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213 Cards in this Set
- Front
- Back
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What is ARM 34?
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-Issued in 1920
-Resulted from the enactment of prohibition (determined of intangible value lost) -Goodwill exists if business has excess earnings -Goodwill is determined by capitalizing excess earnings |
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What is Rev Rul 59-60?
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-Considered most important
-Outlined methods in valuation -Involved with Estate/Gift tax -Provided for a series of valuation methods -ie Comparable Price Method; Asset Method; Income Method; Combined Method; etc. |
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What is Rev Rul 65-193?
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-Modified Rev Rul 59-60
-Concerned with seperatly valuing tangible/intangible property |
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What is Rev Rul 68-609?
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-Referred to as "excess earnings method"
-Outlined "formula" to determine goodwill & intangibles. |
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What is Rev Rul 77-287?
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-Amplified Rev Rul 59-60
-Specifically criteria for DLOM |
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What is Rev Rul 93-12?
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-Superceded Rev Rul 81-253
-A minority interest will not be disallowed due to family interest aggregation |
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What is IRC 2703?
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-States for estate/gift purposes, value is determined without regard to any right or restriction relating to property
-Must be greater than 50% owned by non-family members of transferor |
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What does the DOL do?
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-Issues reg's pertaining to business valuations for ESOPs
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How did FASB weigh into the business valuation field?
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-Issued FAS 141 "Business Combinations
-Issued FAS 142 "Goodwill & other intangibles |
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What are the three standards of value?
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-FMV
-Fair Value -Strategic/"Investment" Value |
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Define FMV per Rev Rul 59-60?
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-The price at which the property would change hands between a willing buyer and seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts (both parties are considered hypothetical)
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Define Fair Value?
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-The amount that will compensate an owner involuntarily deprived of property.
-Most commonly with dissenting shareholder actions and divorce -May be considered FMV without discounts -Mandated by states |
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Define strategic/"investment" value?
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-Value to a particular investor
-Based on individual investment requirements/expectations -ie M&A |
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What are the four premises of value?
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-Book value
-Liquidation value -Replacement value -Going concern valu |
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What is IRC 6662?
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-Consolidated into one code section several different accuracy-related penalties related to valuations
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What are the four principles of valution?
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-Rate of return / Level of risk principle (risk / reward ratio)
-Alternatives principle (opportunity costs) -Investment value principle (benefit stream / Req'd rate of return) -Substitution principle (replacement costs) |
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What are the two main classes of business valutions?
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-Tax
-Nontax |
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What are the 5 main regulatory bodies of business valuations?
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-IRS
-DOL -FASB -NACVA -IACVA |
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What are the main categories of financial ratios?
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-Internal liquidity ratios
-Operating efficiency ratios -Operating profitability ratios -Business risk (operating) analysis ratios -Financial risk (leverage) ratios |
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What are the internal liquidity ratios?
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-Current ratio
-Quick ratio -Cash ratio -Recievable turnover -Inventory turnover -Payables turnover -Cash conversion cycle |
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Define current ratio
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-Measures a firms ability to pay its near-term financial obligations.
= CA/CL |
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Define quick ratio
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-If inventories are not easily liquidated, provides better indication of solvency.
= Cash+Mkt Sec+Rec'b/CL |
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Define cash ratio
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-Most conservative measure of solvency.
=Cash+Mkt Sec/CL |
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Define receivable turnover
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-Based on credit sales only, shows how many times avg A/R is collected. Divide into 365 to get average time to collect A/R.
=Sales/((Beg A/R+End A/R)/2) |
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Define inventory turnover
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-Shows how many times inventory is sold during the year. Divide into 365 to get number of days to completely sell companies inventory.
=COGS/((Beg Inv+End Inv)/2) |
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Define payables turnover
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-Shows the number of times a company pays its A/P balance. Divide into 365 to get average time A/P is outstanding before being paid.
=COGS/((Beg A/P+End A/P)/2) |
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Define cash conversion cycle
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-Measures time between outlay of cash for inventory and the collection of cash from the sale of that inventory.
=Inv turnover+Days to collect A/R-A/P payment period. |
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What are the 2 operating efficiency ratios
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-Net fixed asset turnover
-Total asset turnover |
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Define net fixed asset turnover
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-Indicates management's ability to utilize fixed assets.
