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University of Nigeria Research Publications
OYEDEJI, Benjamin O.
A
utho
r
PG/MBA/99/0435
Title
Appraisal of Asset Valuation as a Tool for Marketing Business
Facu
lty
Business Administration
Dep
artm
ent
Marketing
Dat
e
June, 2001
Sign
atur
e
APPRAISAL OF ASSET VALUATION MODELS
AS A TOOL FOR MARKETING BUSINESSES
OYEDEJI BENJAMIN OLUWAFISAYO CMb=UNN/PG/EMBA/99/0435
DEPARTMENT OF MARKETING, FACULTY OF BUSINESS ADMINISTRATION,
UNIVERSITY OF NIGERIA, ENUGU CAMPUS, ENUGU
JUNE, 2001.
ABPM%SAL AS A TOOL
1
OF ASSET WALUA$EdbN MODELS FOR MARKETING BUSINESSES
OYEDEJI BENJAMIN OLUWAFISAYO
SUBMIlTED TO THE DEPARTMENT OF MARKETING, FACULTY OF BUSINESS ADMINISTRATION, UNIVERShY OF NIGERIA, ENUGU CAMPUS, ENUGU
I N PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE AWARD OF MASTER OF BUSINESS ADMINISTRATION
(MBA MARKETING)
JUNE, 2001. ---
OYEDUI, BENYAMI OLUWAFISAYO, a postgraduate student in the
Department of Marketing, faculty of Buslness Administration, University of
Nlgeria, Enugu Campus, Enugu, with registration number CMD-
UNN/PG/EMBA/99/0435 has satlsfactorily completed the requirements for the
award of degree of Master In Buslness Administration (MBA) ~ a r k e t i n ~ .
The work embodied in this report is original and has not been submitted In
part or in full for any other diploma, degree or award of this university or any
other univepy.
MRS. D, A, NNOUM PROJECT SUPERVISOR
DATE:
P rof. J, 0, Onah HEAD OF DEPARTMENT
iii
DEDICATION
THIS RESEARCH WORK I S DEDICATED TO MY WIFE - MRS A. 0. OYEDUI,
TOSIN ARE, YEMISI OYEDEJI, FEMI OYEDEJI, TIRENI OYEDUI; WHO IN THE
MAIN BEAR THE BRUNT OF THE PROGRAMME FINANCIALLY AND
EMOTIONALLY,
ACKNOWLEDGEMENT
I am most grateful to the almighty God through our Lord Jesus Christ for
the great opportunity he gave me to complete the work.
I am sincerely grateful to the numerous persons who have made
invaluable contributions towards the success of this research project.
Particularly my supervisor ME. 0. A. Nnolim for his motherly guidance and
encouragement. I am specially thankful to Mr. Raymond ~angana of
Centre for Management Development (CMD), for his too numerous support
and encouragement.
I am also grateful to others who have contributed one way or the other to
the successful completion of this work.
It would be well with all of us in Jesus name!
ABSTRACT
The success or failure of any business depends largely on the marketing .
function. It also provides a vital interface between the organization and its
environment.
Sirnilarty every investment has some "opportunity cost", since each involves
the owner foregoing some alternative. Similarities not withstanding, there
are great many differences among investments. They differ as to the nature
of economic activity, the magnitude of the outlay, asset type/class and otl
mundane issues as location and identity of owners,
her
To this effect, financial theorists and market analysis have developed many
techniques to evaluate and market specialized product of this nature. As for
market analyst, asset valuation is to aid the marketing of businesses either in
part or in whole In an effective and efficient manner. Therefore the concept
of value and the different valuation methods like, book value, earnings
potential, market value must be accorded its prime place in the course of
evaluation, This must also be considered alongside the marketing objectives,
Investor's preferences and the operating environment: economic,
social/political, legal and other components of the environment.
Essential however, it is important to remember that no single approach will
ever give the 'right" answer. To a large extent the appropriateness of any
method depends on the evaluator and the prevailing circumstances.
Therefore the purpose of this study is not to arrive at 'the answer' but lay a
solid foundation for a market to identify critical variables for a target buyer
and develop realistic scenarios to enable him establish a 'value' for the assets.
This definitely would lead to the attainment of marketing objectives in an
efficient and effective manner.
vii
CONTENTS
Title Page Certification Dedication Acknowledgement Abstract Table of Content
CHAPTER ONE 1.0 Introduction
11 Defining Customer Value and Satisfaction 1.2 Valuation Models 1.3 Basics for classification Investments in Asset 1,4 InvestmentinAssetascashflow 1.5 Investment in Financial Assets 1.6 Types of Securities 1.7 Statement of Problems 1,8 Research Objectives 1,9 Research Questions 1.10 Hypothesis 1 1 Relevance and Significance of Study 1,12 Limitation and scope of study 1 l Definition of terms References
CHAPTER TWO 2,O Review of Related Literature
2,l An Overview of marketing 2.2 Marketing Financial services 2.3 Some Definition of services 2.4 Characteristic of services 2.5 Marketing strategies for sewice firms 2.6 Financial securities valuation techniques 2.7 Cash flow valuations
i ii iii iv v vii
2.8 Summary of Related Literature References
CHAPTER THREE 3.0 Research Methodology
3.1 Research objectives 3.2 Research questions 3.3 Hypothesis 3.4 Research design/methodology References
CHAPTER FOUR 4.0 Data Presentation and Analysis
4.1 Asset based method 4 2 Cash flow based method 4.3 Earning based valuation methods 4.4 Declsion Rule 4.5 Data Presentation 4.6 Notes of Financial Statements 4,7 Classification of analysis/analysis 4,8 Analysis 4,9 Summarj of valuations 4.10 Analyst option
CHAPTER FIVE 5,O Summary of Findings, Conclusions, Recommendations
And Suggestion for Further Studies 5.1 Reasons for valuation 5.2 Inferences 5.3 Summary of findings 5.4 Conclusion 5.5 Recommendations 5.6 Suggestions f ~ r further research
Bibliography
CHAPTER ONE
1.0 INTRODUCTION
Marketing is perhaps the most dynamic, complicated and challenging ,
function of business. Especially having regard to the specialized nature of
financial assets (securities) marketing.
Indeed, more and more discerning financial institutions are recognizing
that a detailed and objective appraisal of the assets (securities) is a pivotal
determinant of investor/investment success in the marketing of hnancial
products and services.
The success or failure of any business depends largely on the marketing
function. It also provides a vital interface between organisation and the
environment. Service should run through an organisation like blood
through a body.
Service marketing is a deliberate and systematic planning and execution of
a set of rational activities designed to satisfy end users of intangible
products.
Sewice marketing is concerned with the happiness satisfaction and
pleasure given by the representative of an organisation to the consumer of
intangible goods.
1 DEFINING CUSTOMER VALUE AND SATISFACTION
Peter Drucker insightfully observed that a company's first task is "to create
customer." But today's customers face a vast array of product and brand
choices, prices, and suppliers. Then the question: How do customers
make their choices?
Customers estimate, which offer, will deliver the most value. Customers
are value maximizers, within the bound of search costs and limited
knowledge, mobility, and income. They form an expectation of value and
act on it. Then they learn whether the offer lived up to the value
expectation and this affects their satisfaction and their repurchase
probability.
Total customer value can then be seen as a bundle of benefits customers
expect from a given product or service. Therefore customer's delivered
value would then be the difference between total customer value and total
customer cost.
1.2 VALUATION MODELS
One of the entrepreneur's critical tasks is determining value. This is
important not only for the individual about to purchase a company, but
also for the entrepreneur who is starting a firm, and is attempting to
estimate the value of the business may have in the future. Finally,
understanding value is a key step for the entrepreneur about to harvest a
venture, either through sale or taking the business public,
Financial theorists have developed many techniques, which can be used to
evaluate a going concern of course, for a large public company; one could
simple take the market value of the equity. For a going concerning with
along history of audited financials, earnings and cash-flow projections are
possible. But the valuation of a small, privately held business is difficult
and uncertain at best.
I f the hurdles can be scaled one way or the other, we still have to contend
with characteristic nature of all investments where they all look alike, in
the sense that every investment involves the outlay of resources in the
expectation of future benefits.
Similarly, every investment has some "opportunity cost", since each
involves the owner foregoing some alternative opportunity. Similarities not
withstanding, there ate a great many differences among investments.
They differ on basic issues such as the nature of economic activity
involved, the magnitude of the outlay, etc and on such superficial issues as
the geographical location of the activity or the identity of owners, Such
differences give rise to various classifications of investments.
