Valuation related to mergers and acquisitions usually follow these three methods: market based method, asset based method and income based method. It may be felt that the market based method is the most relevant, but all three methods are significant depending upon the situation prevailing during the course of the mergers as well as acquisitions.
Market based method:
Valuation related to mergers and acquisitions estimated by the market based method, compares various aspects of the target company with the same aspects of the other companies in the market. These companies (not the target company) usually possess a market value, which has been established previously.
There are a few things to be kept in mind prior to comparing the various aspects, such as which factors need to be compared and which are the companies that will serve as comparable companies to the target one. Public companies, belonging to similar industries (of the target company) may be opted for as comparable, but if the target company is not listed on the stock exchange or if it is comparatively smaller in size than the public companies, comparison with the public companies may not be of much help. In such cases, private as well as public databases are available, which are commercial in nature.
Other aspects that need to be compared include book value and earnings, or total revenue. Once all the data is collected, an extensive comparison is made to find the value of the target/subject company.
Asset based method:
Valuation related to mergers and acquisitions employ this method when the subject or the target company is a loss making company. Under such circumstances, the assets of the loss making company are calculated. Along with this method, the market based method and the income based method may also be employed. Valuations obtained from this method may generate very small value, however it is more likely to generate the actual picture of the assets of the target company.
Income based method:
Valuation related to mergers and acquisitions employing the income based method take the net present value into consideration. The net present value of income, which is likely to be in the future, is taken into account by the application of a mathematical formula.