=Net sales/((Beg F/A+End F/A)/2) |
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Define total asset turnover
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-Indicates management's ability to utilize total assets.
=Net sales/((Beg Assets+End Assets)/2) |
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What are the operating profitability ratios?
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-COS/Sales (%)
-Operating exp/Sales (%) -Return on Assets (%) ROA -Gross margin (%) -Return on Equity (%) ROE -Operating margin (%) |
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Define COS/Sales (%)
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-Indicates profit margin efficiency.
=COS/Sales |
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Define Gross Margin (%)
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-Indicates profit margin efficiency. Inverse of COS/Sales (%). Both = 100%
=Sales-COS/Sales |
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Define operating expenses/sales (%)
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-Generally used as a measure of managements ability to control its operating expenses.
=Operating expenses/Sales |
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Define operating margin (%)
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-Analyzes operating expense ratio.
=Income from operations/Sales |
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Define return on assets (%)
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-Measures managements ability to earn a return on assets funded from all sources (debt & equity). Net income should be before interest expense.
=Net Inc/((Beg Assets+End Assets)/2) |
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Define return on equity (%)
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-Measures return on equity.
=Net Inc/((Beg Equity+End Equity)/2) |
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What are the 3 Business risk (operating) analysis ratios?
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-Coefficient of variation of operating income (EBIT)
-Sales volatility -Degree of operating leverage (DOL) |
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Define coefficient of variation of operating income (EBIT)
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-Measures volatility of earnings over time.
=Std Dev of EBIT/Mean (Avg) EBIT |
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Define sales volatility
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-Measures sales volatility over time
=Std Dev of Sales/Mean (Avg) Sales |
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Define degree of operating leverage (DOL)
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-Measures inherent risks of operations and is largely a function of firms cost structure.
=% Change in EBIT/% Change in Sales |
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Define business risk
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-Largely a function of a firm's cost structure. The greater the proporation of variable costs, the better a firm can weather an economic downturn or rapid obsolescence. Companies with significant capital investment and large fixed costs are riskier.
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What are the financial risk (leverage) ratios?
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-Debt to Equity ratio
-Operating cash flow ratio -Interest coverage ratio -Total debt to invested capital ratio -Total debt to total assets ratio -Operating cash flow to LTD -Operating cash to total debt ratio |
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Define debt to equity ratio
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=LTD+Deferred Tax Liab/Total Equity
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Define total debt to total invested capital ratio
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-Measures what % of a firm's assets is financed with debt
=C/L+LTD/Total Liab+Total Capital |
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Define total debt to total assets ratio
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-Measures proportion of a company's assets which are financed through debt.
=C/L+LTD/Total Assets |
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Define interest coverage ratio
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-Measure of a firm's ability to meet it's interest payments.
=EBIT/Interest expense |
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Define operating cash flow ratio
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-Measures a firm's ability to generate the resources req'd to meet it's current liab.
=OCT/Curr Liab |
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Define operating cash flow to total debt ratio
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-Measures the ability to service LTD, including lease obligations.
=OCF/Book Val LTD+PV of lease obligations |
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Define operating cash flow to total debt ratio
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-Measures the ability to service total interest bearing debt.
=OCF/LTD+Current interest bearing debt |
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How many years does Rev Rul 59-60 suggest should be analyzed?
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-5 years historical, perhaps it approximates the typical business cycle.
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What is the main objective for adjusting historical financial statments?
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-To more closely reflect its true economic financial position and results of operations.
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What is the purpose for normalized financial statements?
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-Useful for making comparisons to similiar businesses or industry averages.
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What are the categories of normalizing adjustments?
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-GAAP compliance
-Method of accounting (LIFO, FIFO, etc.) -Nonrecurring transactions -Nonoperating (ie removal of nonoperating asset/expenses from financials) |
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Where a majority interest is being valued, what are some of the "control" adjustments made to normalize financial statements?
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-Adjust excess compensation.
-Remove discretionary spending -Adjust operating inefficiencies -Adjust for financial structure. Note: Minority<50% can't control these factors. |
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In normalizing the balance sheet accounts Allowance for Doubtful Accounts, Notes Receivable, Inventory have in common?