1.3 BASIS FOR CLASSIFYING INVESTMENT I N ASSETS
The fundamental basis for classifying financial assets is the intrinsic nature
of assets in which the out!ay is denominated. Conceptually, there are
many ways of analyzing the nature of assets, for example whether the
investment is in tangible assets such as buildings, or in intangible assets
such as advertising. However, the basic distinction which we make in this
project is between investment in real assets and investment in financial
assets (securities). Both types of investments can further be classified on
the basis of a number of parameters:
(a) Magnitude of outlay:
Major investments could be distinguished from minor investments.
I n investment outlay, size is relative. An investment is major or
minor depending on the relative proportion of the outlay to the total
size of the firm. Thus whereas an investment of N20000 could be
considered a minor investment by a firm capitalized at NZOO million,
it is very major investment to a small firm with total assets valued at
N40000.
(b) Risk environment of Financial Assets:
A distinction is made between investment under conditions of
certainty, investments under conditions of risk, and investments
under conditions of uncertainty.
(c) Motivation for investment in the asset
A distinction could be made among investments for asset
replacement, capacity expansion or modernization, and investments
for strategic purposes.
(d) Sequencing of Cash Flows
Conventional investments are distinguished from non-conventional
investments on the basis of the timing and sequencing of cash flow
arising from the investment.
(e) Nature of expected benefits
A distinction exists between cost saving and revenue yielding, real
asset investment, The former is illustrated by a firm that replaces
old equipment in the hope of cutting operating costs over the life of
the new equipment, I n a revenue expansion programme, on the
other hand, funds are invested in order to increase gross revenue
either through additional sales volume or through increased price
per unit of sales.
When evaluating a cost-saving investment, the value of total costs
saved is compared with the additional investment made. I n the
latter situation, the investor would have to compare the increased
costs with the additional sales revenue realized.
(f) Relationship to other investments
The costs and benefits of a given investment may or may not be
affected by alternative investments. I n this regard, dependent
investments are different from independent investment activities.
Distinction among investments is necessary for meaningful
investment evaluation because various types of investments raise
different problems. A major investment requires detailed evaluation
and the dlrect attention of the top level executives of a corporation.
Conversely minor investments could be appraised superficially at low
levels of an organisation.
Similarly, knowledge of the economic status of an investor.
influences the nature of costs and benefits relevant for appraising
his investment, For example, the cost/benefit implications of a
given investment could be different if it is sponsored by the
government than if the same investment is made by an individual.
Proper classification of an investment is therefore a necessary first
step in its appraisal and management.
1.4 INVESTMENT IN ASSET AS CASH FLOW
Every investment activity has definite or implied costs and benefits. I n
business organizations, the ultimate consequences of investment activities
are expressed in terms of cash flow, i.e., the receipts (cash inflow) or
6
payment (cash oufflow) of cash by an organization. Within a period, a
typical organization makes a series of cash payments and receives a series
of cash benefits. Where the cash inflow of a period exceeds the outflow,
one talks of net cash inflow.
Conversely, a situation of net cash outflow exists where the outflow of a
period exceeds the inflow. There are instances however, where the costs
or benefits of an investment cannot be described solely in terms of cash
flow. A firm for example can donate to a charity for the purpose of
improving its public image. I n such a case, there is some aifficulty in
expressing the future goodwill which accrues from the donation in precise
money terms. A similar analogy applies to a firm which donates
generously to a political campaign In the hope of winning government
patronage if the favoured political or political party comes to power.
Investments whose costs and benefits are difficult to measure in terms of
cash flow abound in non-profit making organizations in both the private
and public sectors. The cost/benefits implications of government
investments are not generally easy to quantify in monetafy terms. A
highway, for example, has direct monetaty costs, such as constructions
and maintenance costs, and many indirect social costs, such as providing
an easy escape to criminals, more accidents, disfigurement of the
landscape, noise, pollution, etc. Similarly, the benefits of such a highway
accrue both in monetary and non-monetary forms. Even in government
7
business enterprises there are several benefits which do not accrue in
direct monetary forms. For instance, a government could decide to set up
an under-productive factory in a depressed section of the community for
the purpose of increasing local employment opportunities.
5 INVESTMENT I N FINANCIAL ASSETS
Financial assets are the 'promissory notes' of various economic units
(government, business firms, etc), which represent claims on the
productive assets of the issuers. Investments in such assets could be
categorized either on the basis of the variability of the price of the financial
assets or on the basis of the nature of income expected from the assets.
In terms of the former, a distinction is made between investments in fixed
price and in variable price financial assets.
Fixed price financial assets are very liquid and virtually risk free because
their money values do not change with time. Examples are deposits in
bank savings accounts and investments in government savings bonds.
Returns on such investments are relatively low and should really be seen
as compensation for potential loss in the real value of the assets over time.
Fixed price financial assets are unusual media for investment. They are
mentioned for purposes of complete analysis.
The bulk of investments in financial assets are in the form of variable price
financial assets such as government and corporate securities. Security
prices fluctuate in response to changes in the environment.
Such price fluctuations create opportunities for potential capital gains or
losses when others sell their securities.
The basic difference between investment in securities and investment in
real assets is that an individual security holder does not necessarily
exercise direct control over the firm whose security he holds. ' Possible
exceptions arise where an investor is the majority equity shareholder. A
majority shareholders can use the might of his voting power to control the
affairs of the firm. I n that case, however, the distinction between real and
financial asset investment tends to be very narrow indeed.
1.6 TYPES OF SECURITIES
The nature of rights and control exercised by a security-holder depends
ultimately on the type of security held. I n that connection, rights inherent
in fixed income securities are different from those of variable income
securities.
1.6.1 Fixed income securities
Fixed income securities are debt instruments (bonds), which provide for
specific rates of money income to holders. Bonds are issued by various
9
types of business organizations (corporate bonds), by federal and state
governments (government development stocks or bonds), or by local
government or municipal authorities (municipal bonds). I n general, bond
holders have two types of claims on the issuers. The first is alright to full
repayment of the nominal value of the bond at maturity. The other is a
right to periodic interest at a specified rate of the principal amount payable
in accordance with conditions stipulated in the bond indenture, Both
claims are unconditional. Investments in fixed income securities are
presumed to have very limited degrees of risk. Consequently, they attract
low rates of return.
Unfortunate!y, the purported safety of investment in bonds is, at times,
illusory. The sophisticated investor is more interested in the real values of
expected income than in the money values of such income. Fixed income
securities could, in fact, expose holders to variable real incomes
particularly during inflationary periods. I n addition, both interest
payments and the repayment of principal are in some cases compromised
where the bond issuer is faced with long periods of irrecoverable losses.
The purported safety of fixed income securities therefore depends both on
the ability of issuers to generate adequate income to cover the claims and
on the ability of the macro-economy to operate at stable price levels.
1.6.2 Variable Income Securities
Variable income securities are equity stock (shares) by various types of
business organizations. Returns on such securities, for any given period,
depend on profit performance of the issuer for the period. They are
therefore subject to a great deal of variability. Both the primary attraction
and the greatest danger of investment in equity stock arise from this
feature of variability of income. I n periods of economic boom and rising
corporate profit performance, equity stock holders reap windfall returns.
Conversely, they receive the greatest losses during periods of depressed
economic conditions.
Other attractions of investment in equity stock arise from rights of
corporate ownership inherent in such investments. Equity stock holders
have rights designed to attract and retain their interest in the corporation.
Apart from the right to share in residual corporate income, other examples
of attractive rights enjoyed by equity holders include the right to a pro-rata
share of corporate assets in liquidation, and voting rights, The other
group of rights is the protective rights which protect the interest of equity
stock holders, They include the right of transfer ownership interest, the
right of prior consideration in subscribing to additional issues of equity
stock, and the right to inspect corporate books.
1.6.3 Hybrid Securities
Hybrid securities make up the last group of securities. They are hybrid
because such securities have some features of fixed income securities and
some characteristics of variable income securities. While the expected
income of a hybrid security is basically a percentage of the value of the
security, the payment of such income is contingent on the profit
performance of the issuer. A typical example of a hybrid security is
preferred stock (preference shares). Preferred stocks are unpopular media
for financial assets investment, particularly, in developing economies. The
reason is that they neither offer the chance of large profits like equity
stock nor the guarantee of steady money income which could compensate
for the shortcoming.
1.7 STATEMENT OF PROBLEM
It has always been difficult marketing businesses because of the technical
and many other complex issues involved in the exercise. The use of
valuation models will no doubt reduce the difficulty, if the approaches to
the valuation of assets/businesses and their appraisal are common
knowledge.
