryman' at its facility in Chennai New Holland Fiat India plans to invest Rs 1,100 crore (US$ 184.56 million) to set up a new Greenfield plant in Maharashtra and also to increase its tractor manufacturing capacity by 50 per cent in the next three years Hero MotoCorp has bought a 49.2 per cent stake in its US-based technology partner Erik Buell Racing (EBR) for US$ 25 million. This is Hero MotoCorp's first-ever equity purchase in an overseas company. Also, Hero MotoCorp has entered into the African continent with launch of its brand and products in Kenya, where it has also set up an assembly unit. The company has also partnered with Ryce East Africa to sell its two-wheelers in the country Daimler is developing its Indian commercial vehicle operations as an export hub. Daimler India Commercial Vehicles (DICV) will export locally assembled trucks from the conglomerate's Mitsubishi Fuso range in 15 markets in Asia and Africa

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Exports During April 2011-March 2012, the industry exported 2.91 million automobiles registering a growth of 25.44%. Passenger Vehicles, Commercial Vehicles, Three Wheelers & Two Wheelers segments recorded growth of 14.18%, 25.15%, 34.41% and 27.13% respectively during April 2011-March 2012. Also the overall automobile exports registered a growth of 17.81% and for the 1st time car exports crossed the half a million mark in a financial year. India has emerged as a leading center for the manufacture of small cars. Hyundai, the biggest exporter from the country, now ships more than 250,000 cars annually from India. Apart from Maruti Exports' shipments to Suzuki's other markets, Maruti Suzuki also manufactures small cars for Nissan, which sells them in Europe. Nissan will also export small cars from its new Indian assembly line. Tata Motors exports its passenger vehicles to Asian and African markets, and is in preparation to launch electric vehicles in Europe in 2010. The firm is also planning to launch an electric version of its low-cost car the Tata Nano in Europe and in the U.S. Mahindra & Mahindra is preparing to introduce its pickup trucks and small SUV models in the U.S. market. Bajaj Auto is designing a low-cost car for Renault Nissan Automotive India, which will market the product worldwide. Renault Nissan may also join domestic commercial vehicle manufacturer Ashok Leyland in another small car project.[83] While the possibilities are impressive, there are challenges that could thwart future growth of the Indian automobile industry. Since the demand for automobiles in recent years is directly linked to overall economic expansion and rising personal incomes, industry growth will slow if the economy weakens.

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Factors that will drive growth in the sector

Rising incomes among Indian population will lead to increased affordability, increasing domestic demand for vehicles, especially in the small car segment. Fuel economy and demand for greater fuel efficiency is a major factor that affects consumer purchase decision that will bring leading companies across two-wheeler and four-wheeler segment to focus on delivering performance-oriented products. Product innovation and market segmentation will channelize growth. Vehicles based on alternative fuels will be an area of interest for both consumers and auto makers. Focus on establishing India as auto-manufacturing hub is reigning in policy support in form of Governments technology modernization fund. Industry will seek to augment sales by tapping into rural markets, youth, women and luxury segments.

Upcoming trends India is emerging as a strong automotive R&D hub with foreign players like Hyundai, Suzuki, and General Motors setting up base in India. This move is further enhanced by Governments support towards setting up centers for development and innovation. Tata Nanos successful entry in the Indian market has steamed up the opportunities of growth available in alternative segments like electric cars, vehicles run on natural gas, etc.

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SWOT analysis of Indian automobile industry:Strengths: Large domestic market Sustainable labour cost Competitive auto component vendor base Government incentives to manufacturing plants Strong engineering skills in design etc. Easy access to raw material Upcoming bases for R&D Low cost with good technology base Ability to cater to low volumes Proficiency in understanding of all technical drawings and well conversant with all global automotive standards: Japanese, Korean, and European etc. Appropriate automation leading to economic production costs Growing IT capability in design, development and simulation. Adoption of high quality and productive initiatives (TQM, TPM, Six sigma etc.) Proximity to market.

