Finc Mgmt D - Financial Valuations Flashcards
In a small town, the announcement of layoffs by the largest employer involves
higher risk of performance results not being met
Two types of valuation engagements described by the Statement on Standards for Valuation Services (SSVS 1) ar
Valuation engagement and Calculation engagement
In valuation engagements:
- analyst is free to employ the use of any valuation approach or method deemed professionally appropriate under the circumstances
- results are expressed in terms of a conclusion of value and can be a single number or range
- premise of value can either be going concern or liuidation
In calculation engagements:
- analyst and client agree upon valuation method and approaches to use
- not free to use any approach or method
- results are expressed in terms of a calculated value and can be a single number or range
- premise of value can either be going concern or liquidation
Per FASB ASC 820, the goal of disclosures presented in F/S related to FV measurements is to provide
enough info to users of F/S so that the inputs used in FV measurement can be assessed
Using risk-free rate, beta coefficent, rate of return on the market portfolio, and required rate of return denotes that the _____ model is being used.
CAPM (capital aset pricing model)
Three basic valuation approaches are:
- cost approach
- market approach
- income approach
Market approach to determining FV uses
market comparisons of identical or comparable items; companies within the industry that have similar performance records and structure will have similar value
Cost approach to determining FV is
an example of the economic substitution principle aka what would it cost to replace the item in question with an asset of like function and capacity
Income approach to determining FV focuses on
the company’s ability to create earnings or some other benefit stream and the risk related to that investment
When using the market approach on a subject, remember that potential guideline companies should:
- use similar GAAP choices
- have similar product diversification
- serve similar markets
- have similar geographic diversification
- be of similar size
- have similar financial and operating leverage
- have similar liquidity, solvency, growth, and profitability
- not be based on a single guideline
- not be identical
Under FASB 820, when determining FV of property, the FV should be based
on the highest and best use as determined from the viewpoint of the purchaser
When using the income approach, the higher the risk, the _____ the discount rate and the ________ the PV of the subject company
higher; lower
Fair market value defines the seller as ______, whereas fair value assumes a ______ seller
hypothetical; specific
Fair market value is
the price, expressed in terms of the cash equivalent, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts
Fair value is
the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
Differences in fair market value and fair value:
- FMV implies a willing buyer/seller
- FV buyer/seller are not necessarily willing
- FMV has a hypothetical seller
- FV has a specific seller
- FMV takes advantage of an unrestricted market
- FV uses the principal or most advantageous market
Four basic categories of normalization adjustments:
- nonoperating adjustments
- nonrecurring adjustments
- comparability adjustments
- discretionary adjustments
Nonoperating adjustments are
the removal of nonoperating items included in the historical financial statements that are not part of normal operations
Nonrecurring adjustments are
the removal of unusual, unexpected, or items not likely to occur again from the financial statements
Comparability adjustments are
the adjustments of the historical financial statements to match GAAP choices of potential guideline companies
ex. LIFO to FIFO
Discretionary adjustments are
the adjustments of the historical financial statement to include or to remove items not considered part of normal operations
ex. excessive wages paid to family members need to be adjusted to market rates
The cost approach is appropriate when:
- the company is in liquidation
- the company is worth more in liquidation than as going concern
- the company’s value is basically related to assets held
- the company has had no income in recent years
- the future benefit streams cannot be adequately predicted
Under FASB ASC 820, the principal market is considered to be the market where
the holder of the asset or liability could find the greatest volume of asset sales or liability transfers of items similar to the one being valued.
Under FASB ASC 820, the most advantageous market is considered to be the market where
the holder of an asset could maximize the price received in an asset sale or minimize the transfer costs in the conveyance of a liability.
Premise of value is
an assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation
Premise of value will be one of two situations:
- going concern
- liquidation
Going concern is when
the company will be expected to continue operations into the future; they can falter, regroup, and continue
Liquidation is when
the company has its assets sold or disposed of in some fashion and will ultimately discontinue ops completely
IRS Revenue Ruling 68-608 provides guidance as to the form o the F/S when used in a valuation process and says that
the past earnings used in the valuation process should fairly reflect the probable future earnings.
The three groups of inputs under FASB ASC 820
- Level 1
- Level 2
- Level 3
Level 1 FV measurement is
directly observable inputs of identical items
Level 2 FV measurement is
directly or indirectly observable inputs of similar items
Level 3 FV measurement is
unobservable inputs
If you have a quoted market price for a similar asset but there are some questions related to the condition being valued in comparison, then consider it a
Level 3
If a company announces negative information that has a negative impact on the market price shortly after the close of the market, the fair value valuation should ______ and list the value of the subject asset at the ________. This would also _____ the input level to Level ____
employ the use of the new information; lower price; drop; Level 2
Price is
the observed exchange price that occurs in the marketplace
Worth is
the advantages of ownership based upon the perceived benefits at a particular point in time and for a particular use
Value is
the determination of what would be received in an exchange between two willing parties in an arm’s-length transaction in the marketplace where both parties had acted with knowledge, with prudence, and without compulsion
Cost is
what was paid for an asset in the marketplace
The focus of a business valuation is
the value
[not the price, worth, or cost]
Under FASB ASC 820, In-exchange premise assumes
that the max value of the subject item would come from the purchaser’s perspective when the item is used alone
Under FASB ASC 820, In-use premise assumes
that the max value of the subject item would come from the purchaser’s perspective when the item is used in conjunction with other assets as a group
To provide support for a valuation estimate arrived at using another method with similar results, a practitioner can use
rule of thumb; [reasonableness check]
