Formulas of Valuation of Firms

1. Net Operating Income Approach:

1. S = V – B = (EBIT/ Ke) – B

Where,

S = Value of equity

V = Value of firm

B = Value of debt

Ke= Equity Capitalization Rate

1. Ke = EBIT – I / V-B x 100

• K = Kd [B/ V] = KE [S/ V]

Where,

Kd = Cost of Equity Capital

S   = Market value of equity

2. Net Income Approach

V = S + B

Where,

V = Value of firm

S = Value of equity

B = Value of debt

Market value of Equity, S can be written as:

S = NI/ Ke

Where,

S  = Value of equity

NI = Earnings available for equity shareholders

Ke = Equity Capitalization Rate

K   = Overall cost of capital

It is also written as:

K = EBIT/ V x 100

NI (Net Income):

Earnings before Interest and Tax                               xx

Less : Interest                                                              xx

PBT                                                                              xx

Less : Tax                                                                     xx

PAT                                                                              xx

Less ; Pre-dividend (if any)

Amount available for equity shareholders                 xx

3. Traditional Approach:

Traditional Approach contains some of the features of Net Income Approach and Net Operation Income Approach.

4. Modigliani and Miller Approach:

1. Value of Levered Firm:

Its formulae can be given by,

Vi = Vu + Bt

Where,

Vi = Value of levered firm

Vu = Value of unlevered firm

B   = Amount of debt

t    = Tax Rate

1. Value of Unlevered Firm:

Vu = (I – t) EBT/ Ke

or,

Vu = Profits available for equity shareholders/ Equity Capitalization Rate

Note: The term unlevered means debt content in Capital Structure whereas the term levered means no debt content in Capital Structure.

Links of Previous Main Topic:-

• Budget and budgetary control
• Limitations of historical accounting
• Introduction to responsibility accounting
• Introduction to financial management
• Introduction and types of dividend
• Concept of cost of capital
• Capitalization meaning

Links of Next Finance Topics:-

• Test questions of capital structure
• Concept of capital expenditure
• Learning objectives and chapter outline
• Limitations of operations research
• Linear programming learning objectives and outline of chapter
• Introduction learning objectives
• Duality in linear programming