Terms and Principals Flashcards
Book Value
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
Adjusted 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.
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
Replacement Value
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.
Depreciated Replacement Cost
The cost to purchase an item which has the nearest utility as the item being appraised, less an allowance for depreciation and obsolescence.
Fair Market Value
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.
Fair Value
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.
Intrinsic Value
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.
Liquidation Value
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.
Market Value
The price at which the owner can sell an asset, given the prevailing conditions in an open market.
Market Value vs Fair Market Value
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.
Net Realizable Value
The net proceeds available upon the sale of an asset after providing for all costs of the disposition, including income tax.
Replacement Costs
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.
Reproduction Costs
Reproduction value is the current cost of manufacturing or reproducing an identical new item.
Value to Owner
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.
Price vs. Value
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.