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-They should all be adjusted to reflect the market as of the date of valuation.
-Note: LIFO inventory is usually adjusted to FIFO as this usually is closer to market value. Adjustment is usually the amount in the LIFO reserve. |
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How is depreciation normalized
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-Restated ot reflect true economic depreciation.
-On a comparative basis, usually adjusted to the subject companies industry. |
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How are leases normalized?
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-Locate all material assets and liabilities and get them into the adjusted net assets of the company.
-Consideration under FASB 13 is necessary to determine if properly classified. |
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How are fixed assets normalized?
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-Adjust to reflect appreciation or impairment.
-Must take into account capital gains tax liability. This is true for marketable securities as well. |
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How are capitalization or expensing policies normalized?
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-Adjust to industry standards if needed.
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What areas need consideration in normalizing the timing of income/expense?
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-Long-term contracts
-Installment sales -Completed contract/% of completion -Note: should conform industry standards for comparability. |
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How are income taxes normalized?
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-Establish the true likliehood of a deferred tax asset/liability and add or remove.
-Consider NOL usage. |
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What is the goal in normalizing extraordinary or non-recurring items?
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-To make adjustments to remove one-time or nonrecurring items.
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What is the goal of normalizing compensation of owners including perquisites?
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-To adjust owners compensation to more closely reflect the reasonable compensation of a replacement officer.
-Can often be found in a database info. -Also remove any salaries of family members, friends and others who are not contributing to business operations. |
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How are contingent liabilities normalized?
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-Usually not an income stream adjustment
-Financials should be adjusted to reflect effects of contingent liabilities under FAS 5. |
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How are non-operating items normalized?
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-Removed from the valuation process and added back.
-Exclude any related income/expense generated by the non-operating assets. |
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How are intangibles normalized?
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-Usually estimated through their impact on the benefit stream.
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How is cash normalized?
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-Adjust for cash in excess of normal operating needs.
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How is rent normalized?
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-Adjust to market value rent.
-This is especially true if rented from owner. |
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What are the considerations in normalizing financials in regards to income taxes?
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-Valutions usually based on pretax earnings because astute tax planning may avoid payment of taxes.
-Nature of investment should be considered, ie asset purchase results in step-up in basis and additional depreciation and tax benefits and capital gains with the former owner. In this case buyer is usually willing to pay full market value for assets. -However, valuations are usually stock based and buyer usually discounts amount paid for these factors. |
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After completing the financial analysis ratios, normalizing historical earnings, analyzing economic and industry conditions and forecasts and evaluating internal and external risk factors of the company, the analyst is in a position to derive an estimate or conclusion of value. What issues need to be addressed at this point?
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-How to define and measure the future benefit stream.
-Will historical or projected benefit streams be used? -Will benefits be projected to equity, or entire company (invested capital)? |
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What type of earnings is generally used in the Discounted Economic Income Method (DCF Method)?
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-Net cash flow to equity or Net cash flow to invested capital.
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What type of earnings is generally used with the Treasury Method?
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-Net income before or net income after tax, as long as rate of return on assets is based on the same type of earnings.
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When using an income approach, why are net cash flows generally preferred as the measurement stream?
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-Net cash flows represent the type of earnings most investors are seeking
-In line with discount rates derived from cost of capital from capital markets and empirical data. -Net cash flow brings into the income approach the expected future changes in the balance sheet. |
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What types of earnings are used as the measurement of economic income when applying the market approach?
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-EBIT, EBITDA, Seller's Discretionary cash flow, operating gross cash flow, etc.
-These are the types of benefits generally capitalized based on the pricing multiples (ie P/E ratio, etc.) |
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When are GAAP earnings (net income) used as a measure of economic income for valuation purposes?
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-When the analyst expects future earnings to approximate the future net cash flows.
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What is the formula to determine net cash flow to equity?
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Net income (after tax)
+Noncash charges (depr, etc) -Capital expenditures -Additions (deletions) to net working capital +Changes in LTD (borrowings) -Changes in LTD (repayments) ------------------------------------ =Net cash flow to equity -Dividends paid to preferred SH's ------------------------------------ =Net cash flow to common SH's (after tax) |
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What is the formula to determine net cash flow to invested capital?