Weaknesses: Low labour productivity High interests and high over heads make the production uncompetitive. Various forms of taxes push up the cost of production and price of produced. Inadequate and low investment in R&D Supply chain infrastructural bottlenecks Multiple tax components in the cost of the vehicle Lack of economies of scale

Opportunities: Commercial vehicle: SC ban on overloading Heavy thrust on mining and construction activity
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Increase in income level Cut in excise duties Rising demand in rural areas MNC focussing on low cost outsourcing opportunities. Viewed as global hub for manufacturing of small cars Export projected to grow at over 30% p.a. Indias share in global auto components is expected to grow over 2.5% by 2015. National Automotive Testing and R&D Infrastructure Projects (NATRIP), a US$ 400 million initiative, aims to create the state-of-art dedicated testing, validation and R&D infrastructure across the country. Opportunity to R&D centres in India. High level of sourcing of components from Low Cost Countries (LCC) to act as a growth driver.

Threats Rising input costs of raw materials Rising interest rates Cut throat competition Increase in fuel prices may lead to slow down in the sales Import of components from ASEAN and China will have adverse effect on GDP.

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Future prospects of Indian automobile industry: Future prospect of Indian Automobile Sector is looking bright. As per industry forecasts, by 2016 India is expected to be the worlds seventh-largest automobile market and third-largest by 2030, behind only the US and China. This confidence is based on strong sector fundamentals which include extremely low current levels of vehicle penetration in the country, projected high rate of GDP growth for the Indian economy, huge investments being made by the Government in infrastructure along with a very large upwardly mobile middle class population with aspirations for better living standards. The key points of the future growth of Indian automobile industry: Passenger car production in India is projected to cross three million units in 2014-15. Sales of passenger cars are expected to grow at a CAGR of around 10% up to 20015-16. Export of passenger cars is anticipated to rise more than the domestic sales during 2008-09 to 2015-16. Motorcycle sales will perform positively in future, exceeding 10 million units in 2012-13. Value of auto components export is likely to attain a double digit figure in 2012-13. Turnover of the Indian auto component industry is forecasted to surpass US$ 50 Billion in 2014-15.

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Research Objective
Primary objective Valuing the pharmaceutical industry on the basis of the top companies selected as per the size of market capitalization using various valuation methods. Secondary objective Understanding the differences in value of the firms using the different valuation methods namely discounted cash flow method, free cash flow method, relative valuation and EVA method Identifying the reasons for such differences

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Literature Review The Economic Value added: An analysis of market reaction

By Bartolom Dey Tortella and Sandro Brusco Using different event case study methodologies and test statistics, the market reaction to the introduction of the Economic Value Added (EVA) management technique is tested. Additionally, the effects over the main company variables, looking at the evolution before and after EVA adoption of three sets of company variables: profitability, investment and cash flow variables were tested. It was first observed that the EVA introduction does not generate significant abnormal returns, either positive or negative. In other words, the market does not appear to react to EVA adoption. Next, the analysis also shows that firms adopt EVA after a long period of bad performance, and performance indicators improve only in the long run after EVA adoption. With respect to the investment variables, it was observed that EVA adoption provides incentives for the managers to increase firm investment activity, and this appears to be linked to higher levels of debt. Finally, we can observe that the EVA adoption affects positively and significantly cash flow measures. A test to find out whether this positive relation between EVA adoption and cash flow measures can be due to the fact that such measures affect directly the part of managerial compensation; but no robust results were obtained.

EVA AND MARKET VALUE

By Stephen F OByrne While according to Stephen F. OByrne, valuation theory is focused on the present value of future cash flows, but investment practice focuses largely on multiple of cash flows, earnings and book values. According to them to develop accurate valuation one need an operating performance measure that is consistent with DCF and other valuation multiples like earnings, Book value, that are highly predictive of public market values. They have focused on using operating performance to predict market values and changes in market value. Stephen observed that EVA as a performance measure captures the true economic profit of an organization. According to his study, EVA explains 55% changes in Five year Market Values, whereas Earnings explain only 24% of the changes. The 10 year changes show a even clearer picture, EVA explains 74% of the 10 year changes in Market value, whereas Earnings explain only 64% of the changes. EVA-based financial management and incentive compensation scheme gives manager better quality information and superior motivation to make decisions that will create the maximum shareholders wealth in an organization. EVA is a performance measure which is most closely linked to the creation of shareholders wealth over a period of time. Accordingly EVA should be made the focal point for financial reporting, planning, and decision-making. EVA is a better predictor given you have understood the relation between the EVA and Market Value, therefore the major objective of the managers should be to understand the relation and
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work towards EVA Improvement. EVA Improvement is the increase in Future EVA that is necessary to provide a good return to shareholders. It is not only important for security analysis, but it is also equally important for corporate compensation committees to set performance standards for the managers.