Therefore there is the need to appraise valuation in a way that would bring
about an understanding of the concept to both the marketer and the
consumer/investor.
1.8 RESEARCH OBJECTIVES
To tackle the above problem, the research objectives are:
Establishing the concept of value and valuation, on the business as
a financial product (service).
X-ray analytical methodsfs what would facilitate an understanding of
assets and business valuations.
Develop an effective and result oriented marketing programme for
business sales.
Integrate the 4 P's of marketing in assets valuation models.
RESEARCH QUESTIONS
What are the main approaches to the valuation of assets/business
and how are they appraised?
How would a marketer develop a marketing programme that can
influence and benefit a potential investor or purchaser?
How can financial services provider/marketer in the context of
marketing for businesses improve their product offering, to ensure
optimum benefits to financial services consumers; for
assets/business valuation and purchase?
1.10 HYPOTHESIS
Effective valuation of assets/business is critical .to marketing of businesses.
RELEVANCE AND SIGNIFICANCE OF STUDY
The study is relevant to the extent that the problem usually encountered in
specialized financial products marketing would be isolated, analysed and
means of managing the problems will be proffered.
1 LIMITATIONSANDSCOPEOFTHESTUDY
This study is limited to the appraisal of valuation techniques as a tool in
marketing businesses. Therefore, its findings may not be generalized as
marketing tool to other products and services given the specialty and
complexity involved in valuation of assets/business in their different modes
and classes.
2.0 DEFINITIONS OF TERMS
The following words are defined as they will be used in the study:
Concept - A perception of reality to which some word labels are attached
for the purpose of identification.
Earnings Per Share (EPS) - defined as:
Profit after tax - Preference dividend
Number of ordinary shares in issue
EBITDA - Earnlngs Before Interest, Taxes, Depreciation and
Amortisation,
Dividend yield - defined as: Dividend per share
Market price per share
Environment - Environment refers to the total influence that have
impact on a business one way or the other.
Hypothesis - A tentative statement about relationship that exist
between two or among other variables.
Model - A model is construction that shows a relationship existing
among variables. An abstraction of reality.
Organisation - An enterprise itself, and a system of or pattern of
any set of relationships in any kind of undertaking.
Price Earnings Ratio (P/E ratio) - A ratio that measures the
number of years it will take to re-coup the amount invested if the
shares were purchased at the current market price and present
earnings is maintained,
Defined as: Market Price Per Share
Earnings Per Share.
Product - A product is anything that can be offered to satisfy a
need or want.
Planning - Planning refers to future oriented activity aimed at
achieving a goal or an objective.
ROI- Return on Investment.
Solvency/Liquidity - The ability of a business to meet its short-
term liabilities, as they fall due out of its short-term assets.
System - A system refers to a set of interrelated items.
Variables - This are concept that vary e.g. National income,
motivation. They vary over time but the mode of variation differs
from one to the other.
REFERENCES:
Brigham, E. F. - Fundamentals of Financial Management (5m Edition,
Dryden Press. Pp. 149-177).
Okafor, F.O. - Investment Decisions: Evaluation of Projects and
Securities (Cassell, London, 1983 pp. 1-21 and 150-
159)
Olowe, R.A. - Financial Management: Concepts, Analysis and Capital
Investments (Brierly Jones Nigeria Ltd, Lagos - 1988 PP* 1-91
Staton, R: - Fundamentals of Marketing (4m ed., 1992, McGraw Hill,
pp, 7-9 and 79-98)
2.0 REVIEW OF RELATED LITERATURE
Marketing thinking starts with the fact of human needs and wants. People
need food, air, water, clothing, and shelter to survive. Beyond this, people
have a strong desire for recreation, education, and other services. They
have strong preferences for particular versions and brands of basic goods
and services; professional or otherwise.
For the purpose of this study, it is useful to draw a distinction between
needs, wants, and demands. A human need is a state of fe/t deprivatlbn
of some basic satisfaction. People require food, clothing, shelter, safety,
belonging, esteem, and a few other things to survival. These needs are
not created by their society or by marketer; they exist in the very texture
of human biology and the human condition.
Wants are desire for specific satisfiers of these deeper needs. Although
peopie's needs are few, their wants are many. Human wants are shaped
and reshaped by social forces and institutions, such as churches, schools,
families, and business corporations.
Demands are wants fbr specific products that are backed by an abiiity and
willingness lo buy them. Wants become demands when supported by
purchasing power. Many people wants a Mercedes; only a few are 18
able and willing to buy one. Companies must therefore measure not only
how many people want their product but, more important, how many
would actually be willing and able to buy it.
2.1 AN OVERVIEW OF MARKETING
Companies and marketers cannot survive today by simply doing a good
job. They must do an excellent job; especially when it has to do with the
marketing of specialized product (businesses) if they are to succeed in the
increasingly competitive global market place. Consumer and business
buyers face an abundance of suppliers seeking to satisfy their evefy need.
Studies have demonstrated that the key to profitable company
performance is knowing and satisfying target customers with competitively
superior officers, And marketing is the company function charged with
defining customers targets and the best way to satisfy their needs and
wants competitively profitably.
Marketing has its origin in the fact that humans are creatures of needs and
wants, Since many products can satisfy a given need, product choice is
guided by the concepts of value, cost, and satisfaction. These products
are obtainable in several ways: self-production, coercion, begging, and
exchange. Most modern societies work on the principle of exchange.
People specialize in producing particular products and trade them for the
other things they need. They engage in transactions and relationship
building. A market is a group of people who share a similar need. I9
Marketing encompasses those activities involved in working with markets,
that is, in trying to actualize potential exchanges.
Marketing management is the conscious effort to achieve desired
exchange outcomes with target markets. The marketer's bask skill lies in
influencing the level, timing, and composition of demand for a product,
service, organization, place, person, or idea.
Five alternative philosophies can guide organizations in carrying out their
marketing work. The production concepts holds that consumers will
favour products that are affordable and available, and thkrefore
management's major task is to improve production and distribution
efficiency and bring 'down prices. The product concept holds that
consumers will favour quality products that are reasonably priced, and
therefore little promotional effort is required. The selling concept holds
that consumers will not buy enough of the company's products unless they
are stimulated through a substantial selling and promotion effort. The
marketing concept holds that the main task of the company is to
determine the needs, wants, and preferences of a target group of
customers and to deliver the desired satisfactions. Its four principles are
target market, customer needs, coordinated marketing, and profitability.
The societal marketing concept holds that the main task of the company is
to generate customer satisfaction and long run consumer and societal well-
being as the key to satisfying organizational goals and responsibilities.
2.2 MARKETING FINANCIAL SERVICES
Since the end of 80rs, the financial services sector has been subjected to
an unprecedented scale of deregulation and hence intensive competition.
Financial products consumers now think increasingly in terms of qualities
rather quantities. Consumers do not want more of the same, but different
and better. They are increasingly aware of alternatives on offer and rising
standards of service and quality are elevated and they are increasingly
critical of the quality of sewice they experienced.
Marketing thinking developed initially in connection with selling physical
products such as toothpaste, cars, steel, and equipment. Yet one of the
major trends worldwide has been the phenomenal growth of services.
Services industries are quite varied. The government sector, with its
courts, employment services, hospitals, loan agencies, rnilitay sewices,
police and fire departments, post offices, regulatory agencies, and schools,
is in the service business.
A private non-profit sector, with its museums, charities, churches, colleges,
foundations, and hospitals, is in the service business. A good pari of the
business sector, with its a trlines, banks, computer service bureaus, hotels,
insurance, companies, law firms, management consulting firms, 2 1
medical practices, motion picture companies, plumbing repair companies,
and real estate firms are in the service business.
Many workers in the manufacturing sector are really service providers,
such as the computer operators, accountants, and legal staff. I n fact, they
make up a 'service factory" providing services to the "goods factory".
Not only are there traditional sewice industries, but new types keep
popping up all the time.
"For a fee there are now companies that will balance your budget, drive
you to work. Or you want to rent a garden tractor? I f it is a business
service you want other companies will design your products, handle your
data processing, or supply temporary secretaries or even executives"
2.3 SOME DEFINITIONS OF SERVICES
A service is any act or performance that one party can offer to another
that is essentially intangible and does not result in the ownership of
anything. Its production may or may not be tied to a physical product
(Kotler, 1996).
Operationally marketing is concerned with the happiness, satisfaction and
pleasure given by the representative of an organisation to the consumer of
tangible and intangible goods.
The essence of this definition is to clarify two fundamental principles.
