University of Nigeria · University of Nigeria Research Publications Author OYEDEJI, Benjamin O. PG/MBA/99/0435 ... CHAPTER FOUR 4.0 Data Presentation and Analysis 4.1 Asset based

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

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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,

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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

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Paul, E.G. & Donald S. T: Research for Marketinq Decision (4" ed. McGraw-

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Porter, M.E., - Competitive Advantage: Creating and Sustaining Superior

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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

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Van Home, JtC: Financial Management And Polin, (10'" ed., PHI pp. 3-19

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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.