At some point in the near or distant future, you will need more than just a rough estimate of what your casting facility is worth. Whether you are passing the business down to the next generation, establishing an employee stock ownership plan or selling the business, you will need to have a firm value attached to your company. The value of your company also should be known if there is litigation involving a minority owner or if you are going through a divorce.

However, determining the value of your company can be a messy numbers game. An accredited business appraiser can help, but understanding the basics of calculating your value will keep you from getting lost in the numbers.

Net Asset Approach

Generally, appraisers employ one or more of three approaches to valuing a business: the net asset, income and market approach.

The net asset approach bases the value of the metalcasting facility on the value of its tangible assets minus its liabilities (net assets). Since most businesses, including metalcasters, have total value in excess of their net assets, this approach normally is used only in situations where the business is losing money or its earnings do not support its net assets. The theory behind this approach is that the company may be worth more by selling its assets and paying liabilities than as an ongoing operation.

Value by Income

The income approach values the metalcaster by converting its earnings into value. This is done by discounting the

earnings to present value at a rate that reflects the required return on investment of a prudent investor. Alternatively, earnings can be converted to value by dividing them by a capitalization rate, which encompasses the required rate of return and the anticipated long-term growth rate. The theoretically correct calculation of the capitalization rate for historical earnings is determined by the formula: (discount rate - growth)/(1 + growth). The discount rate is the required rate of return.

For example, ABC Foundry had net income after taxes of \$1 million in the last year. Net income is expected to grow 5% annually on a long-term basis. The required rate of return, or discount rate, is determined to be 20%. Using the formula from the previous paragraph ([0.20-0.05]/[1 + 0.05]), the capitalization rate is calculated to be roughly 14%.

Dividing the net income of \$1 million by the capitalization rate of 14% produces a value for ABC Foundry of about \$7.1 million.

The discount rate is normally determined using benchmarks derived from public market data. A review of publicly-traded data suggests that the median discount rate in the public market was 19% near the beginning of 2006. However, discount rates vary widely from company to company and depend largely on the level of risk associated with the earnings being capitalized.

If the discount rate is derived from public market data, more often than not it is reflective of a minority interest and the value derived would be a minority interest. If the appraiser is valuing 100% of the casting facility, a control premium, which is the increase in value normally paid to obtain control, must be applied. In 2005, the median control premium across all industries was 24%; however, the premiums vary widely in individual transactions.

Market Effect

The market approach to appraising your metalcasting facility looks at sales of other private or public metalcasters and uses their multiples of earnings to establish a value for your company. A common multiple of earnings is a price to earnings multiple, or P/E ratio. This ratio is multiplied by net income to derive the value of the business. For example, a P/E ratio of 10, multiplied by net income of \$1 million produces a value of \$10 million. As in the income approach, if the P/E multiple were derived from the public market, it likely would reflect a minority interest. If the appraiser were valuing 100% of the facility, a control premium would have to be applied.

Calculating Earnings

In the income and market approaches, earnings typically are used to estimate value. Earnings can be measured by net income, pretax income, net cash flow, earnings before interest and taxes (EBIT), or earnings before interest, taxes, or depreciation and amortization (EBITDA). They can be a projection of future earnings or represent earnings from the last fiscal year, an average of several years or a weighted average, in which most of the Weight is placed on the most recent years.

The value of a business is based on future earnings, so historical earnings normally are used only when they are a reasonable representation of the future. If historical earnings are used, they must be normalized--adjusted to reflect normal operations. For example, one-time gains in sale of assets usually are eliminated from historical earnings.

During the valuation of your casting facility, the business appraiser may apply discounts or premiums, depending on the circumstances. As mentioned before, control premiums result when investors pay more to obtain control of a company. This often is seen in mergers and acquisitions, where the purchase price per share is significantly higher than the prior public market price per share.

Conversely, a minority discount, or discount for lack of control, could be applied when you are requesting the appraiser to value a non-controlling portion of the company, and the initial value is derived from comparison to controlling interests.

A control premium can be converted to a minority discount by the formula: control premium/(1 + control premium).

A discount for lack of marketability often is applied when the initial value is derived from comparison to marketable interests, such as publicly-traded stock, when the portion you want valued is not publicly-traded. The level of this discount varies with the degree of marketability. If the casting facility is highly marketable, a low discount for lack of marketability will be applied, but if it is not marketable, a high discount will be applied. Lack of marketability discounts can range from 5 to 40%.

Private Sale Comps

As a final check on the concluded value of your casting facility, a business appraiser may look to private sales of metalcasting companies. Although data on some private transactions are available, data is normally limited, and its use should be reserved as a cross-check on values derived by other methods.

For example, a quick search found three private transactions of metalcasters that reported invested capital to EBITDA multiples. The multiples ranged from 2.9 to 12.5, with an average of 6.3. Why would the range be so large? The answer can't be found in the limited data that is available, but a likely reason is that the company with the highest multiple expected to have a higher level of growth.

Be Prepared

Typically, a business appraiser will want to tour the facility and interview management. During the appraisal, be prepared to offer the following information:

* Five years of annual financial statements

* The latest interim financial statements

* A list of major customers

* A list of major competitors

* Budgets

* Projections

* Strategic plans

* Industry data

Inside This Story

* Many legal situations will require you to have a clear understanding of what your metalcasting facility is worth.

A business appraiser is a professional resource that will help you determine the value of your company, but you want to make sure you choose a qualified appraiser. A first step is to make sure the appraiser is accredited. A variety of business valuation organizations, including the American Society of Appraisers (ASA), the Institute of Business Appraisers, the National Association of Certified Valuation Analysts, and the American Institute of Certified Public Accountants, accredit business appraisers. Each of these organizations, as well as the Appraisal Foundation, has business valuation standards with which the business appraisers must comply.

In addition to accreditation, an appraiser with experience in valuing metalcasting facilities is preferable. Ask the appraiser what metalcasting facilities he or she has appraised in the past and request a contact at that company to use as a reference. Don't hesitate to call the reference to inquire about the appraiser's performance.

Experience by the appraiser in defending his or her opinion before a third party, such as a court, also is desired. Finally, the business appraiser should not have a personal or business relationship with the parties involved.