Valuation estimated find application in various purposes and situations. As an example, in case of a merger or acquisition, both the target company and the acquiring company conduct a diligent process for the determination of the value of the company so as to determine a fair value for the deal. While this valuation is conducted on a macro basis, individual and institutional investors also carry out the security valuation process so as to determine whether the stock is over-valued or under-valued in the market and accordingly, plan their investment decisions and timing. Thus depending on the context in which the valuation is being performed, the model for valuation is selected (Lorenz, Truck, & Lutzkendorf, 2006).
In practicality, a wide range of models are available, which can be used for valuing a particular security (Bailey et al, 2008). These models can be categorized under various categories, but on a general basis, they are classified as relative valuation methods and DCF valuation methods (i.e. models based on the principles of discounted cash flow). Another popular variant of the DCF model as proposed by Penman (2001) is the residual income valuation model. Several newer valuation models are also developed like the use of the concept of options to value the security of the company. In this approach, the equity is treated as a call option on the assets of the company and accordingly, its value is derived. Theoretically, for one particular company, the valuation models must provide consistent and similar estimates with minimal variances in the tolerable region. However, in practicality, this is an exception rather than a rule. The valuation model that is chosen is also dependent on the analyst’s instincts as well as the industry in which the company is a major operating player.