These are:
1. Services is prevalent in all organization activities i.e. whether
manufacturing or non-manufacturing.
2. The concept of services would have gone through the marketing
process of articulating the specified need in terms of services which
is required as part of service delivery.
Ey and large the degree of services requirement in every
organization vary from profession to profession. Some
organizations have become synonymous with sewice. They include
the following:
a. Hospitality Services: Catering, hotels, tourism, entertainment,
radio, television, leisure.
b. Financial: banking, insurance, pensions, property services,
accounting.
c. Heath services: medical/para-medical, hospitals, ambulances,
medical laboratories, dentists, opticians.
d. Professional: building design (architects), surveying, legal, law
enforcement, security, engineering, product management,
quality management, consultancy, training and
23
e. Technical: consultancy, photography, test laboratories.
f. Utilities: cleansing, waste management, water supply, ground
maintenance, electricity, gas and energy supply, fire, police,
public services.
g. Trading: wholesale, retail, stockist, distributor, marketing,
packaging.
h. Scientific: research, development, studies, decision aids.
i. Communications: airports and airlines, road, rail and sea
transport, telecommunications, postal, data.
j. Purchasing: contracting, inventory management and
distribution.
k. Administration: personnel, computing, office services.
I.. Maintenance: electrical, mechanical, vehicles, heating systems,
air conditioning, buildings, and computers.
2.4 CHARACTERISTICS OF SERVICES
A. Intangibility - Services are intangible. Unlike physical products,
they cannot be seen, tasted, felt, heard, or smelled before they are
bought. Therefore, the service provider's task is to "manage the
evidence", to "tangi b ike the intangible"
B. Inseparability - Services are typically produced and consumed
simultaneously. This is not true of physical goods that are
manufactured, put into inventory, distributed through multiple
resellers, and consumed later. Both the provider and the client
affect the service outcome.
C. Variability - Services are highly variable, since they depend on
who provides them and when and where they are provided. Service
firms can take three steps toward quality control.
1 Investing in good personnel selection and training.
2. Standardizing the sewice performance process.
3. Monitoring customer satisfaction through suggestion
and complaint systems.
D. Perishability - Services cannot be stored.
2.5 MARKETING STRATEGIES FOR SERVICE FIRMS
Service business is more difficult to manage using a traditional marketing
approach. As services competition intensifies, more marketing
sophistication will be needed. One of the main agents of change will be
product marketers who move into service industries.
2.5.1 DIFFERENTIATION STRATEGIES
Service marketers frequently complain about the difficulty of differentiating
their services from those of competitors e.g. Banking that offer fmancial
services, once customer view a service as fairly homogenous, price would
therefore become a dominant factor as opposed to the service provider.
The solution to price differentiation is to develop a differentiated offer,
delivery, and image - innovations.
However, the major problem is that most service innovations are easily
c y + ~ ! . Few of them are preemptive in the long run. Still, the service
company that regularly researches and introduces service innovations will
gain a succession of temporary advantages over competitors, and through
earning a reputation for innovation, may retain customers who want to g0
for the best.
The service company can differentiate its service delivery in three ways,
people, physical environment, and process (the 3P's of service marketing).
A service company can differentiate itself by having more able and reliable
customer contact people than its competitors, develop a more attractive
physical environment In which service is delivered.
Finally, a service company can design a superior delivery process, such as
home banking.
2.5.2 CONCEPTS OF VALUE
The term "value" is used to connote different meanings. The different
concepts of value are significant for different purposes. Therefore, it is
useful to discuss the various meanings of value to provide contrasts with
each other and to appreciate the appropriateness of each of them
(I.M.Pandey, 1979).
2.5.3 TRUE CONCEPT OF VALUE
An asset or resource has value to the firm or an individual only because it
generates cash inflows. Value is the function of the cash inflows and their
timing and risk.
When the cash inflows are discounted a t an appropriate, or required, rate
of return to account for their timing and risk, we get the value or
appropriately the present value of the asset. In financial decision making
in general and the valuation of securities, the term fair, or intrinsic value is
used to refer to the present or true value of assets or securities.
2.5.4 TIME VALUE OF MONEY (lVM).
The recognition of the time value of money is extremely vital in financial
decision making.
In simplified form, a Naira expected in the future is not equivalent to a
Naira held today, because of the time value of money. We can invest the
Naira available today to earn interest, so that it will increase in value more
than one Naira in the future. Consequently we would rather receive a
Naira now than receive the same amount in the future, even if we are
certain of receiving it later.
Interest is the payment made for the use of money. Thus, an interest rate
is the measure of the time value of money.
2.6 FINANCIAL SECURITIES VALUATION TECHNIQUES
Breadly & Myers (1991) refers to financial assets (securities) as pieces of
paper that have value because they are claims on firm's real assets.
Financial assets include not only shares or stock, but all forms of debt
instruments and issuance, bank loans/deposit, lease obligation and so on.
2.6.1 ASSET VALUATION
One approach to valuation is to look at the underlying worth of the assets
of the business. Asset valuation is one measure of the investor's exposure
to risk. I f within the company there are assets whose market value
approximates the price of the company plus its liabilities, the immediate
downside risk is low. I n some instances an increase in the value of the
assets of a company may represent a major portion of the investor's
anticipated return. The various approaches to asset valuation include:
2.6.2 BOOK VALUE
The most obvious asset value that a prospective purchaser can examine is
the book value. I n a situation with many variables and unknowns it
provides a tangible starting point. The accounting practices of the
company as well as other things can have a significant effect on the firm's
book value. For example, if the reserve for losses on accounts receivable
is too low for the business it will inflate the book value and vice versa.
Similarly treatment of asset accounts such as research and development
costs, patents, organization expense, and so on, can vary widely.
Nevertheless, the book value of a firm provides a point of departure when
,considering asset valuation.
2.6.3 ADJUSTED BOOK VALUE
An obvious refinement of stated book value is to adjust for large
discrepancies between the stated book value and actual market value of
tangible assets, such as buildings and equipment which have been
depreciated far below their market value, or land which has substantially
appreciated above its book value which stands at the original cost. An
adjustment would probably also reduce the book value of intangible assets
to zero unless they, like the tangible assets, also have a market value.
The figure resulting from these adjustments should more accurately
represent the value of the company's assets.
2.6.4 LIQUIDATION VALUE
One step beyond adjusted book value is to consider the net cash amount,
which could be realized if the assets of the company were disposed of in a
"quick sale" and all liabilities of the company paid off or otherwise settled.
This value would take into account that many assets, especially inventory
and real estate, would not realize as much as they would were the
company to continue as a going concern or were the sale made 'more
deliberately. Also, calculation of a liquidation value would make
allowances for the various costs of carrying out a liquidation sale.
The liquidation value, it should be noted, is only an indication of what
might be realized if the firm were liquidated immediately. Should the
company continue its operations and encounter diff~culties, most likely a
subsequent liquidation would yield significantly less than the liquidation
value calculated for the company in its current condition.
The liquidation value of a firm is not usually of importance to a buyer who
is interested in the maintenance of a going concern. One would assume,
however, that the liquidation value represent some kind of a flow below
which the seller would be unwilling to sell because he should be able to
liquidate the company himself.
30
2.6.5 REPLACEMENT VALUE
The current cost of reproducing the tangible assets of a business can at
times be significant in that starting a new company may be an alternative
means of getting into business. It sometimes happen that the market
value for existing facilities is considerably less than the cost of building a
plant and purchasing equivalent equipment from other sources.
In most instances, however, this calculation is used more as a reference
point than as a seriously considered possibility.
2.6.6 EARNINGS VALUATIONS
A second common approach to an investor's valuation of a company is to
capitalize earnings. This involves multiplying an earnings figure by a
capitalization factor or price earnings ratio. Of course, this raises two
questions: (1) which earnings? And (2) what factor?
Earnings figure:
One can use three basic kinds of earnings:
Historical Earnings: The logic behind looking at historical earnings
is that they can be used to reflect the company's future
performance; there is no logic in evaluating a company on the basis
of what it has earned in the past. Historical earnings should be
given careful consideration in their use as a guide to the future.
3 1
They should provide concrete realism to what otherwise would be
just a best guess.
Historical earnings per se can rarely be used directly and an
extrapolation of these figures to obtain a picture of the future must
be considered a rough, and frequently a poor, approximation. To
gain the benefit from the information in a company's financial
history of past operations, it is necessary to study each of the cost
and income elements, their interrelationships, and their trends.
In pursuit of this study it is essential that random and non-recurring
items be factored out. Expenses should be reviewed to determine
that they are normal and do not contain extra ordinary expenses nor
omit some unusual expenses of operations.
