When state owned enterprises are sold, how should thier value be established? should it be based on
The cost of the assets in place?
The past earning power of the enterprise?
The future earning power of the enterprises?
Explain the above options and their relative advantages and disadvantages of thier selection
Present earning by using annuity value and net present value
When establishing the value of state-owned enterprises (SOEs) that are being sold, there are different approaches to consider. The three common methods include:
1. Cost of the assets in place: This approach values the SOE based on the cost of its physical assets, such as buildings, equipment, and inventory. It focuses on the historical investment in these assets.
Advantages:
- Tangible and objective method as it relies on actual cost figures.
- Useful for industries with assets that have a stable value and do not rely heavily on intangible assets.
Disadvantages:
- Ignores the potential value of intangible assets, such as reputation, intellectual property, or brand equity.
- Fails to reflect changes in market conditions and technology advancements.
2. Past earning power of the enterprise: This approach determines the value based on the SOE's historical earnings and profitability. It assumes that past performance is a good indicator of future profitability.
Advantages:
- Considers the historical profitability of the enterprise, which can be a reflection of its competitive advantage and market position.
- Provides a benchmark for potential buyers to assess the enterprise's financial performance.
Disadvantages:
- Does not account for potential changes in the industry or market dynamics.
- Assumes that past performance is a reliable predictor of future success, which may not always be the case.
3. Future earning power of the enterprise: This approach values the SOE based on its potential future profitability. It takes into account factors such as market demand, growth prospects, competitive landscape, and industry trends.
Advantages:
- Focuses on the SOE's potential to generate future cash flows, which is considered more important than historical performance.
- Incorporates market conditions and future growth potential, making it a forward-looking method.
Disadvantages:
- Requires accurate forecasting and assumptions about future economic, industry, and market conditions, which may be uncertain.
- Subject to bias and speculation, as predictions about future earnings are not guaranteed.
In practice, the selection of the appropriate method often depends on several factors. These may include the nature of the industry, the availability of reliable and comprehensive data, the level of competition, and the preferences of potential buyers. Additionally, professional valuers and advisors with expertise in business valuation can help determine the most appropriate method and reconcile any potential conflicts between the various approaches.