Ch.18 Valuations: Asset based approaches

Question 1

Liquidation approach

Answer 1

not a going concern
Orderly (voluntary) liquidation-iquidation is not forced on the entity by the courts; rather, it is undertaken by a voluntary act of the members.
forced liquidation, the assets are sold to the highest bidder, usually after a relatively short period of market exposure.results in a lower net realizable value (NRV) of the assets.
1. The balance sheet’s values for assets are adjusted to reflect the NRV of the individual assets at the valuation date.
2. Liabilities are deducted from the NRV of the assets (from Step 1).
3. Corporate income taxes are calculated based on the tax consequences of the sale of the assets. The amount remaining, after deducting taxes, is deemed the proceeds available for distribution.
4. Personal income taxes are calculated on the proceeds available for distribution to determine the liquidation value to the shareholders of the company.

Question 2

Adjusted net asset approach

Answer 2

(a) a company does not maintain active operations or (b) a company has active operations but does not have excess earnings aka goodwill=0
fair market value (FMV) of the assets is used to value the entity
FMV determined using the adjusted net asset approach is normally considered the “floor value” of an entity=lowest value the owners of the entity would accept in a sale of the entity.
1. The balance sheet values for each asset and liability are adjusted to reflect the FMV of the individual assets and liabilities as at the valuation date.
2. The forgone tax shield is deducted
3. Latent taxes and selling costs associated with the sale of assets are deducted. Latent taxes are those that would arise from selling the assets, such as taxes on capital gains and/or recapture.

Question 3

Adjusting asset values

Answer 3

Intangible assets resulting from goodwill, deferred charges, or anything else that is not a separately identifiable intangible asset should be valued at nil
If the entity has intangible assets resulting from royalty agreements, patents, licences, and so forth, and a meaningful value can be determined, it may be appropriate to assign value.
Redundant assets are included in the adjusted net asset approach. Redundant liabilities are likewise deducted under the adjusted net asset approach.

Question 4

Forgone tax shield

Answer 4

arises if FMV of the assets is greater than current tax values for those assets
If individual assets are sold instead of the shares of the entity, the purchaser gets a bump-up in the cost base of the assets to the extent that the FMV of the assets is greater than their tax value.
forgone tax shield is the net present value of the additional tax deductions on future capital cost allowance (CCA) not available to a purchaser of shares.

Question 5

latent tax

Answer 5

fair value bump arises if the FMV of the tangible assets exceeds the tax cost of the asset. The eventual disposal will create a tax liability. This is referred to as a latent tax liability. This liability is deducted from the FMV of the asset.
Latent taxes on capital assets can be calculated as follows:
• Capital gain = Net proceeds on disposition – Adjusted cost base
• Taxable capital gain = ½ × capital gain
• Latent tax liability = Income tax rate × Taxable capital gain

Question 6

Replacement cost approach

Answer 6

actual current cost to replace the assets of an entity is considered.
replacement cost is usually higher than book value because depreciation is not taken into account
asset values are adjusted up or down to their current replacement cost. Liabilities and any related tax consequences are then deducted from that replacement cost to arrive at the value of the business.
rarely used to value an entity because it lacks economic validity
commonly used for insurance purposes in valuing individual assets