For example, inordinately low maintenance and repair charges over
a period of years may mean that extra ordinary expenses will be
incurred in the future for deferred maintenance. Similarly
nonrecurring "windfall" sales will distort the normal picture.
I n a small, closely held company particular attention should be given
to the salaries of owner-managers and members of their families. I f
these salaries have been unreasonably high or low in the light of the
nature and the size of the business and the duties performed,
3 2
adjustment of the earnings is required. An assessment should also
be made of the depreciation rates to determine their validity and to
estimate the need for the any earnings adjustments for the future.
The amount of federal and state income taxes paid on past may '
influence future earnings because of carryover and carry back
provisions in the tax laws.
Future Earnings Under Present Ownership: These are the earnings
figures which are relevant to the investor who is investing in the
turnaround of a dying company or in the reinvigoration of a
stagnant one.
The basis for the figures - assumptions, relationships between costs
and income, and son on - will probably show significant variance
from the company's past performance.
Plans may be to change substantially the nature of the business,
The evaluation and investment decision may also involve large
capital investments in addition to the purchase price of the
company.
It is the future earnings of the operation of the business which are
helpful in determining the value of the company to the entrepreneur
as these are the earnings which would influence the economic
33
return. Most likely these kinds of projections will have large
elements of uncertainty, and one may find it helpful to consider
high, low, and most likely outcomes for financial performance.
In addition to deciding on an earnings period upon which to focus,
there is also the issue of "what earnings" That is, profit before tax,
profit after tax, operating income or earnings before interest and
taxes (EBTT), Most valuations look at earnings after tax 9 but
before extraordinary items. Of course, the most important rule is to
bc consistent: do not base a multiple on earnings after fax, and
then apply that rnultipk to EBTT. Beyond this, the most important
factor to consider is precisely what you are trjing to measure in
your valuation. A strong argument can be made for using EBIT.
This measures the earning power and value of the basic, underlying
business, without the effects of financinq.
This particularly valuable approach if the entrepreneur is
contemplating using a different financial structure for the business
in the future.
2.6.7 PRICE - EARNINGS MULTIPLE
Next, we have the issue of what multiple to use. Assuming that the
investor's primary return Is anticipated to result from sale of the stock at
some future date, the investor should then ask the question: given the
34
anticipated pattern of earnings of this company, the nature of the industry,
the likely state of the stock market, and so on, what will the public or
some acquisitive conglomerate be willing to pay me fgr my holdings? I n
terms of multiple of some earnings, what prices are paid for stock with
similar records and histories? To estimate with any degree of confidence
the future multiple of a small company is indeed a difficult task. I n many
instances working with a range of values might be more helpful. This
great uncertainty for a potential investor in estimating both a small
company's future earnings and future market conditions for the stock of
that company in part explains why his return on investment requirements
for a new venture investment are so high.
Again it is important to be consistent: always derive the multiple as. a
function of the same base you wish to apply it to:
Up until this point, we have been discussing methods of arriving at a value
for the business as a whole. White the entrepreneur is naturally concerned
with this issue, s/he is also concerned with the valuation of his/her piece of
the business.
Residual pricing is a technique which addresses this issues, Essentially,
residual pricing involves:
Determining the future value of a company in your 'n" through one of the
methods described above. 35
Applying a target rate of return to the amount of money raised via the
initial sale of equity.
Using this information to develop a point of view on how much equity the
entrepreneur must give up in order to get the equity financing required.
The 'residual" or remaining equity can be retained by the entrepreneur as
his return.
For example, if a company is projected to have earnings of Nl00,OOO in
year 5, and if (after some analysis) it seems that the appropriate PIE for
the company is 10, than we can assume that the company will be worth
N100,OOO in year 5. Now if we know that the entrepreneur needs to raise
NS0,000 from a venture capital firm (in equity to start the business, and if
the venture firm requires a 50% annual return on that money then that
N50,000 needs to be worth N50,000 X (1+50°h)=N380,000. So in theory
a t least, the entrepreneur would have to give 38% of the equity to the
venture firm in order to raise this money.
2.7 CASH FLOW VALUATIONS
Traditional approaches to evaluating a company have placed the principal
emphasis upon e m . Assuming that the company will continue in
operation, the earnings method posits that a company is worth what it can
be expected to earn.
But this approach is only partially useful for the individual entrepreneur
who is trying to decide whether or not to invest in a business. Again, the
entrepreneur must distinguish between the value of the business as a
whole and the portion of that value which can be appropriated fa; himself
or herself. The entrepreneur must address the need to acquire resources
from others, and must understand that she/he will have to give up a
portion of the value of the business in order to attract these resources. .
I n addition to personal or subjective reasons for buying a business, the
entrepreneur's chief criterion for appraisal will be return on investment.
Because an entrepreneur's dollar investment is sometimes very small, it
may be useful to think of return more as a return on his or her time, than
a return on his or her dollar investment.
To calculate the latter return, the entrepreneur must calculate his or her
individual prospective cash flow from the business. I t is the entrepreneur's
return from the business, rather than the return inherent in the business
itself, which is important. 3 7
There are several different types of cash flow, which can accrue to the
entrepreneur. They include:
2.7.1 OPERATING CASH FLOW
Cash or value which Rows out of the business during its operations. This
includes:
Perquisites: Perquisites are not literally cash at all, but can be
considered cash equivalents in terms of their direct benefits.
Business related expenses charged to the company (e.g. .company
car and country club memberships) are received by the individual
and are not taxed at corporate or personal level.
Their disadvantage is that they are limited in absolute dollar terms.
Return of Capital via Debt Repayment: This class of cash flow
is a tax free event at both the corporate and personal level. An I I
additional advantage to this type of flow is that it can occur while
enabling the entrepreneur still to maintain a continuous equity
interest in the company. Its disadvantage is, is, of course, that it
requires him/her to make the original investment.
Interest and salary: both of these items constitute personal
income and are taxed as such at the personal level, However, no
tax is imposed at the corporate level.
38
Dividends: As a means of getting cash from a venture, dividends
are the least desirable as the resulllng cash Row has undergone the
greatest net shrinkage. Dividends incur taxes first at the corporate
level (at the 15% or 30% rate as income accrues to the
corporation) and then again at the personal level (at the personal
income tax rate as the dividend payment accrues to the individual).
At the maximum corporate income tax rate of 30% and the
maximum personal income tax rate of 2%, we can see that this
double taxation can reduce N l of pre tax corporate profit to N0.45
after tax cash flow to the individual.
2.7.2 TERMINAL VALUE
Another source of cash is the money the entrepreneur pulls out of the
business when the venture is harvested. Again, there are several
elements to this aspect to return.
Return on Capital via Sale: I f the owner/manager sells all or part of the
business, the amount he receives up to the amount of his cost basis is a
tax free event a t both the corporate and personal level. Since a sale of his
or her interest is involved, however, it is evident that, unlike a return of
capital via debt repayment, the owner/rnanager does not maintain his or
her continuous equity interest in the concern. Also, like a cash flow based
on debt retirement, an original investment is necessary.
Capital gain via Sale: When capital gains are realized in addition to the
return of capital, no tax is imposed at the corporate level, and the tax rate
a t the personal level is less than regular income.
2.7.3 TAX BENEFITS
While not precisely cash flow, tax benefits can enhance cash flow from
other sources. For example, if a star-up has operating losses for several
years, and if these losses can be passed through to the individual, then
they create value by sheltering other income. Because entrepreneurs are
often in a low income phase when starting a business, these tax denefits
may be limited value to them. However, if properly structured, these tax
benefits can provide substantial value to investors. I n a situation when
the structure and form of the organization (i.e. a corporation, does no!:
permit the losses to flow through to the individual, these losses can be
used to offset income of the corporation in prior or future years.
The entrepreneur must also take into account his negative cash flows.
Three types of negative cash flows are particularly important.
Cash portion of the purchase price.
6 Deficient salary.
Additional equity capital.
Frequently the most critical aspect of the cash portion of the purchase
price is that it must be small enough for the entrepreneur to be able to
pay it in the first place, I n this kind of situation the seller finances the
purchase of his company by taking part of the purchase price in the form
of a note. The seller then receives cash later on from future earnings of
the company or from its assets. Of course, the less cash she/he is
required to put up the more cash the entrepreneur has available for other
uses and the greater the opportunity he has to produce a high ROI.
u~t tile oher hand, too much initial debt may hamstrung a company from
the start, thereby hurting the venture's subsequent financial performance
and the entrepreneur's principal source of return - be it the cash
withdrawn from the company or the funds received from eventual sale of
the company.
