Ch.17 Valuations big pic Flashcards
purpose
valuation may be required to value individual assets or to determine the value of a business as a whole. Valuation techniques used will depend on what is being valued
for sales
• A company receives a takeover bid and the offer price is different from (usually higher than) the current market price of the shares.
• A company wishes to go public and must set an issue price for its shares.
• Shares of a private entity are being sold to a third party because the current shareholder wishes to dispose of his or her holding under the terms of a shareholder agreement.
• Shares are being pledged as collateral for a loan.
• A company is being broken up in a liquidation situation.
• A shareholder is going through a divorce, and a division of assets needs to be determined.
• A company is undertaking a reorganization for tax purposes.
• A company needs to evaluate whether any impairment exists.
Fair market value
fair market value (FMV) is an underlying principle of all business valuations, and, as such, it is discussed first.
FMV= highest price available in an open and unrestricted market between informed and prudent parties, acting at arm’s length and under no compulsion to act, expressed in terms of money or money’s worth.
Deciding which valuation approach to use: Valuing a business
assess what must be valued. The simplest and most common scenario involves the valuation of all the outstanding shares of a company.
decision must be made as to which valuation approach to use. The next step is to determine whether the entity being valued is a going concern.
Liquidation approach
asset based
not considered a going concern, a liquidation approach must be used.
two separate liquidation approaches, an orderly liquidation and a forced liquidation
forced liquidation, the owner is being forced to sell the assets (for example, by a bank); the assets are normally sold quickly and for lower proceeds than would be realized in an orderly liquidation.
Adjusted net asset approach
asset based
entity is a going concern, the next step is to determine whether the entity has active operations.
does not maintain active operations, the adjusted net asset approach is appropriate. The adjusted net asset approach is normally used to value holding companies that do not conduct active operations but are considered a going concern
Consider, for example, an investment in shares that do not pay any dividends. The investment still has value but does not generate any cash inflows.
used to calculate the “floor” value of a company with active operations that is a going concern. The floor value is the lowest value that would be accepted in a sale transaction.
appropriate if an entity has active operations but does not have excess earnings and therefore no inherent goodwill.
Replacement cost approach
asset based
This approach is rarely used to value a business because it lacks economic validity; however, it is commonly used for insurance purposes or to value individual tangible assets.
actual cost to replace the assets is considered. Using this approach, the asset values are adjusted to their current replacement value/cost. Liabilities and any tax consequences are deducted from that replacement cost to arrive at the value of the business.
Capitalized cash flow approach
income-based approach
entity has active operations and excess earnings, an income-based approach is most appropriate. The valuator must assess whether the historical cash flow of the entity is reflective of future operations.
has consistent cash flows that are reflective of the future operations= good approach
cash flows expected to occur consistently in the future are determined and a capitalization rate is applied to the expected future annual cash flow to obtain a value for the entity.
Discounted cash flow approach
income based approach
startup stage, the historical cash flow may be negative,
discounted cash flow approach is appropriate. A discounted cash flow approach is also appropriate if past cash flows are not representative of future cash flows of a company and management is able to prepare reliable projections of future cash flow
cash flows for a given number of years are calculated and individually discounted to obtain an initial value for the business. Once expected future cash flows are in a steady state, the amount can be discounted to obtain the terminal value for the business.
Capitalized earnings approach
income-based approach
historical earnings of the company.
Under this approach, earnings are multiplied by a multiplier or divided by a capitalization rate to determine the value of the company. The multiplier is the multiplicative inverse of the capitalization rate.
Discounted earnings approach
used in merger and acquisition valuations
future earnings are expected to be volatile before levelling out. Earnings during the volatile years are valued separately from the earnings in the steady-state years, similar to the discounted cash flow approach.
estimates of future earnings from the business for each forecasted period are determined. The estimated earnings for each year are then discounted at the appropriate discount rate to determine their present value.
Market-based approach
used when the company is a going concern and information required to determine a valuation multiple is publicly available and reasonably comparable
Market data is used to determine a valuation multiple based on valuation multiples used to value companies that are comparable in size, geographic location, product mix, capital structure, and so on. The valuation multiple is then applied to the entity’s earnings before interest, taxes, depreciation, and amortization (EBITDA) to obtain a market-based value for the business. To obtain a market-based value for the equity of a business, a valuation multiple is applied to the entity’s net earnings.
