There are three main methods for valuing a business: Market Approach, Asset
Approach, and Income Approach. The valuation method that would be most effective
for CVS Health will be the Income Approach as they have a diverse business
enterprise that would difficult to value accurately using similar companies or assets.
The Market Approach is based on the value of similar companies or company
acquisitions. The idea behind market valuation is that it can provide a current “going
rate” for a business. However, it is difficult to find a company that has an identical
structure and is therefore difficult to get a truly accurate valuation. This approach
can be used when acquiring a new business, as the exact value is not necessary for
the transaction.
The Asset Approach uses the net value of a company’s assets to calculate value.
While this seems somewhat straight forward, it is important to note that, to get the
most accurate value, the fair market value of assets should be used. As the book and
fair market values may differ, the balance sheet listed values of assets might not be
used. There is also room for discrepancies regarding the value of intangible assets
that require an estimated value. A company that is planning a sale or liquidation may
find the asset valuation method helpful.
The Income Method of valuation would be the most effective method of valuing CVS
Health. To complete a defensible income valuation, a substantial amount of
information must be considered. First, future cash flows for the company must be
projected which is then discounted to present value. To do this, forecasted net
income plus depreciation is reduced by capital expenditures and anticipated debt
reduction. This amount is divided by the valuator’s determined discount rate. The
discount rate must include risks to values from items such as bond rates and equity,
as well as industry and company risks. While this method is not a perfect science—a
lot of information is based on assumptions—the method can give a quality, defensible
valuation for companies like CVS Health.
