DR.A.M.HEGAZY & co

General Principles of Valuation :

The valuation of the company's assets are based on the use of some techniques and it is important to apply more than one technique and method for valuation in order to determine the fair value of the company’s share. The valuation of the company will be based on the following methods :

The historical cost method.
The adjusted historical cost method.
The replacement method.
The discounted profit or cash flow method.
The profit multiplier.

A- The valuation based on the historical cost method :

It is also known as the accounting valuation which is based on the audited financial statements and its related schedules in addition to the details included in the audit management letter. In accordance with the historical cost method, the book value of the company is calculated using the historical cost of the assets at the valuation date using the following steps :

Determine the historical cost of the company’s assets.
Determine the value of the company’s liabilities.
Determine the net book value of shareholders’ equity by subtracting (2) from (1) above.
Determine the book value of the company’s share by dividing the shareholders’ equity by the company’s number of shares.

In addition, the book value of the company’s share can be calculated by adding together capital, reserves, retained earnings (losses) and profit / loss of the year.
The historical cost method is considered an objective method of valuation as it is based on actual values reflecting actual business transactions for the company & supported by the company’s internal and external documents. Also, the historical cost method is considered simple in its application and aid in the determination of the company’s net worth (i.e. shareholder’s equity) and it represents the basis for the application of all other methods.
The disadvantage of the historical cost method is that it assesses the consistency of the value of the company’s assets during the period of acquisition until the period of valuation, a matter which won’t reflect the current market price of such assets. Moreover, the method does not take into consideration while determining the fair value of the company’s shares, the inflation rate, the fluctuation in exchange rate and the ability of the company to generate profit in the future.

B- The Valuation Based on the Adjusted Book Value:

The adjusted historical cost method is based on the use of the general price level index which reflects the modification in the general level of prices. Such method requires the changes of historical cost values for non – cash assets to its equivalent of cash value reflecting its cash purchasing power available at the date of the assets acquisition. Such method relies on the evaluation of the cash unit based on its ability to purchase the same group of products or assets under valuation depending on its current purchasing values.
There is a number of steps which should be followed when applying the adjusted historical cost method:

Prepare the company's financial statements under valuation using the historical cost basis.
Determine the general price level for changes in the value of cash units related to the needed cost to maintain a suitable standard of living in Egypt which is represented in the general price level for people living in cities, who are the main users of the company's financial statements in accordance with the following equation:

The Historical cost of the account	X	General price level at end of period
		General price level at the date of purchase or establishment

Modify the non – cash assets in the balance sheet by using the general price level for people living in cities in the Arab Republic of Egypt.
Translate the adjusted historical cost value of the asset imported with foreign currencies at the valuation date by multiplying the adjusted historical cost value of the asset in foreign currency by the current exchange rate at the valuation date and the historical cost of the imported asset will be modified using the general price level of the foreign currencies used to acquire such assets.

The adjusted historical cost method is characterized by its simplicity in calculating the value of non–cash asset using the general price level in addition to the objectivity found in its procedures application and also its effect on assets in the balance sheet can be grasped easily

C- The Valuation of the Assets Using Replacement Cost Method:

The concept of the replacement cost method means the value to purchase assets similar to the assets owned and used currently by the company taking into consideration that the asset to be purchased will have the same characteristics and operating conditions as similar assets in the market. The application of such method requires the assistance of a technical engineering consultant to determine the useful life of the asset and its current operating conditions compared with similar assets in the market as well as its market prices. In general the replacement cost method reflects all costs that could be bared by the company in order to replace the assets under valuation by a similar asset that has the same production capabilities.
The use of such method will minimize the disadvantages associated with the historical cost method as the valuation is made by preparing the company's balance sheet at the date of valuation after assessing the following factors:

The current condition of the assets:
The rate of technical obsolescence affecting the company's assets as a result of technological development in similar assets.
The technical condition of the assets and its remaining economic useful life which means its validity at the valuation date and which relies heavily on the company's maintenance program and operating conditions for such assets.
The appropriateness of depreciation rates applied for those assets under valuation and the modification of accumulated depreciation to determine the values that can suit the use of such assets in the previous periods.
The percentage of changes in the selling prices of such assets with the continuous increase in the value of assets due to local and international inflation rates and the change in foreign currencies exchange rates.
The production capacity of the company's assets and their ability to achieve a net annual surplus to help the company in financing the cost of its operations.
The competitive advantage of the company's products compared with products of other similar companies and its relationship with the type of technology used and the current technical conditions of the existing assets and its effect on operating and production capacities.

Concepts associated with the replacement cost method are as follows:

The cost of purchasing a similar asset or an asset which has the same production capabilities in a market of used assets. Information about prices of used assets can be obtained by contacting local and foreign suppliers or through proposals presented by companies producing such assets which certainly includes the selling price of those assets.

