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SKS Microfinance Case Study

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SKS being a microfinance institution (MFI) faces numerous challenges in valuing its business operations. While the valuation techniques differ significantly, a variety of common methods can be used to estimate the value of SKS business. Relatively small businesses generally use one or a combination of the following valuation methods; book value, price-earnings comparisons and discounted cash flow analysis. In the book value method, only those balance sheet accounts that reflect assets expected to generate earnings for buyers are included in the calculations. Price-earnings comparison or ratio simply matches the SKS’s prior year profits with an average price earnings ratio derived form published trading records of public companies in the industry; providing SKS a comparable with which to start negotiations. Discounted cash flow involves the analysis of the value of the future benefits, usually cash benefits that will accrue to the business, then discounting back to a present value at an appropriate capitalization or discount rate (Nelling, 2010).

The value for SKS Branch will be given as follows;

Cash flows to equity = Net Income – Depreciation + Capital Expenditure + Net Borrowing

As the end of the financial period for the company was after eight (8) quarters, the valuation of the company will be;

 

FY06

FY07

FY08

FY09

Net Income

161198

325371

321405

317441

Less: Depreciation

2.9

1.9

13.2

38.2

Capital expenditure

30500

30500

30500

30500

Net Borrowing

692.2

2053.1

6563.9

15138.1

Cash flow

192387.3

357922.2

358455.7

363040.9

Discounting of equity cash flows;

FY

Cash flow

(1 + r) –n; r = 8%

PV

06

192387.3

0.9259

178131

07

357922.2

0.8573

306847

08

358455.7

0.7938

284542

09

363040.9

0.7350

266835

Discounted equity cash flows

1,036,355

Akula should select discounting cash flow method of valuing a business. By using the SKS’s financial projections, Akula can develop preliminary cash flow projections for SKS. However, it is typical for Akula to use a range of valuation methods and then triangulating with each other. Comparable methods that draw on either previous transactions in the industry or previous transactions in the similar entities are unlikely to be useful for SKS’s transforming in new regulatory contexts, and while price-earnings ratio may be readily available for the organization; it tends to privilege unique entities serving a targeted market (Nelling, 2010).

Consequently, the use of discounted cash flow method of valuation provides the financial management and investment appraisal with soundness it adequately needs. As such, SKS should be worth the present value of its expected future cash flows unlike other methods which does not put into consideration the future implications of the strategy deployed (Zyla, 2009). However, its main demerit to the organization is that the valuation requires a wide range of assumptions to be made about the components of free cash flow, growth rates, and the cost of capital. Unreasonable assumptions will ultimately lead to unreasonable results.

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