Corporate Valuation, 1e

by Holthausen, Zmijewski

ISBN: 978-1-61853-036-3 | Copyright 2014

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Welcome to the first edition of Corporate Valuation: Theory, Practice & Evidence.

We wrote this book to equip our students and practitioners - many of whom are our former students - with the current knowledge used to value companies, parts of companies, and the securities issued by companies. Our goal is to provide current conceptual and theoretical valuation frameworks and translate those frameworks into practical approaches for valuing companies. We present the research and descriptive data underpinning these frameworks and use detailed examples to demonstrate how to implement them, often using data from real companies.

Corporate Valuation: Theory, Practice & Evidence has been the industry standard on valuation for over a decade despite not being widely available. The corporate valuation course based on this book is one of the few unstated requirements for graduates of The Wharton School that hope to enter into the field of finance. Having hired dozens of Wharton alumni who have learned valuation from this book, I cannot imagine a more thorough guide or a better reference to learn valuation.

Ben Frost, Managing Director Morgan Stanley's Mergers and Acquisitions Department

Innovative, Detailed, and Practical Pedagogy

In teaching valuation, we found that students generally lacked the detailed knowledge required to value a company. Although other finance textbooks cover these topics, they do so at a fairly low level of detail and generally do not cover the relevant finance and accounting complexities required to perform valuations. As such, students who use these textbooks typically struggle in the workplace because they either lack the requisite knowledge or fail to understand how to integrate the accounting information with the appropriate finance theory. We integrate the relevant accounting topics with the appropriate finance theory, and demonstrate, using step-by-step examples, how to implement the valuation frameworks we discuss. The book is organized so that instructors can choose not to assign certain chapters or sections of chapters and omit some of these details. in addition, we incorporate relevant empirical evidence and theory from prior studies as well as our own work.

Overview of the Structure of the Book

The book consists of six parts. Part I (Chapters 1 through 4) presents an overview of valuation issues and topics, how valuation is used in practice, and discusses the basic tools needed to value a company. These tools include analyzing financial statements, measuring performance, understanding and measuring cash flows, and creating a financial model. Part II (Chapters 5 through 7) discusses the discounted cash flow (DCF) valuation model, including the residual income valuation model. This part of the book rigorously demonstrates the equivalence of the alternative forms of the DCF valuation model and when each of the forms is more appropriate to use. Part III (Chapters 8 through 11) discusses how to measure the various costs of capital used in the different valuation frameworks. Part IV (Chapter 12) discusses how to value and measure the cost of capital for warrants, options, and other equity-linked securities. Part V (Chapters 13 and 14) discusses the conceptual framework and practical application of the market multiple valuation method. Finally, Part VI (Chapters 15 through 17) applies and extends these valuation frameworks to specific settings such as highly leveraged transactions, mergers and acquisitions, and cross-border valuations.

Steps in the Valuation Process

In Chapter 1, we provide a top-level overview of the steps in a valuation process used to value a company. These overview steps include analyzing the competitive landscape, analyzing the company and its potential competitive advantage, creating a financial model, measuring the costs of capital, market multiple valuation, and alternative valuation approaches. in the relevant subsequent chapters, we provide detailed steps for each of these overview steps discussed in Chapter 1. For example, in Chapter 4, we provide a detailed step-by-step process for developing a financial model. These step-by-step process guides are included in many subsequent chapters. We show an example of this step-by-step process from exhibit 15.8 for leveraged buyout transactions.

Real Companies and Detailed Examples Incorporated Throughout

The understanding of valuation and how it plays a role in business decisions is essential to the success of any business and its decision makers. Throughout each chapter we incorporate relevant examples of the use of valuation in industry to engage students and provide an understanding of how the theory is used in practice.real company data have been integrated throughout each chapter to engage and provide relevance to students as they utilize the concepts in practice. Each chapter contains short illustrations of how the topics in the chapter apply to real companies using the Valuation in Practive notes as well as an opening vignette. In addition each chapter contains one or more deteailed examples demonstrating a step-by-step application of the concepts discussed in the chapter. These detailed examples provide an important bridge from the concepts to practice that students often need to understand how to apply the concepts. Many of these detailed examples use inforamtion from real companies and some are created by the authors. For example, we use the Xerox Corporation and Affiliated Computer Services, Inc. merger to demonstrate a step-by-step application of the concepts discussed in Chapter 16 of on mergers and acquisitions (Exhibit 16.19 is one of the exhibits detailing a valuation in the context of mergers and acqusitions).

Learning objectives, Vignettes, and Chapter Organizational Charts

At the beginning of every chapter, we present learning objectives for that chapter, a small vignette of a real-world example that applies to the content of the chapter, and an organizational chart of the chapter. Thus, even before reading the introduction to the chapter, the reader has a sense of the content of the chapter, its importance, and how the chapter will be organized, which makes it easier to learn the material that follows.

Example Learning Objective

Example Vignette

Example Chapter Organizational Chart

Valuation Keys

Each chapter contains numerous boxed summeries of key concepts and tools called Valuation Keys. The Valuation Keys help focus the reader on the key issue or issues in each section of the chapter.

