Final Report

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Business Valuation Final Report Robert Stinson Georgia Southern University Dr. Chuck Harter November 30, 2023

Business valuation can be an arduous and ambiguous task. Analysis of published financial data requires a detailed understanding of the various approaches to business valuation. They are the market approach, the earnings-based approach, and the asset-based approach. Each method has its own strengths and limitations, and it is important to understand some companies may be better suited to an earnings-based approach, while the asset-based approach may provide a more complete picture for others. The intricacies of each company will provide criteria to determine the best approach or approaches. This report will serve as a framework for each approach. In addition, it will look at how each approach impacts the business valuation of General Motors (GM) and provide an analysis of the investment potential with the company. The first approach is market based. Simply, an analysis is performed to determine the business’s worth by comparing the company to similar firms. Public trading data is often critical to this approach. According to EY, “enterprise value can be estimated by observing the value at which titles for comparable businesses change, either on the capital market or on the mergers and acquisitions market,” (2023). Simply, companies that have been recently sold or have publicly available trading data can be used to determine the value of similar firms. There are several key factors in successful use of the market-based approach. The most important step is identifying the right companies to compare. Characteristics to consider include industry, revenues, recent growth trends, and geography. These are not the only relevant characteristics. Each market-based valuation will have its own set of details to consider when choosing comparable companies (EY 2023).

Applying valuation multiples is the next step in the market-based approach. Valuation multiples are ratios that evaluate financial metrics. Examples include the price per earnings ratio, enterprise value per net sales ratio, enterprise value per EBITDA, and others ( Multiples analysis 2023). These ratios will provide data points for comparison. As with selecting comparable companies, selecting the right multiples to evaluate is crucial. Industry and business type play large roles in determining the correct multiples to evaluate (EY 2023). There are several advantages of the market-based approach. First, the data needed to perform this analysis is often easily obtained. Public companies routinely publish audited GAAP financial reporting. This helps in selecting comparable companies and the relevant multiples, as well as improving transparency (EY 2023). It is also a simple approach. If analysis determines two companies are similar, it is logical to expect them to trade at similar prices. The recency of analyzed financial reporting also provides a current look at market. This also provides a potential drawback. In industries subject to high market volatility, the market-based approach will likely provide an inaccurate picture. In the analysis of GM, three multiples can be used as examples. First is EBITDA profit margin. Tesla and Ford were chosen as comparable companies:

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The five-year margin average shows Tesla as the highest. Their most recent reporting shows an almost seven-point improvement. Conversely, Ford and GM saw increases in this metric in 2021, but their 2022 results fell closer to historical averages. Price to earnings is another multiple that can be applied. The figures for the three companies are as follows: This provides an interesting comparison. All three companies faced considerable drops in their PE ratios in 2022. Falling stock prices drove down the numerator of this ratio, significantly dropping results. Ford posted negative earnings per share in 2022. GM saw the smallest percentage change in 2022. Stock price will be the final example for the sake of brevity: Auto manufacturers saw dramatic downward swings in stock price in 2022. When adding the most recent data as a reference point, all three companies saw notable downturns in share price since 2021. Ford and GM are still below their 12/31/2023 share price, but Tesla has seen a noted improvement.

A full market-based valuation would contain significantly more detail and analysis. However, if using the figures above, investing in GM appears a less than attractive prospect. The intention of the investor would play a large role in this decision. On a short-term basis, there are better investment choices. However, a long-term investment may be more sensible given GM’s historical performance over a longer period. The second approach to business valuation is the earnings-based approach. The central idea behind this approach is to use future potential earnings to estimate the business value (EY Netherlands 2019). The main component of this process is a discounted cash flow (DCF) analysis. DCF relies on two assumptions. First, valuation will be determined by projected future results. Second, projected earnings would have higher value if they could be had now. According to EY, future projections will be discounted to present value (PV). The discount rate is determined by the weighted average cost of capital (WACC). Risk assessment plays a large role in the discount rate. DCF analysis is more rigorous than the market-based approach. Although this method has its complexities, it can be applied to a wide variety of firms. As all firms expect earnings, and earnings projections can be used to value the firm. This approach can be tailored to a specific organization. The discount rate can also be adjusted if there are changes in a company’s risk assessment. However, it is important to note the complexities associated with this approach. All the inputs are assumptions. Assumptions can be prone to bias or incorrect calculations. Incorrect assumptions nullify any potential valuation. The need for complex calculations related to calculating future cash flows and discount rates adds an additional degree of difficulty

(EY 2019). Due to the potential difficulties in this approach, a detailed analysis and review are needed to ensure assumptions and calculations are proper. GM’s DCF analysis is as follows: Sales forecasts were determined by looking at historical performance and trending market conditions. There are concerning figures within this data. Net operating assets (NOA) rate of increase outpaces the increase in net operating profit after tax (NOPAT). This trend is not sustainable long-term. Increases in NOA means the company spent to increase its net assets. If the increase in spending outpaces earnings, severe financial difficulty will likely follow. Based on this DCF model, GM does not appear to be a suitable investment. The asset-based approach is the final valuation method. This method is best suited to companies where the value of its assets is the primary value of the firm. Income generation from these assets is not a focal point. However, assets and liabilities must be evaluated to determine their fair market values. Fair market value may differ wildly from book value, as GAAP directs firms to book values based on the lower of cost or market. This may not reflect the current economic reality (Mohendroo

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2017). The difference between fair market and book value provides the lens which asset-based valuation becomes valuable. This approach is known for its simplicity. There is no discounting or estimating future earnings. While determining fair value can be a tricky prospect, this approach is generally seen as easier than the earnings-based approach. This approach is also useful for companies facing liquidation, as the fair market values of assets can be used as a guideline for liquidating assets. When using this approach, determining the fair value of liabilities is also necessary because it impacts the net asset value (Mohendroo 2017). Useful lives and depreciated value also play a role in determining the difference in book and fair market value. There are limitations to this approach. As with the other approaches, industries subject to large market swings may not be ideal candidates for this method because determining the fair value of assets may be difficult. Intangible assets can also appear undervalued because of the inherent difficulties in valuing intangible assets (Mohendroo 2017). GM was not analyzed under the asset-based approach. There was insufficient time and data available to provide a clear picture of the fair value of the company’s assets and liabilities. The sheer volume of GM’s asset and liability portfolios makes this analysis a greater undertaking than is possible in a graduate level class. Business valuation is a fundamental part of markets. Investors and other stakeholders must take a detailed and nuanced approach to understanding and valuing a potential target. There is a myriad of factors to consider, and a detailed

understanding of the various valuation methods greatly simplifies the process. As for General Motors, the data within this report highlights some issues with the business. The firm is in an asset-heavy industry with large capital requirements. Recent market performance of the firm should generate hesitancy in potential investors.

References EY Netherlands. (2019, March 20). Startup valuation: Applying the discounted cash flow method in six easy steps . EY Netherlands. https://www.ey.com/en_nl/finance- navigator/startup-valuation-applying-the-discounted-cash-flow-method-in-six-easy- steps EY. (2023). How can value Realized Today Reshape tomorrow? - EY . Ernst & Young Support Services. https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/global-review/ 2022/ey-value-realized-2022-v3.pdf Mohendroo, M. (2017, Spring). Reading between the lines . Deloitte US. https://www2.deloitte.com/content/dam/Deloitte/xe/Documents/About-Deloitte/ mepovdocuments/mepovissue22/reading-between-the-lines_mepov22.pdf Multiples analysis . Corporate Finance Institute. (2023, November). https://corporatefinanceinstitute.com/resources/valuation/multiples-analysis/

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