ISSUES IN VALUATION UNDER FEMA

Transcription

1 ISSUES IN VALUATION UNDER FEMA REGIONAL CONFERENCE OF WIRC CA. SUJAL SHAH AUGUST 31,

2 VALUATION - INTRODUCTION What is Valuation? Valuation means assigning a value to underlying assets The value should be a fair value Valuation is not a science; more of an art Valuation is largely influenced by Valuer s judgment, knowledge of business, analysis and interpretation and the use of different methods Valuation varies with purpose Valuation is time sensitive 2

3 METHODS OF VALUATION Asset Based Approach Book Value Replacement Value/Realizable Value Earning Based Approach Capitalization of Maintainable Earnings Discounted Cash Flow Method Market Approach Market Price Market Comparables 3

4 Valuation Requirements under FEMA Fresh Issue Of Shares Of Indian Company Transfer Of Indian Company Shares Listed On Stock Exchange (Quoted) Unquoted Listed On Stock Exchange (Quoted) Unquoted As Per Listing Guidelines Of SEBI DCF Method Certified by a Merchant Banker or a CA As Per Listing Guidelines Of SEBI DCF Method Certified by a Merchant Banker or a CA 4

5 Valuation Requirements under FEMA Direct Investment Outside India Investment > USD 5 Million Investment < USD 5 Million Fair Valuation by Category I Merchant Banker Registered with SEBI or Investment Banker / Merchant Banker registered in target country Fair Valuation by a CA or a Certified Public Accountant (CPA) 5

6 DISCOUNTED CASH FLOWS (DCF) Values a business based on the expected cash flows over a given period of time Involves determination of discount factor and growth rate for perpetuity Value of business is aggregate of discounted value of the cash flows for the explicit period and perpetuity 6

7 DCF CASH FLOWS Considers Cash Flow and Not Profits Cash is King Free Cash Flow ( FCF ) - FCF to Firm - FCF to Equity FCF to Firm Preferred Cont.. 7

8 DCF - CASH FLOWS (Cont.) Business Plan Business Cycle Working Capital Capital Expenditure Depreciation Amortization Tax 8

9 DCF - DISCOUNTING Weighted Average Cost of Capital (WACC) D E WACC = x Kd + x (D + E) (D + E) Ke D = Debt E = Equity Kd = Post tax cost of debt Ke = Cost of equity Cont.. 9

10 DCF DISCOUNTING (Cont.) In CAPM Method, all the market risk is captured in the beta, measured relative to a market portfolio, which at least in theory should include all traded assets in the market place held in proportion to their market value. Ke = (Rf + (β x Erp)) Where, Ke = Cost of Equity Rf = Risk free return Erp = Equity risk premium β = Beta 10

11 DCF - TERMINAL VALUE Terminal Value is the residual value of business at the end of projection period used in discounted cash flow method. Terminal Value Liquidation Approach Multiple Approach Stable Growth Approach 11

12 DCF AN EXAMPLE (Rs. in Mn.) Particulars Perpetuity Opearting PBT Add: Inflows Interest Depreciation Total Inflows Less: Outflows Capital Expenditure Incremental Working Capital Tax Total Outflows Free Cash Flows (FCF) Free Cash Flows for Growth Rate 2% Capitalised Value for Perpetuity 1,956 Discounting Factor 14.00% Net Present Value of Cash Flows ,016 Enterprise Value 1,692 Less: Loan Funds (350) Less: Contingent Liabilities (50) Less: Preference Share Capital (800) Add: Surplus Funds 120 Add: Value of Investments 1,000 Adjusted Value for Equity Shareholders 1,612 No. of Equity Shares 79,69,000 Value per Share (FV Rs. 10)

13 Difficult to value firm(s) PITFALLS OF DCF Having unutilized assets (including unexploited patents/ licenses) In acquisition mode or in the process of restructuring (difficulties in measuring synergies, change in capital structure, sale of assets, changes in management compensation, etc.) NBFC s or Investment Holding Companies Under Liquidation In trouble 13

14 ISSUES IN DCF Inconsistency in assumptions for future operations between Director s Report and that provided for valuation Working capital assumptions Inaccurate Capex assumptions Treatment of surplus funds and investments Difficulties in measuring risks for unlisted companies (calculation of β) Code of Ethics for CAs with regards to projections 14

15 ISSUES SPECIFIC TO DCF VALUATION FOR FEMA Difficult to value firm(s) Obtaining projections by a minority investor for transferring his shares when required to do a DCF valuation Pre-Money or a Post Money Valuation? Valuation for a start-up Company Valuation of NBFC under DCF method 15

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