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Net income (after tax)
+Noncash charges (depr, etc) -Capital expenditures -Additions (deletions) to net working capital +Interest expense net of tax benefits resulting from interest as a tax deductible expense ------------------------------------- =Net cash flow to invested capital (after tax) ***NOTE: DOES NOT INCLUDE CHANGES IN LTD (BORROWINGS/REPAYMENTS)*** |
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In discounting net cash flow to equity or net cash flow to invested capital, what is the appropriate discount rate to use?
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-Net cash flow to equity = Cost of equity
-Net cash flow to invested capital = WACC (weighted avg cost of capital) |
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For what types of engagements are historical income vs projected income appropriate?
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-Historical income = tax, buy/sell and divorce, because it is based on fact.
-Projected = litigation matters, ESOPs and transactional valuations, because projected income may be more representative of future results. -Note: when income is linear, historical income is usually used vs projected when nonlinear income streams are present. |
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What is the unweighted average method and when is it employed?
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-Sum of variables/Number of variables
-Used when all past earnings are representative of expected future benefits. |
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What is the weighted average method and when is it employed?
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-ew1+ew2,etc/w1+w2,etc (where e=earnings & w=weight factor assigned)
-Used when there is a general pattern that may be extrapolated into the future. |
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Discuss the theory of free-cash flows.
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-Provides a measure of the available to the company for discretionary uses.
-Discretionary = Growth oriented capital expenditures Debt principle reduction SH payments (ie dividends) |
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What is an adequate number of years to use to estimate future benefits?
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-No correct answer, however generally projected as many years as necessary until the benefit stream stabilizes and become linear.
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What are the two components of the capitalization/discount rate?
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-Safe (or reasonable) rate of return on secure investments
-An additional return (premium) that compensates for relative degree of risk. |
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What are the 3 risk factor adjustments in the calculation of discount/capitalization rate?
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-External factors
-Internal factors -Investment factors |
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What are the external risk factors in the discount/capitalization rate?
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-Expectations of the general economy
-Existing conditions of the general economy -Expectations of a particular industry -Existing conditions of a particular industry -Competitive environment of a particular industry |
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What are the internal risk factors in the discount/capitalization rate?
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-Quality and depth of the organization and staffing
-Competitive position of the business being valued -Financial position/condition of the business being valued -Nature of business being -Size of business being valued valued -General expectations of the particular industry being valued -Reliability of earnings. |
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What are the investment risk factors in the discount/capitalization rate?
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-Risk factors with the investment itself
-Expectations of capital appreciation of investment -Amount invested in the particular business relative to other investments in the portfolio -Level of expected management burden of the investment -Expectations of liquidity of investment |
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What are the two primary criteria for determination of cap/discount rate in the context of valuing closely held businesses?
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-Cap/discount rate should be essentially the same as the rate of return that is currently being offered to attract capital to the type, size and financial condition of the business being valued.
-The cap/discount rate should be consistent with the "type" of benefit stream to be capitalized. |
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Define capitalization rate
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-Discount rate less long-term sustainable growth
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What is the formula for Ibbotson Build Up Method?
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Cost of Equity =
+Risk free rate (long-term 20yr) +Industry risk premium +Size premium +Specific company risk premium +Equity risk premium |
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What is the formula for Ibbotson industry risk premium?
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Industry Risk Premium =
(Risk Index for Industry x Equity Risk premium) - Equity risk premium |
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Define equity risk premium
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-The return an investor would have recieved on the S&P 500 in excess of the return on Treasury securities (long-term).
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What is unsytematic risk?
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-Measures uncertainty of returns arising from charecteristics of the industry and individual company. Can be mitigated through diversification.
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What are the factors to consider in specific company risk?
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-Financial risk: consider financial ratios & debt burden
-Other operational charecteristics: key-man, mgmt depth, etc. -Diversification: less risk for diversified geography, product line, etc. |
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What should growth rate equal?
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-Inflation plus real growth acheivable without additional capital investment.
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What is the CAPM formula?
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-Risk free rate + Beta x (expected return on mkt portfolio - risk free rate)
-Risk free rate is long-term (20yr) |
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What does Duff & Phelps LLC report?
