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Valuation and Financial Intermediation

What role does a financial department play in valuing business opportunities and what are some of the key financial concepts that valuation work must consider?

What role(s) do financial institutions play in financial intermediation, why these roles are necessary, and how does the company need to respond to the increased intermediation scrutiny due to the company IPO?

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Please refer to file response attached, which is also presented below.

RESPONSE:

1. "What role does a financial department play in valuing business opportunities..."

Financial departments determine the value of potential business opportunities (i.e., companies), through applying the various valuation concepts presented in the next question. For example, the financial department could use a graphical spreadsheet that uses these concepts in comparing the relative valuations of two companies (see example in next question).

For example, in the Victorian Government and the Victorian Government Purchasing Board (VGPB), in relation to government procurement of goods and services, priority will be given to creating additional value for public expenditure through judiciously aligning departmental requirements, and by aggregating purchasing demand into State Purchase Contracts (SPCs). This includes the mission and role for the financial department.

In relation to decisions on business case analysis, tender evaluations and contract/category management are to be based on a value-for-money test using measures of quality, quantity, timeliness and cost benefits to government on a whole-of-life basis. Purchases (one-off or in aggregate) under $15,000, a financial department may elect to provide a regional office delegate with the flexibility to make such a purchase outside any SPC arrangement if they assess that a regional supplier would provide equal or better value for money. Therefore in such a corporate structure, it is important that financial departments (as well as other departments) consider regional impacts in terms of value for money outcomes. In other words, the role of the financial department is dictated by the mandate and policies of the organization. Everything the financial department (as well as other departments) does will be in line with the mission of the organization, mainly, in relation to procurement of goods and services, priority will be given to creating additional value for public expenditure through judiciously aligning departmental requirements, and by aggregating purchasing demand into State Purchase Contracts (SPCs).

Therefore, in this organization, this company mission includes the financial department (i.e., business opportunities bases on value-for money evaluations using valuation concepts) (http://www.vgpb.vic.gov.au/CA256C450016850B/0/686DA5B53FD13348CA256FC0001B05CC?OpenDocument).

2. "... and what are some of the key financial concepts that valuation work must consider?"

Valuation Concepts

In an effort to provide some guidance in determining the value of companies, here are some standard concepts and definitions. Presented is a graphical spreadsheet that uses these concepts in comparing the relative valuations of two companies. Applied iteratively this should help guide discussions when considering specific industries or other groups of companies.

Valuation Ratios

Many valuation ratios exist to judge the value the stock market places on any given company. Three such ratios used in this work are the price/earnings ratio (p/e), the price/sales ratio (p/s), and the price/free cash flow ratio (p/fcf). Other examples not used at his time are price/book and price/cash flow. The three chosen are easily understood and described below. Others can be added later as we become more sophisticated in analyzing valuations. (Much of the following description/definition of terms is cut from yahoo.marketguide and is quoted.)

P/E Ratio

"The Price-to-Earnings (P/E) ratio is the single most widely used measure of a stock's value. That's because the key to stock ownership is the shareholder's stake in a portion of the company's profit stream." The p/e is the price per share divided by the earnings per share.

Price/Sales Ratio

"Price-to-Sales is generally used to evaluate companies that don't have earnings and don't pay dividends. For these companies, you may consider that ...

Solution Summary

This solution explains the role of the financial department in valuing business opportunities and the key financial concepts that valuation work must consider. An explanation of the role(s) of financial institutions in financial intermediation is provided, as well as the reason(s) why these roles are necessary. It then explains how the company needs to respond to the increased intermediation scrutiny due to the company IPO.

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