Introduction to Corporate Finance

5: Valuing Shares

have several alternative approaches at their disposal for estimating the value of shares. Not all of these

methods involve discounted cash flow calculations, but in many cases, they may arrive at similar estimates

for the value of a share.

CONCEPT REVIEW QUESTIONS 5-3

5 How can the free cash flow approach to valuing an enterprise be used to resolve the valuation

challenge presented by companies that do not pay dividends? Compare and contrast this model

with the dividend valuation model.

5-4 otHER APPRoACHES to oRdINARY

SHARE VALUAtIoN

So far, we have discussed valuation methods that require analysts to discount future dividends or free

cash flows. These methods tend to work best for relatively mature, stable companies. Other methods

may be used to value companies in different circumstances. For example, when a company is performing

very poorly and is on the verge of going bankrupt, the value of the company’s shares may reflect only

the amount that analysts believe can be recovered by liquidating the company’s assets and paying off its

debts. Or consider a relatively young, high-growth company. Such a company may have no dividends and

negative free cash flow, because the investments that it needs to make in working capital and fixed assets

may exceed the company’s operating cash flow. In this situation, an analyst may value the company by

comparing it with other existing companies.

5-4a LIQUIdAtIoN VALUE, Book VALUE ANd RESIdUAL INCoME

MEASUREMENt

To calculate liquidation value, analysts estimate the amount of cash that remains if the company’s

assets are sold and all liabilities paid. In most cases, a company’s liquidation value is far below its

market value. That’s because a healthy company has competitive advantages, such as brand value or

intellectual property, which make it more valuable as a going concern. For instance, the total market

value of Google’s outstanding shares in mid-2015 was about US$471 billion, but the total assets that

the company owned (cash, plant and equipment) totalled about US$138 billion.^11 Google’s market

equity value in 2015 was based primarily on its ability to generate cash in the future by developing

innovative products and services.

However, there are times when it may be better to liquidate a company than to keep operating it. For

example, if a company owns valuable assets that could be sold, but it is not able to use those assets to

generate a profit, the shareholders may be better off if the company liquidates.

Unfortunately, estimating liquidation value is a challenge, because it is often difficult to know the

value of the assets appearing on a company’s balance sheet. As a starting point, analysts might look at

11 Data from Google Investor and Tech Times. https://investor.google.com/financial/tables.html and http://www.techtimes.com/

articles/70001/20150720/record-surge-googles-market-value-up-by-65-billion-on-friday.htm. Accessed 16 December 2015.

LO5.4

liquidation value

The value that remains after a

company’s assets are sold and

its liabilities are paid