The relationship between firm valuation methods and market value for companies quoted at the NSE

Abstract

There are practical problems in firm valuation due to uncertainty and the instability surrounding income attributable to equity holders. This study seeks to investigate the relative explanatory power of the alternative firm valuation models when applied to firms quoted on the NSE. This helps understand which method has a higher explanatory power than the other. When investing in bonds there is certainty in income as long as interest and principal on a bond are adequately secured. It is this complication in income attributable to equity holders that has led to a number of models and this study seeks to test two of this valuation models. Data collected included market prices, income statements, balance sheet and dividend payouts of the various firms quoted on the NSE. Two methods, the discounted free cash flow method, and the economic profit method were used to estimate the value of the firm and the resulting value compared to the market values, where a regression analysis was done. The findings were that when the market values were compared with the equity values derived from the discounted free cash flow method the regression resulted in an r2 of 0.31 within a confidence level of 95%. The market value when compared with equity value derived from the economic profit model derived an r2 of 0.01 and the p-value was more than 0.05. We therefore concluded that the test of significance carried out to determine whether the two equity values were significantly different showed that, while the discount cash flow had a p-value of 0.02 showing the differences were not significant and therefore the model was a good indicator of the market equity value. The economic capital method had a p- value of 0.6 showing the differences were significant and therefore the model was not a good indicator of the market equity value.