The Valuation of Cash flow forecasts: An Empirical Analysis

by Steven N. Kaplan and Richard S. Ruback They talk about empirical analysis on valuation of cash flow forecast. He shows the comparison of the market value of management buyouts and leveraged recapitalization to the discounted value of their respective corresponding cash flows forecast because this transaction typically release the cash flow information and transaction value required for the analysis. He provides strong relation between the market value of the highly leveraged transactions and the discount rate of their corresponding cash flow forecast. The test compares the transaction values in HTLs to estimates of the present value of the relevant cash flow. The author uses a sample of management buyouts and leveraged recapitalization. The CAPM is used to discount the terminal and cash flow. . The valuation techniques were as follows: Transaction value, Compressed Adjusted present value Technique, measuring capital cash flow, finding terminal value, discount rate (CAPM). The article suggests that the DCF techniques are both useful and reliable. Greater attention to individual assumption and to the HTL complications would presumably lead to better DCF valuation. The implied discount rate the discount rate that equates the discount cash flow forecasts to the transaction value is inverted in the analysis. The findings were that the implied risk premium are not significantly related to firm size or pre transaction book to market ratio, but are positively related to firm and industrial beta. So their major focus on CAPM based approach to discount rates over those based on size or book to market ratios. In the article the author feel the success of the discounted cash flow valuation is because the cash flow of the firm might somehow be endogenous, and that endogeneity causes the DCF valuation to be spurious estimate of transaction value. They find that one potential source of endogeneity is that deal maker and manager in the HLTs may have had incentives to adjust the cash flow forecast

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Research Methodology
The valuation will be based on the secondary data which includes annual reports, stock market prices available on financial websites. The flow of the project will be as follows: Extracting data for the selected companies of pharmaceutical industry for past 5 years Calculating the free cash flows to the firm and free cash flows to the equity using valuation models Calculating the weighted average cost of capital and cost of equity for each of the firm Value the firms using 1, 2 and 3 Calculating /finding out the standardized multiples for the industry as well as the firms Relative valuation of the firms using the multiples Comparing both the valuations and explaining the differences Performing Sensitivity analysis for the discounted cash flows based valuation Calculating the Enterprise value and valuing the firm Try and test the relationship between EVA and stock price

Limitations
There are a few limitations of this study which includes: The valuation is based on the top 5 companies with highest market capitalization and hence it may not represent the entire industry The data used in the valuation is historical data which may or may not be a true representative of the future. Hence, it poses a threat on the reliability of the entire exercise

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Bibliography
Automobile Industry Information. (2013, July). Retrieved from Shine.com: http://info.shine.com/Industry-Information/Automobiles/783.aspx Bartolom Dey Tortella, S. B. (n.d.). An Analysis of Market Reaction. The Economic Value Added (EVA): An Analysis of Market Reaction. Indian Automobile Industry. (2013, July). Retrieved from www.ibef.org: http://www.ibef.org/industry/india-automobiles.aspx Industry Staistics. (n.d.). Retrieved July 2013, from www.siamindia.com: http://www.siamindia.com/scripts/industrystatistics.aspx Naveen Kumar, J. S. (n.d.). Discounted Cash Flow and Its Implication on Intangible Valuation. Rappaport, A. (1986). Englewood Cliffs: Prentice Hall. Creating Shareholders Value. SIAM. (n.d.). Forecasts. Retrieved July 2013, from www.siamindia.com: http://www.siamindia.com/upload/SIAM-Forecasts.pdf Stephen F. OByrne, S. S. (n.d.). EVA AND MARKET VALUE. Applied corporate finance , 125. Stern, J., & Stewart, G. &. (1995). The EVA Financial Management System. Journal of Applied Corporate Finance . Steven N. Kaplan, a. R. (n.d.). The Valuation of cash flow forecast: An Emperical Analysis. The Valuation of cash flow forecast: An Emperical Analysis . Tebay, G. M. (n.d.). An Introduction to Business Valuation.

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