Introduction to Financial Valuation

Question 1

What is valuation?

Answer 1

Processes of assigning worth or value to something

Question 2

What is financial valuation?

Answer 2

Process of estimating the fair value of an asset, liability, or an entire business

Question 3

When is valuation used?

Answer 3

• Recognition of assets, liabilities, equity
• Investment analysis
• Capital budgeting
• Business mergers and acquisitions
• Tax determinations

Question 4

What is the US GAAP hierarchy of inputs?

Answer 4

Level 1- Highest and best inputs
Level 2
Level 3- Lowest and least desirable inputs, with most assumptions

Question 5

What is a level 1 input?

Answer 5

Unadjusted quoted prices obtained at the measurement date in active markets for assets and liabilities IDENTICAL to those being valued

• Quoted price in an active market
• Should be used when available

Question 6

What is a level 2 input?

Answer 6

Observable for the item being valued, either directly or indirectly, but are other than quoted prices described in level 1; including the following four categories:

• Quoted prices for similar, but not identical, item in active market
• Quoted prices for identical or similar item in market that is not active
• Inputs other than quoted prices that are observable for the item being valued

Question 7

What are level 3 inputs?

Answer 7

Unobservable for item being valued

• Entity assumptions used
• Entity internal data

Use only when observable inputs are not available

Question 8

What are the three approaches under GAAP for developing fair value?

Answer 8

1) Market approach
2) Income approach
3) Cost approach

Question 9

What is the market approach?

Answer 9

Uses prices and other relevant information generated by market transactions for items identical or comparable to item being value
- Common in establishing value of pre-existing house or building

Question 10

What is the income approach?

Answer 10

Uses valuation techniques to convert future amounts of economic benefits or sacrifices of economic benefits to determine wha the future amounts are worth

• Discounted cash flows
• Option pricing models
• Earnings Capitilization method

Question 11

What is the cost approach?

Answer 11

uses valuation techniques to determine the amount required to acquire or construct a substitute item

• Replacement cost approach
• Reproduction cost approach

More limited than market approach or income approach