Firm Valuation
Overview
Valuation is the process of calculating a value for a firm. For publicly traded firms, a firm value can be calculated
by taking the market price of its shares and then multiplying by the shares outstanding. Even though an exact firm
value can be known, valuation is still useful in the sense that many market participants believe that the market
can misprice assets, and valuation is a useful tool to help identify those mispricings.
For privately held firms, valuation can be useful when the company wants to sell itself, or for banks making loans
to the firm.
Valuation in Theory
Microeconomic Theory
provides a context by which to understand what valuation is and how it should be understood.
Valuation Techniques
Valuation is not an exact science. Various tools have been developed to try to approximate an answer.
- Discounted Cash Flow is a technique based
on a present value analysis of a companies earnings
or cash flows.
- Relative Valuation does not seek to build a valuation
from the asset fundamentals, but by comparing to assets of a similar type and quality.
- Arbitrage Free Valuation
looks to calculate a fair value for an asset based on the assumption that arbitrage does not exist in the market.
Valuation Techniques by Firm Type
Some firms, primarily financial firms, are difficult to value by the standard techniques listed above.
The following represent alternative methods to tackle the specific challenges related to these types of firms.
