Terms and Principals

Question 1

Book Value

Answer 1

aka Net Book Value

Method of valuing a company by subtracting Total Liabilities from its TANGIBLE assets. Tangible, meaning it can be sold for cash, ignores intangibles such as Goodwill. Book value is typically calculated off of the balance sheet with no adjustments.

It is a way for investors to understand what capital would be left if the company sold all its assets and paid all its liabilities.

Formula: Tangible Assets - Total Liabilities = Book Value

Question 2

Adjusted Book Value

Answer 2

Method of valuing a company by subtracting Total Liabilities from its TANGIBLE assets. Tangible, meaning it can be sold for cash, ignores intangibles such as Goodwill.

The assets are gone through line by line and adjusted to their fair market value (what the market would be willing to pay for them). Old inventory, doubtful receivables, etc are adjusted down, while aggressively depreciated assets would be adjusted up.

It is a way for investors to understand what capital would be left if the company sold all its assets and paid all its liabilities.

Formula: Adjusted Tangible Assets - Total Liabilities = Adjusted Book Value

Question 3

Replacement Value

Answer 3

The cost to purchase a new item which has the nearest utility as the item being appraised. This includes costs to have the item fully functional, such as delivery and installation fees.

This is used when the item being replaced or appraised is new, in which case depreciation would not typically be considered.

Question 4

Depreciated Replacement Cost

Answer 4

The cost to purchase an item which has the nearest utility as the item being appraised, less an allowance for depreciation and obsolescence.

Question 5

Fair Market Value

Answer 5

The highest price, expressed in terms of cash and equivalents, at which property would exchange hands between a willing and able buyer and a willing and able seller, acting at an arm’s length in an open and unrestricted market, where neither is under compulsion to sell and both have knowledge of the relative facts.

1) Highest Price - the assets will be used in its “highest and best use” sold to a special interest purchaser.
2) Cash and Equivalents - the price at which the absolute transfer of risks and rights associated with the property would take place (not able to use earn outs, promissory notes, etc.)
3) Arms Length - assumes that each party has opposing, self interested economics that prevents decisions to be made on sentiment.
4) Open and Unrestricted Market - Open Market assumes that no one is exempt from the open market. Everyone, including special interested purchasers, should be considered.

Unrestricted refers to the asset having no restrictions on its marketability. For example, a shareholder agreement may prevent the sale of a certain asset.

5) Neither under compulsion to act - meaning, neither party is being forced to sell and instead are engaging in bargaining.
6) Reasonable Knowledge - that all relevant information as of the valuation date is available for consideration. Hindsight is not to be considered in the conclusion of value.

Question 6

Fair Value

Answer 6

Used as a fair value standard for CPA Canada.

The definition is essentially the same as Fair Market Value, but excludes “highest price in an open and unrestricted market”.

This is often used when a more specific scenario is being analyzed. For example, when determining equalization payments in a divorce proceeding, the court may look at a business’ value at a “just and equitable” value to make things fair for both parties, rather than determining what a special interest purchaser would pay.

In Oppression Remedy and Dissent Right cases, Fair Value is the pro rata equity amount of Total Fair Market Value being looked at, without the consideration of equity discounts of premiums.

Question 7

Intrinsic Value

Answer 7

Is a hypothetical market value based on rates of return required by investors, given economic and business conditions at the time of the valuation date, WITHOUT possible synergistic or economies of scale that may accrue to the purchaser.

Question 8

Liquidation Value

Answer 8

The net value to equity holders following a voluntary liquidation, a reorganization of the business at the proposal of creditors, or the liquidation as a result of receivership or bankruptcy.

Question 9

Market Value

Answer 9

The price at which the owner can sell an asset, given the prevailing conditions in an open market.

Question 10

Market Value vs Fair Market Value

Answer 10

It has been suggested that the difference between market value and fair market value comes from the word “fair.” It has been articulated in the courts that the word “fair” suggests that: “… the market price must have some consistency and not be the effect of a transient boom or sudden panic on the market…”
This suggests that in determining a “fair” market value, one must look beyond prevailing market conditions.

Question 11

Net Realizable Value

Answer 11

The net proceeds available upon the sale of an asset after providing for all costs of the disposition, including income tax.

Question 12

Replacement Costs

Answer 12

Replacement value is the current cost of purchasing a similar new item having the nearest equivalent util- ity as the item being appraised. Because the asset is replaced in its current location, any relevant delivery and installation costs would be included.

