Value comes last

Value is what the cash is worth to a buyer who has other uses for money. It comes after the model, not before it. This chapter shows a deliberately simple valuation so the assumptions stay visible, and then lists the ways people nudge the number toward the price they have already seen.

Cash to the owner, not profit

Start from the cash the business can pay out without starving itself. In the workshop, that is cash from operations after the capital spending required to keep the workshop the size you assumed. A year with heavy spending on a new machine is a low year for this figure even if profit is fine. A later year, when the machine is in and spending falls back, is a high year. Using next year’s profit as ‘the cash’ skips both the working-capital trap and the machine. You already built those. Use them.

A simple discount, done in the open

Suppose, after a few years of explicit forecasts, you believe the business can pay out ₹12 lakh a year and that this can grow at 3% for a long time, and you require 12% a year to hold a small, risky workshop rather than a safer asset. One standard way to turn a growing perpetuity into a present value is next year’s payout divided by (required return minus growth), which here is ₹12 lakh × 1.03 / (0.12 − 0.03), about ₹1.37 crore. The formula is not the point. The point is that both 12% and 3% are yours, they sit in the input block, and a reader can push them. If you require 15% instead, the same payout is worth about ₹89 lakh. Nothing about the workshop changed. Your alternatives did. A valuation that cannot show this sensitivity is a valuation that has been aimed at a target.

The ways the number gets aimed

• Lowering the required return until the value matches today’s share price, and then describing the return as ‘reasonable’.
• Raising the growth rate into the perpetuity so that a short stretch of good years is treated as permanent.
• Forgetting the debt. The ₹1.37 crore above is a value of the business’s payouts. If the workshop owes ₹40 lakh that has to be repaid from those payouts, the equity is not worth ₹1.37 crore.
• Adding a ‘strategic premium’ with no cash behind it. If the premium is real, it changes units, price, or cost, and it should enter the model there.
• Using a multiple from a different company because it was handy. A multiple smuggles in someone else’s required return and someone else’s growth. If you use one, say whose, and say why the workshop deserves it.

Bring it back to the share

Whatever value you reach for the equity, divide by the number of shares that will exist, not by the number that exist today if you have assumed a new issue to fund the machine. Then compare with the price, and write one sentence on what would make you wrong: debtor days stretching, the margin failing to hold, the required return being higher because the business is riskier than you admitted. If you cannot name the assumption that does the work, you do not have a valuation. You have a multiplication.

What to remember

• Value the cash that can be taken out after the business has funded its own working capital and its necessary machines.
• Put the required return and the long-run growth in the input block, and show how the value moves when they move.
• Subtract the debt. Equity value is what remains.
• Do not edit the assumptions until the number matches the market price. That is the market’s valuation, which you can simply read.
• State the assumption that does the work, and the fact that would retire it.