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-Equity risk premium
-Excludes financial svcs companies, must be publicly traded for 5 yrs, sales greater than $1m, must have positive EBIDTA for previous 5 yrs. -Can use risk premium in build-up methods. |
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What is the formula for WACC?
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-WACC =
[cost of equity x % of equity] +[cost of debt pre-tax x (1-tax rate) x % of debt] -Note: computed as after-tax WACC |
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What is the initial problem in calculating WACC for privately-held companies?
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-No market value exits for capital structure weightings. Analyst must estimate mkt values and do iterations based on initial book value.
-Initially use a cost of equity based on a build up method. |
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Describe the risk rate component model (RRCM)
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-Adds a weighted avg risk premium to risk free rate.
-Considers the following in the risk premium: Competition Financial strength Profitability & sustainability of earnings Mgmt dept/ability Local economic effects National economic effects |
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What is the Black/Green build-up summation method?
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-Pretty much the same as the RRCM.
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What is the difference between the Black/Green build-up and Value-Netex methods?
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-Value-Netex method defines areas of risk differently. Breaks down into:
Quantitative Risk: -------------------- Liquidity Leverage Operations Cost control Growth Qualitative Risk: -------------------- Competition Management Stability |
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Pre-tax cap/discount rates must be applied to pre-tax earnings & vica versa. What are the formulas to convert rates back and forth?
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-After-tax cap rate = pre-tax cap rate x (1 - tax rate)
-Pre-tax cap rate = after-tax cap rate / (1 - tax rate) |
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What are the 3 general methods (categories) of valuations?
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-Asset based approach
-Income approach -Market approach |
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What are the 2 asset based approaches?
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-Book value method: GAAP value of equity section of balance sheet.
-Adjusted net assets method: Measures the difference between the FMV of the businesses assets and its liabilities. Valued at liquidiation value, it sets a floor, but does not address the operating earnings potential. |
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What are the 4 major adjustments under the adjusted net asset method?
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-Adjust PP&E to estimated FMV based on appraisels.
-Convert LIFO to FIFO inventory -Remove non-operating assets (ie excess cash, etc) -Estimate NPV of deferred income tax liability associated with built-in gain. |
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What does Rev Rul 59-60 require when it lists the earning capacity of a company as a factor to consider?
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-Applicaton of the income approach
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What are the two main approaches under the income approach?
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-Capitalization of earnings/cash flows
-Discounted earnings/cash flows |
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What is the capitalization of earnings method?
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-Estimated future benefits are capitalized using cap rate.
-Assumes all assets are indistinguishable parts of the business and does not attempt to seperate their values. -Income/expenses from non-operating assets must be removed prior to application. |
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What is the discounted earnings method?
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-Referred to as the DCF method
-Based on the theory that the total value of the business is the PV of its projected future earnings plus PV of the terminal value |
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When using net cash flow to invested capital and valuing a controlling vs minority interest, what is important to keep in mind regarding WACC?
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-A controlling interest has the ability to change the capital structure, thus base the WACC on the optimum capital structure (usually industry average).
-Should avoid using net cash flow to invested capital in a DCF model for minority interests when capital structure is changing over the forecast period. |
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What is the Gordon Growth Model & formula?
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-Assumes cash flows will grow at a uniform rate in perpetuity.
Formula Is: ------------------------------------ Cash flow in period before valuation date x (1 + growth rate) / (cap Rate - growth rate) |
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What are the advantages & disadvantages of the market approach?
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Advantages
-------------------------------------- -User freindly. -Does not rely on forecasts -Used actual data -Relatively simple to apply Disadvantages -------------------------------------- -Costly approach -Reliability of data is questionable -Important assumptions are hidden -Sometimes no comparable data -Standard of value may be unclear |
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What is the formula for the market approach?
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-Value = Price/Parameter (comp) x Parameter (subject)
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What are the 6 main data sources for the market method?
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-IBA & Bizcomps (smaller companies)
-Pratts Stats (medium sized) -Done Deals, Mid Market Comps & Mergerstat (deals where one of the companies "buyer" was publicly traded) |
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In the market approach formula what denominator is paired with MVIC & MVeq as the numerator?
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-MVIC is usually the numerator paired with:
1. EBITDA 2. EBIT -MVeq is usually the numerator paired with: 1. Net income 2. Cash flow |
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Under the market approach, what is the dividend paying capacity method?
