VALUATION OF NEW PRIVATE COMPANIES

The valuation process for new private companies occurs in two phases. The first phase is the pricing evaluation. The objective of this phase is to determine the initial offering price for shares in the new company. The second phase is the market evaluation. The results of this phase reflect the actual worth of the new company based on the market's response to the company's initial public offering (IPO). IPOs are equity stock issues when a corporation first initiates public trading of its shares.

Investors are interested in IPOs because they "offer the prospect of swift gains: a doubling of the share price on the first day of trading is not uncommon" ("American IPOs: What Crash?" 1997, p. 83). Over time, however, IPOs generally tend to under perform in relation to the market as a whole.

In 1997 as an example, 469 IPOs had been floated in stock markets in the United States through mid-November ("American IPOs: What Crash?" 1997). These IPOs generated $24.2 billion for the issuing corporations. In the wake of the seven-percent drop in the Dow-Jones Industrials Index that occurred in October 1997, small investors, seeking quick returns as the bull market appeared to be imperiled, began turning to IPOs in greater numbers ("American IPOs: What Cra

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lationship between portfolio risk and return" (p. 149). This determination is made through the use of the capital market line concept. "Preferred investment strategies plot along (a, sic) line à representing alternative combinations of risk and return obtainable by combining market portfolio with borrowing or lending" at the risk-free rate of interest (Sharpe, 1999, p. 149). All investment strategies other than those combining market portfolio and the risk-free rate of interest in an optimal manner would be expected to fall below the capital market line. The slope of the capital market line "can be regarded as the reward per unit of risk borne, (and) equals the difference between the expected return of the market portfolio and that of the risk-free security divided by the difference in their risks" (Sharpe, 1999, p. 149). The capital market line develops the capital asset pricing model with respect to portfolios. The security market line develops the model with respect to specific individual securities (Brigham, 2000). "Under the assumptions of the à capital-asset pricing model, all securities and portfolios plot on a security market line going through a point representing the riskless rate of interest" (Sharpe, 1999, p. 16
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Approximate Word count = 3573
Approximate Pages = 14 (250 words per page)

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