Question 13

Reproduction Costs

Answer 13

Reproduction value is the current cost of manufacturing or reproducing an identical new item.

Question 14

Value to Owner

Answer 14

Value to owner describes owner-perceived economic advantages, non-economic advantages, or a com- bination of both. It is never less than fair market value, but it may be equal to or greater than fair market value.

Ex. Pizza Express has its FMV based on its performance, but it has additional incremental value to to Dad becuase hes worked there his whole life, has memories starting it with his father, and enjoys cherishes what it has done for him and his family. However, payers in the market would not place the same value on these items. This increase is the Value to Owner.

Question 15

Price vs. Value

Answer 15

Price in an Open Market and Value in a Notional Market may differ for a number of the following reasons:

1) parties may have different negotiating skills, knowledge of the business, or financial strength,
2) emotional considerations may override objective decisions
3) All special interest purchases may not be identifiable.
4) Legal and contractual restrictions may exist.
5) party may be under compulsion to act.
6) Not always in cash. Alternative structures for payment may exist (earn-outs, etc) where time value of money should be considered.

Only way to know the true value of an asset is to expose it to the open market and negotiate with true potential buyers.

Question 16

Tangible Asset Backing

Answer 16

Tangible asset backing is the value of the operating assets minus operating liabilities of a business. Thus, tangible asset backing does not include redundant assets or debt. Tangible asset backing (TAB) is not a primary valuation technique but rather it is generally used in con􏰂unction with an income-based technique (e.g., capitalized earnings or cash flows) to assess risk. The value of the operating assets when calculating TAB is based on a going-concern assumption.

• TAB includes the value of assets as part of an ongoing operation rather than the value of each asset if sold individually.
• TAB does not consider costs of disposition.

Question 17

TAB vs Adjusted Net Book Value

Answer 17

Mathematically, the calculation of TAB is identical to adjusted net book value. However, different terminology is used to distinguish whether the result is a measure of value or a measure of risk. TAB is a measure of risk. Adjusted net book value represents the value of a business as a going concern when there is no expectation of any type of non-identifiable intangible value or commercially transferable goodwill.

Question 18

Special Interest Purchaser

Answer 18

The term “special interest purchaser” refers to purchasers who expect to enjoy incremental economic benefits and/or post-acquisition value additions (i.e., synergies) by combining the acquired business with their own. Put another way, a special interest purchaser may be willing to pay more to acquire a business than they would for others if they believe they will reap unique benefits by combining their business with the newly acquired one.

Question 19

Intangible Value

Answer 19

Intangible value is the amount by which the going-concern value of the equity exceeds the value of the net tangible assets of the business. Intangible value is sometimes referred to as the “going-concern risk” of a business, despite the fact that the going-concern value of tangible assets is greater than a liquidation value (i.e., after considering realization issues on receivables and inventory on liquidation, shut-down costs, etc.).

Question 20

Identifiable Intangibles

Answer 20

Identifiable intangible assets are assets that can be transferred separately from the business that owns them and have intrinsic value on a going-concern basis. including brand names, patents, copyrights, franchise agreements, trademarks, etc.; where the value of such assets can be valued separately and can be traded.

Question 21

Unidentifiable intangibles

Answer 21

Also known as Goodwill, on the other hand, represents an
intangible asset, which is more general in nature and is therefore more difficult to quantify (e.g., management strength and reputation).

Question 22

Locational Goodwill

Answer 22

Goodwill of location (or locational goodwill as noted above) is generally associated with a particular loca- tion and is premised on the assumption that existing customers will return to the location for goods or services regardless of who owns the premises. This may be due to being in a high traffic area or in close proximity to its customer base. This type of goodwill is not dependent on any individual employees and is commercial (transferable) in nature.

Question 23

Personal Goodwill

Answer 23

A business can often earn high profits as a result of an individual’s personal talents, skill, effort and reputation. Such profits will diminish or disappear entirely upon the death or retirement of that person. Personal goodwill cannot be transferred to another individual.

Question 24

Individual Goodwill

Answer 24

Individual goodwill is the economic advantage that a business accrues by employing a person with certain abilities, business contacts, and reputation. If that person left the business and competed with it, the profitability of the former business could be damaged. However, in contrast to personal goodwill (which is discussed below), the business has the capacity to substitute other people with similar skills and experience in the subject role.

Question 25

Commercial Goodwill

Answer 25

Is goodwill that can be sold or transfered to a buyer. The alternative is Value-to-Owner, which are benefits that cannot be had by a buyers, therefore not commercial in nature.