Review Exercises with Solutions Throughout Each Chapter and End-of-Chapter Problems

Conducting a valuation on a real company is challenging to most students. And it is especially challenging for students with less business experience or previous exposure to finance, management, and other valuation-related business courses. To reinforce concepts presented in each section of the chapter, we include review exercises that allow students to apply the topic discussed in each section. The solutions to the review exercises appear at the end of each chapter. In addition, each chapter contains additional end-of-chapter exercises and problems instructors can assign separately.

Example Review Exercise and Solution

Valuation From a Practical Perspective

Naturally, it is not possible for a textbook or any other book to discuss the valuation frameworks and applications of those frameworks that apply to every valuation context that might arise. Each company and valuation context will have specific and potentially unique facts and circumstances that require the valuation expert to choose the frameworks and implement them in a way that is appropriate for the specific valuation context. The chapters in this book are meant to provide a guide to understanding the alternative frameworks and ways they can be implemented. Valuation experts must use their informed judgments to choose the specific valuation frameworks to use in a valuation and how to best implement them based on the facts and circumstances for the specific valuation.

Focus Companies for Each Module

The following table lists the real companies discussed in the text by chapter.

Chapter 1 Apple Inc. Altria, Inc. and Kraft Foods spinoff
Facebook Inc. FMC Corporation

Expand/Collapse All
Chapter 1: Introduction to Valuation (pg. 2)
Chapter 2: Financial Statement Analyisis (pg. 30)
Chapter 3: Measuring Free Cash Flows (pg. 81)
Chapter 4: Creating a Financial Model (pg. 124)
Chapter 5: The Adjusted Present Value and Weighted Average Cost of Capital Discounted Cash Flow Valuation Methods (pg. 164)
Chapter 6: Measuring Continuing Value Using the Constant-Growth Perpetuity Model (pg. 210)
Chapter 7: The Excess Earnings Valuation Method (pg. 250)
Chapter 8: Estimating the Equity Cost of Capital (pg. 284)
Chapter 9: Measuring the Cost of Capital for Debt and Preferred Securities (pg. 336)
Chapter 10: The Effects of Financial Leverage on the Cost of Capital (pg. 382)
Chapter 11: Measuring the Weighted Average Cost of Capital and Exploring Other Capital Structure Issues (pg. 420)
Chapter 12: Option Pricing Model Applications to Valuation Issues (pg. 472)
Chapter 13: Introduction to Market Multiple Valuation Methods (pg. 508)
Chapter 14: Market Multiple Measurement and Implementation (pg. 544)
Chapter 15: Leveraged Buyout Transactions (pg. 600)
Chapter 16: Mergers and Acquisitions (pg. 665)
Chapter 17: Valuing Businesses Across Borders (pg. 722)
Robert W. Holthausen

Robert W. Holthausen

Robert W. Holthausen is the Ernst and Young and the Nomura Securities Company Professor of Accounting and Finance and is the Chairman of the Department of Accounting.

Prior in going to Wharton, he was a Professor of Accounting and Finance at the Graduate School of Business of the University of Chicago. He earned his doctorate at the University of Rochester where he also earned his M.B.A. Prior to his academic career, he was a C.P.A. working at Price Waterhouse and he was also in the finance group at Mobil.

Professor Holthausen is widely published in both finance and accounting journals. His research has studied the effects of management compensation and governance structures on firm performance, the effects of information on volume and prices, corporate restructuring and valuation, the effects of large block sales on common stock prices, and numerous other topics. His research has appeared in such journals as the Journal of Accounting and Economics, The Accounting Review, the Journal of Accounting Research, the Journal of Finance and the Journal of Financial Economics. He has served in various editorial capacities for all five journals listed above; either as consulting editor, associate editor, editorial board member or reviewer. He is currently an editor of the Journal of Accounting and Economics.

His teaching has been concentrated in the areas of investment management and valuation. Currently, his primary teaching responsibility is for the valuation class he developed. He has teaching experience at the undergraduate, M.B.A., and Ph.D. levels and has won teaching awards from both the undergraduate and M.B.A. students at Wharton, including the David J. Hauck award. He is currently the academic director of Wharton’s Mergers and Acquisitions program.

Professor Holthausen has consulted with a variety of companies. His specific consulting engagements are varied and include such diverse activities as serving as a compensation consultant to a Fortune 500 Company, consulting with an investment company in the development of fundamental trading rules used to manage equity portfolios and performing valuation analysis in a variety of situations.

Mark E. Zmijewski

Mark E. Zmijewski

Mark E. Zmijewski is the Leon Carroll Marshall Professor of Accounting at The University of Chicago Booth School of Business. He has been a member of Chicago Booth since 1984. Professor Zmijewski earned his doctorate at the State University of New York at Buffalo, where he also earned his B.S. and M.B.A. degrees.

Professor Zmijewski's research focuses on the valuation of the firm and its parts, as well as the ways in which various capital market participants use information to value securities. He has published various articles in academic journals such as the Journal of Accounting Research and the Journal of Accounting and Economics, and won the American Accounting Association's Competitive Manuscript Award (1984). He has been an Associate editor of The Accounting Review and on the editorial Boards of both the Journal of Accounting Research and The Accounting Review. In addition to his faculty duties at the University of Chicago, Professor Zmijewski also held the positions of Deputy Dean, Ph.D. Program faculty director, and the Center for Research in Security Prices faculty director. He teaches courses in valuation, mergers and acquisitions, financial analysis, accounting, and entrepreneurship and has won teaching awards for his teaching in both the M.B.A. and executive M.B.A. programs at Booth.

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