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Financial Accounting > Finance > Flashcards

Finance Flashcards

1
Q

Valuations - FMV

A

Highest price available in an open and unrestricted market between informed and prudent parties, acting at arms length and under no compulsion to act, expressed in terms of money or money’s worth

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2
Q

Valuations - Notional Market

A

Hypothetical transaction, whereas the open market is where the real transaction occurs

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3
Q

Valuations - FMV - Highest Price Available

A

Valuator determines highest price that an arms length purchaser would be willing to pay

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4
Q

Valuations - FMV - Open and Unrestricted Market

A

In this notional market, there are no potential purchasers excluded from participating in the potential transaction.
No statutory, contractual or other restrictions affecting marketability

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5
Q

Valuations - FMV - Informed and Prudent Parties

A

Both the vendor and the purchase know all the facts that would be of importance to the valuation at hand

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6
Q

Valuations - FMV - Acting at arms length

A

Opposing parties will have an economic interest in the outcome of the transaction

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7
Q

Valuations - FMV - Under no compulsion to act

A

Neither of the parties involved is under any obligation and can walk away at any point

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8
Q

Valuations - FMV - Expressed in terms of moneys worth

A

Open-market transaction could occur by exchanging non-cash, the FMV is expressed in cash-equivalent

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9
Q

3 Valuation Approaches

A
  1. Asset Based
  2. Income Based
  3. Market Based
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10
Q

Asset- Based Valuations

A
  1. Liquidation
  2. Adjusted Net Assets
  3. Replacement Cost
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11
Q

Income-Based Valuations

A
  1. Capitalized Cash Flows
  2. Discounted Cash Flows
  3. Capitalized Earnings
  4. Discounted Earnings
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12
Q

Market-Based Valuations

A
  1. Assets with an Active Market

2. Comparable Transactions

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13
Q

Liquidation Approach

A

Asset-Based Valuation

  1. Not considered a going concern
    a) Orderly - assets sold at NRV
    b) forced - assets are sold quickly and for lower proceeds
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14
Q

Adjusted Net Assets Approach

A

Asset-Based Valuation

  1. Going Concern
  2. Does not have active operations or does not have excess earnings (no inherent GW)
    - Holding companies
    - Calculate a “floor” value - lowest value that would be accepted
    - All assets are valued at FMV’s net of disposition costs
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15
Q

Replacement Cost Approach

A

Asset-Based Valuation

  • Rarely used because it lacks economic validity
  • Used for insurance purposes or valuing intangible assets
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16
Q

Income Based Approaches

A

CF’s or earnings are normalized - adjusted for unusual items or items that may not occur when the new owner takes over

17
Q

Capitalized CF report

A

Income-Based Approach
- Entity has active operations and excess earnings
- Historical CF’s relative to future earnings
Determine CF’s and apply capitalization rate

18
Q

Discounted CF Approach

A

Income-Based Approach
- Startups
- Historical CF are negative
CF’s for a given number of years are calculated and individually discounted
- Lack of regularly prepared forecast and unreliability of the information

19
Q

Capitalized Earnings Approach

A

Income-Based Approach

  • Based on historical earnings
  • Earnings are multiplied by a multiplier or divided by capitalization rate
20
Q

Discounted Earnings Approach

A

Income-Based Approach

  • Merger & Acquisition
  • Future earnings are expected to be volatile and are separated out from earnings in steady-state years
  • Estimates are discounted at the appropriate discount rate
21
Q

Market Based Approach

A
  1. Going Concern
  2. Information required is publicly available and reasonably comparable
    - Corroborative
    - Valuation multiple is applied to entity’s net earnings
22
Q

Latent Taxes

A

Those that would arise from selling the assets, such as taxes on capital gains and/ or recapture

23
Q

Foregone tax shield

A

FMV of assets are greater than current tax values for those assets

24
Q

Replacement Cost Approach

A

Higher than BV because depreciation is not taken into account

25
Q

Redundant Assets

A

Tangible or Intangible asses that can be sold without impacting the normal operations of the business
- Marketable securities

26
Q

Calculating Equity Value (Capitalized CF Approach)

A
  1. Maintainable Operating CF
  2. Deduct Income Taxes
  3. Deduct Sustaining Capital Investment
    = Estimated Maintainable Free CF Balance
  4. Divide Capitalization Rate
    = Capitalized CF
  5. Add PV of existing tax pools
  6. Deduct Redundant NA
  7. Deduce Outstanding-Interest Bearing Debt
    = Equity Value
27
Q

Calculating Equity Value (DCF Approach)

A
  1. PV of free cash flows
  2. Plus PC of residual/ Terminal Value
  3. Plus PV of tax shield
    = Enterprise Value
  4. Plus NRV of redundant assets and liabilities
  5. Less Outstanding interest-bearing debt
    = Equity Value
28
Q

Financial Risks

A

Unexpected changes in interest rates, exchange rates and commodity prices

29
Q

Derivative Financial Instrument

A

Contracts that are linked to changes in value of underlying variable

30
Q

Two types of Derivatives

A
  1. Privately traded - Over the Counter - OTC
  2. Exchange Traded - ETD
    - ETDs are regulated
31
Q

Forward Contract

A

Delivery of a specified good/item on a specified future date at a specified price

  • Non standardized, written by parties involved
  • Must be fulfilled at an agreed upon date
  • No upfront cost
  • Counterparty Risk
32
Q

Counterparty Risk

A

Risk that one of the parties will not be able to perform as required under the contract

33
Q

Future Contract

A

Standardized contract to buy/ sell an asset on or before a future date at a specified price

  • written by a clearing house
  • Used to manage price risk or foreign currency risk
  • Requirement to maintain a margin account as deposit
  • Net balance of daily profit or loss is kept in the margin account
  • If you buy back a future you can sell at any time
34
Q

Options

A

Give the owner the right to buy (call) or sell (put) an asset at the strike price or exercise price

35
Q

Call Option Terminology

A

In the money - Strike Price is below current market price

Out of the money - Strike Price is above current market price

Intrinsic Value - Equal to the spot price less the exercise price time the specified quantity

36
Q

Option Premium

A

Upfront amount to be paid to buy the option and is in current no matter if the option is exercised or not.

  • depends on options length of time to maturity
  • strike price
  • current value of underlying asset
  • prevailing risk-free rate
37
Q

Implications to FV - Call Option

A

Underlying Item Price
- Higher price, the higher the FV

Exercise Price
- Lower EP, higher the value

Volatility
- Higher volatility, higher FV

Risk-Free Interest Rate
- Higher Rate, Higher FV

Time
- Longer Period, Higher FV

38
Q

Implications on FV - Put Option

A

Underlying Item Price
- Lower price, the higher the FV

Exercise Price
- Higher EP, higher the value

Volatility
- Higher volatility, higher FV

Risk-Free Interest Rate
- Lower Rate, Higher FV

Time
- Longer Period, Higher FV

Financial Accounting (4 decks)

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