Answer 22

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Read more on accounting for crossholdings and valuing crossholdings

If you are valuing the firm (rather than equity), you began with operating income as your measure of earnings to get to cashflows. Therefore, you have not valued any assets whose earnings are not part of operating income. The first of these assets is cash and marketable securities - interest income from these holdings shows up below the operating income line. You have to add the value of cash and marketable securities to your operating asset value. The second is minority holdings in other companies. The income from these cross holdings is variously accounted for but is almost never part of operating income. If you wanted a complete valuation, you would have to value each of these subsidiary companies individually and take the share of each company that your company owns into consideration. If you have a majority holding in another company, you have a different problem since you are required to consolidate 100% of that company into your financials. If you want your valuation to hold up to scrutiny, it is best to remove the consolidated subsidiary from your financials, value the parent company first and then add the majority stake of the consolidated subsidiary to this value.

If you are valuing equity, using net income or earnings per share as your starting point, you have valued cash and cross holdings implicitly since the income from these holdings is part of net income. The problem, though, is that you have also implicitly assumed that the share of income generated by these assets (cash and cross holdings) will not change over time. This is a dangerous assumption. It is safer to remove the income from cash and cross holdings from your net income, value equity based upon this adjusted net income and then add on cash and your share of cross holdings at the end of the process.


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