The significance to the entrepreneur of a negative cash flow based on a
deficient salary is clear - a lower income for personal use than could be
obtained elsewhere. I n addition, there is the effect that these early
negative cash flows may have on the entrepreneur: faced with an
immediate equity requirement for working capitat or fixed assets, the
ownerjmanager may be forced to seek outside investors, thereby diluting
his or her future value in the business and also introducing the possibility
of divergent goals in the financial and other aspects of the company's
operations.
At this point in our analysis it will appear obvious to some that the next
step for the entrepreneur is to find the present value of the cash flow he
predicts for the venture. I n other words, discounting the value the value of
the future cash flows to arrive at a value of the venture in terms of cash
today. We shall see, however, that in many respeck this approach raises
more questions than answers and therefore its usefulness to the analysis is
questionable at best,
The essence of the problem is that present value is basically an investment
concept utilizing ROI to determine the allocation of a limited supply of
funds among alternatives, whereas the entrepreneur is faced basically with
a personal situation where return on both investment and time are key. In
addition, the entrepreneur may have made a considerable investment in
generating the particular option, and It is difficult to weigh this tangible
opportunity against unknown options. Because the entrepreneur does not
have a portfolio of well defined opportunities to choose from he needs to
define some standard comparisons. This typically the salary that could be
obtained by working.
In an investment analysis utilizing present value the discount rate is
selected to reflect uncertainty associated with cash flows; the higher the
uncertainty, the higher the discount rate and consequently the lower the
present value of the cash flows. I n the corporate context there is usually a
minimal ROI criterion for non critical investments to keep the ROI greater 42
than the firm's cost of capital.
For the individual entrepreneur, however, the decision to buy or start a
company is fundamentally a subjective one. Return on Investment and
time for this kind of decisions is measured not only in terms of dollars, but
also in terms of what s/he will be doing, who his or her associates will be,
how much time and energy will have to be expended, and what life style
will result. Different kinds of ventures Present different kinds of return on
time. As cash to the entrepreneur is as important enabling factor for some
"f the things entrepreneur is seeking, it is important that she/he &ulate
what these cash flows might be and when they can be expected.
However, because decisions affecting cash flow also affect the pother
returns may be at least as important as the financial returns, a present
value calculation often is not the most important measure.
In thinking about the attractiveness of a particular opportunity an
entrepreneur rarely has similar situations as alternatives to compare. More
than likely the decision is either to go ahead with a venture or to stay
where she/he is until something else comes along. Perhaps the most
useful way to think of this position is to imagine an individual looking down
the corridor which would provide a range of opportunities - opportunities
to achieve different levels of financial and other rewards with their
accompanying risks and sacrifices. Financial theorists, for instance, have
recently begun to study investments in terms of their ability to generate a
future stream of growth opportunities.
2.8 SUMMARY OF RELATED LITERATURE
It is important to remember that no single approach will ever give the
'right" answer. To a large extent, the 'appropriateness of any method
depends upon the evaluator. However, both in this study and in "real lifef'
one must come to some point of view on the worth of a firm, no matter
how scant the data. This is vety important, even if the value is only a
yr t i i ~ i i i t~a ty one, because it permits the individual to delve further 'into the
issues at hand.
Nonetheless, the true purpose of the analysis is not to arrive at "the
answer" but lay a solid foundation for a financial asset marketer to,
identify critical assumptions;
evaluate the interrelationships among elements of the
situation to determine which aspects are crucial;
develop realistic scenarios, not a best case, worst case
analysis;
surface and understand potential outcomes and
consequences, both good and bad; and
examine the manner in which the value of the business is
being carved up to satisfy the needs of prospective
suppliers of resources.
No single valuation captures the true value of any firm. Rather its value is
a function of the individual's perception of opportunity, risk, the nature of
financial resources available to the purchaser, the prospective strategy for
operation, the time horizon of the analysis, alternatives available given the
time and money invested and prospective methods of harvesting. Prince
and value are not equivalent. I f the entrepreneur pays what the business
is worth, he has appropriated any value for himself. The difference is
determined by information, market behaviour, pressure forcing either
purchase or sale, and negotiating skills.
Brealey & Myers: Princi~les of Corporate Finance
(4m ed., 1991, McGraw Hill pp. 3-5, 339-343)
Jennings, R: Financial Accountinq (5" ed. 1995 ME, pp. 37-47 and
58-69)
Kotler, Phillip: Marketing manaqement - Analvsis, planninq,
Imolementation, And Control (8th ed., 1996, PHI pp.
15-32, 92-93 and 463-485).
Magee, 1.0: Com~anv Accounts (3rd ed., 1985 ME pp. 7-19 and 79-
88)
Pandey, 1.M: Financial Mana~ement (Vani Educational books, 1987 pp.
41-62)
6. Paul, E.G. & Donald ST: Research for Marketins Decision (4th ed., Mc
Graw Hill pp. 3-9 and 37-46)
7. Qazi, Z et al: Business Mathematics (3rd ed., 1985, Vikas Press pp. 67-
84)
8. Weston, 1.F: "New Themes in Finance", Journal of Finance, Vol. 24,
March 1974 pp. 237-243,
9. Van Home, J.C. Finance Management And Policy (10'" ed., PHI pp. 919
and 143-177)
CHAPTER THREE
3.0 RESEARCH METHODOLOGY
Most people buy or sell a business/financial asset either in part or in whole
to fill an important need.
I n this regard a marketer need to do a rigorous evaluation of the many
valuation techniques for shefhe to be able to satisv this diverse need of
financial assets consumer appropriately.
To achieve a thorough evaluation of the techniques, research
objectives/questions and the hypothesis are restated and the study area
clearly defined. Similarly, procedures of analysis are clearly defined, while
the limitation of the methodology is stated.
3.1 RESEARCH OBJECTIVES
To tackle the above problem, the research objectives are:
1 Establishing the concept of value and valuation, on the business as
a financial product (service).
2. Xray analytical method/s that would facilitate an understanding of
assets and business valuations.
3. Develop an effective and result oriented marketing programme for
business sales.
Integrate the 4 P's of marketing in assets valuation models.
RESEARCH QUESTIONS
What are the main approaches to the valuation of assets/business
and how are they appraised?
How would a marketer develop a marketing programme that can
influence and benefit a potential investor or purchaser?
; ;ir r~ La 11 financial services provider/marketer in the context of
marketing for businesses improve their product offering, to ensure
optimum benefits to financial services consumers; for
assets/business valuation and purchase?
HYPOTHESIS
Effective valuation of assets/business is critical to marketing of businesses.
3.4 RESEARCH DESIGN AND PROCEDURES
In order to develop a meaningful marketing programmes for financial
securities, quantitative techniques would be applied on illustrative
examples and on a typical financial statement of an unquoted company,
This will involve the application of algebraic, accounting formulas, ratios
and charts on all the valuation methods as stated in chapter two,
49
Analysis, interpretation would also be applied on the figures obtained to
enable the marketer (seller) and the buyer arrive at rational and optimum
decision.
3.5 LIMITATIONS OF THE STUDY
The appraisal of valuation models was conducted as a tool of marketing
assets/businesses. The appraisal placed emphasis on financial valuation
methods in spite of the fact that there other ways to arrive at the value of
an asset. This clearly is a limitation of the study and it therefore makes
generalization of the concept difficult.
The study was also only able to use illustrative data and a company
(Akwete Nigeria Limited - Unquoted) as a demonstration of the
techniques. This due to non availability of many non-quoted companies
financial statements since they are not necessarily compelled by law to
publish their result.
REFERENCES
I, Asika, Nnamdi, Research Methodoloqv in Behavioural Science. Is' ed,
Longman Nigeria, 1991, pp. 1-13 and 79-82
CHAPTER FOUR DATA PRESENTATION AND ANALYSIS
4.0 DATA ANALYSIS
To invest is to acquire ownership of income generating securities issued by
others. Security evaluation therefore takes a total systems view. The
evaluation process relies on an overall assessment of the performance of a
firm in order to assess the worth of specific securities issued by it.
Most valuations are carried out by or on behalf of investors who would like
to know whether total benefits anticipated from a given investment
opportunity justify the amount of time and money involved. This is
because genuine activities are undertaken in anticipation of economic
rewards. No rational investor will therefore commit his funds unless he
anticipates a rate of return which is commensurate with the level of risk
assumed.
The objective of this chapter is to examine the basic principles underlying
the valuation methods employed for valuing businesses:
Asset Based Valuation Methods;
Cash-Flow Based Valuation methods;
Earnings Based valuation methods;
4.1 ASSET BASED METHOD
Assesses a company's value as the net value of its undertakings.