The cost of purchasing a new similar asset by decreasing the value of such asset to reflect the information technology changes and the assets current production capabilities. Such concept is used whenever there is no market for the used assets under valuation.
Making relevant modifications to the original historical cost value of the assets using the general price level index to determine the current purchasing price of such assets in case such assets was found in the market. The advantage of using the above concept is that it takes into consideration changes in the prices of such assets which helps in determining the current purchasing price of the assets under valuation.

Some of the reasons behind the preference of the use of the above method compared with other methods:

The non – existence of markets for used assets in a large number of countries worldwide.
The difficulty in finding similar used assets for assets under valuation because production of such assets was cancelled or because differences in its technical specifications in addition to fast technological development.

The disadvantages of the above method

are its inability to consider the company generating future profits, in addition, it's not consistent with the nature of some assets that can't be easily re-evaluated by using changes in general level price index and adding inflation rate for instance (furniture, fixtures and tools) due to the nature of such assets and the developments related to its condition.

D-The Valuation of the Assets Based on the Discounted Future Cash Flow or Discounted Future Profit Figures:

This method is considered one of the most important methods for valuation as it is used as a test for determining the future profits of the company under valuation and shows the benefit of the company under sale which sells its products in a way that can achieve an appropriate return on investments and realize a positive internal rate of return.

The above method is considered the most objective and realistic valuation method for companies which are expected to continue in operations or expected to be liquidated or a significant part of its assets are expected to be sold in the short-run.

In the DCF/DFP methods, the company's value is determined in accordance with what is expected to be achieved in the future from profit or cash flow compared with the return on time deposits in banks or treasury bills. Such future profit or cash flow is discounted using a discounting rate while taking into consideration the company's business risk, the economic and political conditions surrounding the country in which the company operates in addition to the industry conditions.

The DCF/DFP methods determine the value of the company's assets based upon the company's ability to generate continuous increase in the rate of return on its investment through its successful marketing and financial policies and strategies.

There is another method called "The Company's Residual Value" which determines the value of the assets based upon the value of the assets at the end of its useful life discounted using appropriate discounting rate to reflect the business risk of the company as well as the economic and political condition surrounding the company's operations. In the following we are going to present details about the application of each of the above methods.

(1) The Valuation of the Company Using the Discounted Future Profit Figures:

The discounted future profit method considers the value of the company's assets as the present value of its future profit figures taking into consideration that the value of the company's assets is calculated based upon the replacement cost concepts or the date of valuation or the residual value of the company's assets.

First Method: The Calculation of the DFP Based upon the Replacement Concept

Second Method: The DFP Valuation Based Upon the Residual Value of the Assets

(2)The Economic Value of the Company Based upon the Discounted Cash Flow:

The discounted cash flow method determine the economic value of the company based upon the adjusted net book value of the company's assets in addition to the net present value of its future cash flow.

The value of the asset is determined based upon the replacement value of its assets reflecting the amount of cash to be realized in case the assets are sold or replaced with other assets. The economic value of the company can be calculated using the residual value of the units by discounting the last year of the predicted period cash flow using an appropriate discounting rate and adding the adjusted net book value or replacement value of the company net assets.

First Method: The Calculation of the DCF Based upon the ability to achieve cash flow

Second Method: The Calculation of the DCF Based upon the Residual Value

E- Valuation of the Company's Assets Using the Profit Multiplier:

The percentage of the company's share in the profit is used to assess the financial performance of the company at the end of each accounting period in order to compare such company's operating performance results with other companies' performance. The P/E ratio is calculated using the following equation:

P/E Ratio	=	The market price of the share
		The share percentage of profit

*The suggested study frame work

The general frame work for evaluation studies performed by Dr.Abdel-Aziz Hegazy and Co- Horwath includes the following items, which could be adjusted according to customers’ needs and the purpose of preparing these studies, whether it was prepared for buying the corporate shares, selling or issuing it to the public or for margining, segmenting or changing the legal status of evaluated companies in general:

(1) Evaluating the company’s financial and administrative system

Evaluation of organizational structure and job description
Evaluation of documentary flow charts, group of books, and chart of accounts
Evaluation of manual

(2) Financial study:

1. Examining components of assets and liabilities separately in light of the following items:

Reports of evaluation committees formed by the company or the report issued by the independent consultant engineer
The report issued by the Central Auditing Organization and other external supervising bodies
Detailed reports issued by the company’s independent auditors
Accounting principles and standards

2. Preparing a summary for the book value and the value per share after re-evaluation

(3)Financial analysis:

1. Vertical analysis of financial statements
2. Liquidity indicators
3. Profit indicators
4. Debt analysis indicators
5. Efficient use of assets indicators
6. Materiality indicators related to the shares in the exchange market
7. Company’s default indicators

(4)Economic study:

1. Income statement components expectation summary
2. Determining the economic value per share
3. Results of the financial and economic study