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3. Price/Earnings Business Valuation Method
A company’s value under the Price/Earnings business valuation method is based on the assumption that the company value should be similar to companies whose shares are traded in the stock market. The company’s value is calculated according to the future profit of the business and the industry average P/E ratio or the P/E ratio of another firm with a similar business profile.
The Formula
Where:
Profit in Year i = Net profit in any chosen year (I)
Comparative P/E = P/E of any public company or industry average
r = Discount Rate
This Value is discounted to the beginning of the forecast period.
Operating Steps
Step 1
Enter the PE factor – the average PE of the industry or the PE of a similar company. If the PE is unavailable or is high due to seasonal high rates in the stock market, it is recommended to use a PE of 7-12.
Step 2
Enter the discount rate. This rate is based on the free risk interest rate in the market (e.g. government bonds) with a Market Risk Premium which grow as much as the risk which is involved in the business, or as much as the uncertainty in the business, its products and its markets.
Step 3
View the company value as it varies during the plan period.
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