The present value of a company's existing assets and goodwill:
Equity = Present Value (PV) of Existing Assets - PV of liabilities
PV of Assets = PV of Existing Investments + Net Present Value (NPV) of
future Investments.
PV of Assets = PV of Existing Products + NPV of New Product + PV of
Residual Values of Assets.
Valuation of Existing Assets:
Economic value in existing use
Second-hand market value
Written down replacement cost
Written down Historical cost.
Drawbacks:
Not suitable in going-concern situation.
Net assets may generate revenues under or above asset value
4.2 CASH FLOW BASED METHOD
Assesses company value as the discounted stream of future
cash flows
Considered the best method, but requires estimate to be
made of:
- future cash flows;
- an appropriate risk-adjusted discount rate;
ESTIMATING FREE CASH FLOW
Earnings after tax
+ Depreciation and other non cash charges
+ Interest after tax
- Replacement Expenditure
= Change in net working capital
+ R & D Expense after tax
= Free Cash Flow from Existing Products.
4.3 EARNINGS BASED VALUATION METHODS
P/E Ratio and EBITDA methods.
are relatively simple/rnost commonly used;
allow for easy comparisons with other companies (particularly
companies in the same market sector)
Part of everyday world stock markets vocabulary.
However:
do not satisfactorily account for time value of money; and
suffer from arbitrariness of earnings based on different
accounting policies employed.
Algebraic Formula for Valuation
Earnings Yield basis method:
1. VB=MPS
EPS
Where: VB = Value of business (shares)
EPS = Earnings per share
MPS = Market price per share
Note - Current maintainable earnings is that earnings that is expected a
company would be able to maintain for the foreseeable future.
2. Dividend yield basis:
Here, the value of a business is the capitalized value of the current
dividend payment i.e,
5 5
VB = TEAD
OY
or TEAD
OY - DGR
TEAD = Current annual dividend
OY = Opportunity yield
DGR = Dividend Growth rate
Note: opportunity yield is the likely return from a similar investment as
business being valued.
DGR - is applicable where there is expected growth in dividend.
3. Book Value Method:
This involves valuing on the basis of Net Tangible Assets of the
business. It is usually argued that this is the lowest price that the
owner of the business will be ready to accept i.e.
VB = (TA - [CL + LTL]
Where:
VB = Value of the business
TA = Total assets (current year)
CL = Current Liabilities
LTL = Long - term liabilities 56
4. Assets + Goodwill method
This involves valuing a business on the basis of net tangible assets
plus a provision for goodwill which is calculated on any of the
acceptable methods: arbitrary, the number of years purchase of
average profits, a number of years super profits and capitalization of
earnings method.
VB = Book value of Net Tangible assets + Goodwill
5, NPV of future cash flows method
This method treats the valuation of a business as an investment
decision hence an attempt is made to calculate the NPV of expected
cash flows from the business:
Where fi, f2, f3, ... fn are the net cash inflows in respective years.
n = estimated life of the business
r = rate of return or cost of capital
6. Replacement Cost method
Under this method the asset of the business are valued at what it
will cost if they, are to be replaced at current market prices in their
current position.
7. Liquidation (Break-up) method
Liquidation value of a business is the amount, of money.,that could
be realized from an immediate sale of assets less the amount
required to settle long term liabilities. Also any incidental cost for
realization/liquidation should be provided for. Where preference
shares are in issue, then their liquidating value should be deducted
in arriving at the value of the ordinary shares.
8. Market Price Method
This method of valuation is only applicable to companies whose
shares are quoted on recognized stock exchanges. The value of the
business is this case is simply the product of the market pricelshare
and the number of shares in issue. However, the method has a
basic shortcoming that market price fluctuates almost on a daily
basis. Value of business, therefore will be:
VB = MPS X NSI
Where:
VB = Value of Business
MPS = Market Price per Share
NSI - No of shares in issue.
4.4 DECISION OR ADVISE RULE:
In taking a decision or giving advice or commenting on the valuation
ofa business based on all or some of the above basis of calculation,
one should not jump into a conclusion based on his judgement.
Rather, all the pros and cons of the different method used in the
valuation should be discussed, Hence the demonstration of one's
understanding of the different methods is what the prospective
buyer required from the marketer.
Apart going through the merits and demerits, one would then be
able to come up with suggestion on the value,
The advise is also subject to other qualitative factors (external and
internal) such as the government policy, industry in which the
company operates, the general economic conditions, the ownership
of the business, the caliber of management and so on. ,;
DATA: FINANCIALS OF AKWETE NIGERIA LIMITED
The data of Akwete Nigerla Limited would be used to test the
valuation models quantitatively and qualitatively. The company is
59
unquoted and is therefore suitable for conceptual analysis given the
challenges the seller (marketer) and the buyer are likely to face in
arriving a t value. The marketer must therefore be above to present
all the options and thereafter advise the investor of rational decision
taking into consideration the investor's preferences e.g. risk and
return profile.
4.5 DATAPRESENTATION
SUMMARY BALANCE SHEETS AND INCOME STATEMENTS OF A W E T E
LTD.
Balance Sheetsat December 31St
Freehold Property
Equipment (less Dep.)
Stock-in-trade
Trade Debtors
Issued Share Capital
Revenue Reserves
Trade Creditors
Bank Overdraft
Income statement for the year ended 31 December
Sales 400000 440000 480000
Gain on sale of property - 28000 - - 4Q0000 468000 480000 -
Cost of gds sold & Rev. 312000 412000 480000 '
Depreciation of equip. 8000 8000 8000
Loss on Sales on equip. 24000 - -
Directors' ~ekuneration 20000 24000 28000
Net Profit
4.6 NOTES OF FINANCIAL STATEMENTS
A. The issued share capital of Akwete Ltd. is wholly owned by the
company's directors, who are considering an offer from Gombe Ltd.
to purchase all their shares in Gombe Ltd. would pay a total of eight
times the maintainable earnings of the company defined as the
average of net profit over the past three years. For this purpose,
net profit will be calculated after exclusion of extraordinary items,
after charging depreciation at replacement cost instead of historical
cost and after charging annual management salaries N18000
instead of directors' remuneration.
B. A t 31d December, 2001, the following information also relates to the
assets of Akwete Ltd.
1. Freehold properties have an estimated net realizable value of
N 120000. The acquisitfon of cornpara ble property would cost
N 128000 (including legal fees, etc).
2. Equipment was purchased on 1" January, 1999 for N00000.
At 31" December, 2000, the equipment has an estimated 8
years life (with nil scrap value on disposal at the end of that
life). Comparable new equipment with an 8 years life would
cost N80000 at 31St December 2001. The existing equipment,
if sold separately from the other assets of the business, would
realize only N48000.
3. Stock In trade has a net realizable value of Nli2000 if sold in
the normal course of business, but would realize only N88000
if sold on closure of the business.
4. Trade debtors are all considered good.
4.7 CLASSIFICATION OF ANALYSIS
A. Maintainable earnings.
62
Earnings yield basis (current year)
Book value basis
Liquidation (break-up) bask
Replacement cost basis
Comparative analysis
Decision.
4.8 ANALYSIS
Valuation on Maintainable Earnings Basis
Yrs 1999 2000
N'000 N'000
Net profit 36000 24000
Less: Gain on sale of Prop. - (28000)
Add: Loss on Sale of prop. 24000 -
Dep. @ Rep. Cost X-charges (2000) (2000)
Add: Surplus on Directors Rem. 2000 6000
60000 - Total N84000
Average Profit: N84000 - - N28000
2
I Value of Business: 8 X maintainable earnings = 8 x 28000 =
N224000
2, Valuation on Earnings Yield basis:
Value of Business: Total Earnincis Nr. 2001)
Earnings yield
= 16000
8%
2, Valuation on book value basis:
Book value of asset (current yr.) N288000
Less: current liabilities:
Trade creditors 60000
Bank overdraft 20000 (soooo)
N208000
Valuation on Liquidation basis:
Liquidation value of assets:
Freehold Property
Equipment
Stock
Debtors
Less:
Current liabilities 80000
Liquidation cost 4000 - 84000
N256000 --
Valuation of Replacement N
Freehold property 128000
Equipment cost 80000
Less: Depreciation 30000 (for 3 yrs) 50000
Stock 96000
Debtors 84000
358000
Less: current liabilities -- 80000
N278000 --
AKWETE LTD. ON 31- DECEMBER, 2001.
