Breakup value is precisely the market value of overall entity. It is usually computed by large stock listed entities which are dealing in multiple sectors/ markets. Value of every sector is determined separately and the compared with overall market capitalization of the entity. When it comes to other non-listed public and private companies, breakup value is computed according to the needs of the person asking for computation. While computing breakup value, it must be deemed that the intension is to sell off the entity with its operation. Value of its assets and liabilities are determined at a fixed date.
There are two broad methods to identify breakup value:
Price earning ratio is used when the user is entity’s own management and it intends to decide whether market value of share is matching the breakup value per share or not to check whether return to its shareholders are in accordance with their perceived value or not.
In discounted cash flow method, total expected net cash inflow is computed. It means assets and liabilities are valued at their recoverable amount and settlement amount respectively and any assets which are not part of financial statements but still is the asset of the entity will also be part of the net assets for computation of breakup value examples may be internally generated goodwill, patients etc. Present value of net cash inflow is computed based on following formula:
DCF = [CF1 / (1+r)1] + [CF2 / (1+r)2] + … + [CFn / (1+r)n]
n – is number of years required to settle / recover specific assets/ liabilities
r – is applicable discount
Discounted cash flows method is usually used by investors for acquiring any private or public unlisted entity because it is the most suitable method providing comparison of their investment cost wit the intrinsic value of investment.
Computed amount if divided by the number of outstanding shares will give breakup value per share.
Points to remember while computation breakup value under discounted cash flow method:
It is advised if separate value of all identifiable assets and liabilities are used to compute breakup value rater tan using equity directly.
As mentioned above, it needs to be remember that breakup value is generally used by large entities dealing in different segments / markets. It determines breakup value of each of its component/ segment for different comparisons especially to know whether components are performing better independently or collectively.
Second major use of breakup value is to determine intrinsic value of potential investment or from the point of view of entity, breakup value is a way to determine a potential floor for its stock price or a potential entry point for a prospective stock buyer.
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