Chapter 3: The Market Approach to Valuation

Question 1

How do you identify the guideline company that is comparable in terms of capital structure?

Answer 1

Total Liabilities/Total Assets (book value)

Question 2

How do you identify the guideline company that is comparable in terms of growth?

Answer 2

Revenue percentage???

Question 3

How do you identify the guideline company that is comparable in terms of profitability?

Answer 3

EBIT Margin or EBITDA Margin

Question 4

How do you apply the price and earnings multiple to calculate the FMV of equity?

Answer 4

[Pre-tax income * price/earnings multiple * (1-tax rate)] + (net assets excluded from definition of price)

Question 5

How does Pratt’s Stats determine EBITDA?

Answer 5

EBITDA - Net Other (non-operating) Income

Question 6

How does Pratt’s Stats determine Discretionary Earnings?

Answer 6

EBITDA - Net Other (non-operating) Income + Owner’s Compensation

Question 7

What does Pratt’s Stats exclude from MVIC?

Answer 7

Real estate, employment or consulting agreement values, and all contingent payments

Question 8

What is MVIC (generally)?

Answer 8

Market Value of Invested Capital = long-term interest-bearing debt + market value of the equity

Question 9

What is the principle of substitution?

Answer 9

An appraisal principle that states that nobody will pay more for something than he or she would pay for an equally desirable substitute.

Question 10

How do you apply the MVIC to EBITDA multiple to calculate the FMV of equity?

Answer 10

MVIC = (EBITDA * MVIC/EBITDA multiple)

Equity = MVIC - long-term interest-bearing debt

Question 11

What database has the largest known source of market transactions for small closely held businesses?

Answer 11

Institute of Business Appraisers (IBA) Market Database

Question 12

Which database has contains the largest number of transaction data?

Answer 12

Thomson Reuters M&A

Question 13

When is the price to earnings multiple most appropriate?

Answer 13

–Depreciation representing actual or economic physical wear and tear

–Average capital structure

Question 14

What is a major advantage of Pratt’s Stats?

Answer 14

The database contains more data points for each transaction.

Question 15

What transactions comprise the Public Stats database?

Answer 15

Transactions where 100% of the entity is sold.

Question 16

When is the guideline public company method least relevant?

Answer 16

The subject company operates in a niche market in which there are no publicly traded competitors.

Question 17

What are the three common valuation approaches?

Answer 17

Market approach, Asset approach, Income approach

Question 18

What are the primary considerations for using prior transactions to estimate a value under the market approach?

Answer 18

• -Arm’s length transaction
• -Control characteristics
• -Date

Question 19

What type of value estimate is yielded by the guideline company method?

Answer 19

Control or minority and marketable.

Question 20

Which database is based on public companies?

Answer 20

Public Stats

Question 21

What assets are excluded from the sale price listed with BIZCOMPS?

Answer 21

Cash, A/R, and real estate

Question 22

What does R-squared indicate?

Answer 22

The larger the R-squared, the stronger the relationship between the numerator and the denominator.

Question 23

What is the coefficient of variation?

Answer 23

Standard deviation/mean