4.9 SUMMARY OF VALUATIONS USING VARIOUS TECHNIQUES
I Maintainable earnings
2. Earnings yield
3. Book value
4. Liquidation (break up)
5, Replacement Cost
4.9.1 Qualitative Analysis
Valuation on the basis of maintainable earnings yielded the amount of
N224000 which incidentally is the price being offered by Gombe Ltd.
Valuation on earnings basis resulted in the least value of N200000,
suggesting that the earnings capacity of the company is not too
encouraging. I n fact it can be noted that the original net profit declined
from N36 million 1999 to N26 million in 2001. Also the adjusted net profit
fluctuated from N60 million in 1999 to zero in 2000 and finally to N24
million in 2001.
Valuation on book value basis gave N208 million. This is the lowest value
that the shareholders of Akwete will be prepared to accept, because
proper& and stock are likely to realize higher values than the book value.
Valuation on liquidation basis resulted with N256 million thereby
suggesting that even in the event of forced sale of asset a higher value
than the amount presently being offered by Gombe Ltd will be realized.
Valuation on replacement cost basis yielded the highest value of N278
m l l h indicating that the prices of the company's assets are in'fluenced
positively by inflationary pressure.
4.10 ANALYST OPINION
The Shareholders of Akwete Ltd should be advised to accept a price that is
not lower than N256 million, however before a final decision is taken, the
following other factors should be considered:
1 The fact that Akwete Ltd is a private company and the
consent of all the shareholders will be required in order to
effect the sale.
2. Future plans of the Director's Akwete Ltd. ie. are they
retiring or do they intend to start a new business?
Note: It is assumed that the Marketer is analyst and s/he is
advising a prospective buyer of business/financial assets.
CHAPTER FIVE
5.0 SUMMARY OF FIND1 NGS, CONCLUSION, RECOMMENDATIONS AND SUGGESTION FOR FURTHER STUDIES
The purpose of the study is to appraise Valuation Models as a tool of
Marketing Sale and Purchase of Businesses. The study and analysis
reveals that:
It is the prospective income in the assets that gives them value and not
the assets in itself, Hence, several definitions of the word "value" is
applicable to assets, firm or shares have been advanced by authors in the
literature of valuation and are used in practice, with different one being
appropriate at different times. They include such values as: Liquidity
value, going concern value, organizational value, book (Balance sheet)
value, Market value and "fairft or "reasonable" value.
Essentially, the idea is that the concept depends on what one is interested
in at a particular point in time i.e. different values can be attached to the
same asset at different times or to different assets at the same time.
5.1 REASONS FOR VALUATION
As noted earlier, businesses or shares are purchased because of the
benefits they are expected to provide in future. The benefits may be
quantitative or qualitative.
Quantitative factors would include hope of better profit in future and
hence greater dividend. Also, it may be with anticipation of capital growth
in future.
Qualitative factors will include hope of acquiring an important distribution
channel of a company's product or to be in control of a vital raw material.
The factors that influence the value placed on a business or shares
inrlyjc:
Dividends policy of the company
Past and potential earning capability of the business.
The market price of the company's shares
The composition of the company's assets
Availability of raw materials (if a manufacturing company)
Market acceptability of the company's product
Ownership structure
Calibre of management.
INFERENCES
Based on the study the following inferences can be drawn:
1 That success or failure of any organization, business depends
largely on marketing functions.
70
That specialized product need specialized marketing strategy
That the major challenge faced by the seller (marketer) and
the buyer (investor) is how to determine value.
That every investment has "opportunity cost" i.e. fore going
some alternative. The marketer must therefore understand
these available alternatives competing for the limited
resources and develop a marketing programme that would
suit the idiosyncracies of the investor (consumer).
That services has peculiar characteristics as in - intangibility,
inseparability, variability, perishability (services cannot be
stored). That having this awareness is important to
developing an effective marketing programmes by the
marketer.
6 . That service business are most difficult to manage because of the
difficulty of product differentiation, service/strategy duplication by
other competitors.
5.3 SUMMARY OF FINDINGS
That there are many approaches to valuation of assets/business and that
the choice of approach depends on a lot of factor (quantitative and
qualitative). That they must be considered thoroughly before arriving at a
course of action (to buy, not to buy and at what price?).
5.4 CONCLUSION
Based on the study and the summary of findings the following conclusion
is reached:
That marketing of asset/busi~ess depends on thorough valuations using
different techniques. And that the marketer and the investor must have a
clear understanding of all the approaches before any meaningful decision
can be made by both parties for mutual benefits,
5.5 RECOMMENDATIONS
That any organization/business that wishes to succeed develop a coherent
marketing strategy. This may include thorough training for all the product
oVerings and services.
All valuation techniques must be employed before decisions to buy or sell
asset/business are taken. Such analysis must have regard for general
economic conditions, specific industry analysis, company analysis as to
competitive position, corporate management, financial performance and
the investor's preferences. This is to avoid sub optimal decision - making.
Heed the advise of Havard Professor of Marketing, Theodore Levitt, that:
There are no such things as service industries. There are only industries
whose service components are greater or less than those of other
industries. Evervbodv is in service.
5.6 SUGGESTIONS FOR FURTHER STUDIES
For further studies, it is suggested that a group of related and unrelated
companies quoted and unquoted be selected for analysis (correlational and
cross sectional analysis). This is with a view to determining different
values and their characteristic features to further expand the frontiers of
learning.
BIBLIOGRAPHY BOOKS
Asi ka, Nnamdi, Research Methodoloqv in Behavioural Science. 1* ed,
Longman Nigeria, 1991, pp. 1-13 and 79-82.
Brealey & Myers: Princi~les of Corporate Finance
(4m ed., 1991 McGraw Hill pp. 3-5, 339-343)
Brigham, E.F. - Fundamentals of Financial Management (sth Edition,
Dryden Press. Pp. 149-177).
Donnelly J.H. and Thompson, T.W., - Marketing Financial Services - A
Strategic Vision (Homewood, IL:
Pow Jones - Irwin, 1985), pp.
Drucker, Peter - Manaqement: Tasks, Res~onsibilities, Practices
(NY:Harper & Row, 1973), pp. 64-65)
Jennings, R: Financial Accounting (5m ed. 1995 ME, pp. 37-47 and 58-69)
Kotler, Phillip: Marketinq Manaqement - Analysis. Planninq,
Im~lementation And Control (sth ed., 1996, PHI pp. 15-32,
92-93 and 463-485)
Magee, 3.0: Comomv Acccunts (3rd ed., 1985 ME pp. 7-19 and 73-88)
Okafor, F.O.: Investment Decisions: Evaluation of Projects and Securities
(Cassell. London, 1983 pp. 1-21 and 150-159)
Olowe, R.A. - Financial Management: Concepts, Analysis and Capital
Investments (Brierly Jones Nigeria Ltd, Lagos - 1998 pp.
1-9)
Pandey, I, M: Financial Management (Vani Educational books, 1986 pp.
41-62).
Paul, E.G. & Donald S. T: Research for Marketinq Decision (4" ed. McGraw-
Hill, pp. 53-56)
Porter, M.E., - Competitive Advantage: Creating and Sustaining Superior
Performance (NY: Free Press, 1991, pp. 136-142)
Qazi, Z et al: Business Mathematics (3rd ed., 1985, Vikas Press pp. 67-84)
Staton, R: - Fundamentals of Marketing (4m ed., 1992, McGraw Hill, pp. 7-
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Weston, l F : "New Themes in Finance", Journal of Finance, Vol. 24, March
1994 pp. 237-243.
Van Home, JtC: Financial Management And Polin, (10'" ed., PHI pp. 3-19
and 143-177)
JOURNALS AND PRIODICALS
Berry, L., "Big Ideas in Service Marketing", Journal of consumer
Marketing, Spring 1986, pp, 47-51.
Elton, E.3, and Gruber, M.J. "Earnings Estimates and the Accuracy of
Exceptional Data", Management
Science, April 1972, pp. 409-424
Hastie, L.K., "One Businessr-rlanfs view of Capital Budgeting",
Financial Management, Vol. 3, Winter 1974, pp. 36-
44.
Lynn, G.S., "Breaking Free from Product Marketing" Journal of
Marketing, April 1977, pp. 73-90.
Theodore, Levitt, "Marketing Intangible Products and Product
Intangibles" HBR, May-June 1981, pp. 94-102.
Umeh, J.A., Feasibility and Viability Appraisal, Ibadan: Onibonoje
Publishers, 1977.
Weston, J.F. "New Themes in Finance" Journal of Finance, Vol. 24,
March 1974, pp. 237-243.
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