Business valuation models

Business valuation theory recognizes three broad approaches to estimating value: the income approach, the asset-based approach, and the market approach. The income approach uses a company’s estimated future income stream as a basis for value. The asset-based approach focuses on determining an entity’s collective asset values. The market approach applies market multiples of assets or income of comparable (peer) companies to estimate equivalent value
In recent years, these traditional valuation methods have been criticised for its failure to adequately capture value of managerial flexibility in plans and options that are not accounted for in discount cash flow methodology. The notion of viewing investment opportunities and managerial flexibility as options is drawn from financial options pricing model, specifically the Black-Scholes option pricing model. Although there are numerous literature of real option valuation applications for illustrative and real-settings, there is growing evidence that the assumptions underlying the Black-Scholes option pricing model are too simplistic or unavailable for pricing option on real assets. Furthermore, the estimation of several input parameters, e.g. the implied volatility, needed in the Black Scholes equation is not a trival exercise.  

Business valuation is as much of an art as it is a science. Although there are standard methods and hard data to generate exact and scientific formulation of valuation; depending on the different methods used, the valuation results will be different in any given business valuation. This variability (in valuations), however, may be understandable as participants in the market for a business will place variable values on the same business or collection of assets because the anticipated uses of these businesses or assets may be different for the different participants.

This sub-section reviews the income, asset, market and real option approaches to business valuation. An illustration of the Total Value Model as espoused by Peter Boer in "The Real Options Solution" is also made to show the economic and strategic value embedded in intangible factors.
Frankie Tan,
16 Feb 2009, 10:06