Business Valuation of British Petroleum

Business Valuation of British Petroleum

Business Valuation of British Petroleum

Literature Review

The need to value companies is progressively becoming essential, primarily due to increased in mergers and acquisitions in recent years. Researchers has define the valuation of the company as the process by which companies seeks to quantify the elements that constitute the heritage of a company, its business, its potential or any other characteristic that is capable of being valued. The measurement of these elements is not simply involving many technical difficulties.

Valuation of the company is determined the intrinsic value of a business and not its market value or price of course. The value is not a fact but, because of its subjectivity, company might consider it as an opinion. It must start from the idea that the value is only a possibility, while the price is a reality. The greatest differences between price and value are often generated by market relations between buyers and sellers.

This paper will discuss the valuation techniques of British Petroleum. In order to get into detail of the valuation model of the British Petroleum, it is important that we understand the different valuation models first. On the other hand, from a technical perspective, the fundamental principles of accrual accounting and the financial statement articulation are the ones that explicitly account for the nonideal valuation techniques.

There are a number of studies that show the theoretical equivalence of the valuation models. These models include the free cash flow valuation method (FCFVM), the residual earnings valuation model (REVM), and the abnormal earnings growth model (AEGM). There are different ways of calculating in which the valuation of the company can be done. The above mentioned are just three of them, while there are others as well such as Dividend Discount Model (DDM), Discounted Cash Flows (DCF) etc. According to Olsson & Levin (2000) and O'Keefe & Lundholm (2001a) pro forma statements are another way how valuation can be done. This type of valuation requires the same rate of growth and the calculation of the terminal values is done through these growth rates.

In the Abnormal Earnings Growth Model (AEGM), if the growth rate is abnormal, the payout ratio will also be abnormal. On the contrary, Penman (2005) shows that the models that are based on the growth rates are the ones that forecast different payoffs for the future. These payoffs include the cash flows, dividends and the residual income. Here, in this case, the growth is huge and abnormal which directly relates to the abnormal payout ratio. It should be made sure that growth rates are carefully studied before implementing and basing the valuation on them.

The Free Cash Flow Valuation Method (FCFVM) is another way of the firm and equity valuation. Free cash flow is the cash left after the payment of expenses, depreciation and the payout to the stockholders. With the cash left, valuation is done for equity and firm. The cash left after the payment of the expenses and the payment of investments is known ...