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-Future estimated dividends or capacity to pay out dividends are capitalized with a 5-year weighted avg of dividend yeilds of 5 comparable companies. (not usually used for smaller non-dividend paying co's)
Note: Req'd per Rev Rul 59-60 for estate & gift purposes. |
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What is the excess earnings/treasury method?
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-Combines the income and asset approaches.
-Takes the adjusted net asset approach value and adds the capitalized earnings of the business in excess of the industry rate of return on the adjusted "identified" net assets of the business. |
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What is the excess earnings/reasonable rate method?
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-Same as the treasury method, except a reasonable rate of return is applied to the adjusted net assets rather than the industry averages used in the treasury method.
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How is goodwill defined in the valuation community?
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-Excess net earnings over and above a fair return on the net tangible assets.
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What are the methods for valuing intangibles?
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-Capitalization of excess earnings (ie excess of FMV over bargain lease discounted over term of lease)
-Capitalization of R&D costs. -Arm-lengths bargaining (ie decided between buyer/seller under IRC 1060) -Residual value (what is left of purchase price after allocation to FMV of tangible assets) -Royalty avoidance (what it would cost to purchse the intangible, ie patent) |
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How does the study material suggest to approach tax-effecting pass through entities?
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-First value the entity as if it were a C Corp, then seperately assess the effect on value of the benefits of avoidance of double taxation and other factors:
1. Expected level of distributions 2. Retention period of stock and related buildup of S Corp stock value. 3. Opportunity to build up R/E's 4. What is possibility S election will be broken? 5. etc. |
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What are the two main discounts applied in valuations?
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-Discount for lack of marketability (liquidity)
-Discount for lack of control (minority) |
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What are some other discounts besides the main 2?
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-Market absorption (blockage)
-Key person/thin mgmt -Investment company discount -Lack of diversification -Restrictive agreements -Small company risk discount -Specific company risk discount -Built-in gains tax discount -Liquidation cost discount |
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How are the 2 main discounts applied?
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-The DLOC & DLOCM are multiplicative, not additive.
-The DLOC is applied first followed by the DLOM. -This is confirmed by the fact that the empirical evidence supporting DLOM is available only at the minority interest level. |
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What are the four basic levels of value?
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-Control, Marketable Value (synergistic or investment value)
-Control, Marketable (FMV basis) -Minority, Marketable Value -Minority, Non-marketable Value |
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What are the main points to consider in regards to control premiums?
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-Performance improvement opportunity.
-Investment protection enhancement -Greater information access -Psychological and intangible benefits -Ability to self-deal -------------------------------------- Note: Control premiums only applicable where you are starting with a lack of control value. |
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What are the 3 methodologies for valuing minority interests?
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-Horizontal: Comparison to other minority interests
-Top Down: Control value less applicable discounts -Bottom up: Minority value plus premiums for control interest valuations |
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What is the most common method for calculating the control premium?
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-Observe premiums in the public securities market days prior to acquisition. Mainly through Mergerstat Review.
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What is the significance of Rev Rul 93-12?
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-The ruling reversed the IRS position prohibiting discounts due to family attribution.
-Spawned the prolific growth of FLP's as an estate/gift tax planning vehicle. -Critical judicial interpretations of the concepts are addressed in the Simplot case. |
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Define marketability.
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-The ability to convert the business ownership interest to cash quickly, with minimum transaction costs, and a high degree of certainty of realizing expected amount of net proceeds.
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Which Rev Rul addressed DLOM?
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-Rev Rul 77-287, saying securities traded on a public market generally are worth more to investors than those not traded on a public market.
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Can DLOM be applied to both controlling & non-controlling interests.
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-Yes, rarely as high as for a non-controlling interest though.
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What are the factors that increase the DLOM?
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1. Restrictions on transfers
2. Little or no dividends or partnership payouts. 3. Little or no prospect of IPO or sale of company 4. Limited access to financial info. |
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What are the factors that decrease the DLOM?
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-High dividends or partnership payouts.
-Imminent public offering -Limited market available. -"Put" option |
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What are the main categories of empirical studies supporting DLOM?
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-Restricted stock studies
-Pre IPO studies |
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What is the main observation in regards to relying exclusively on empirical studies in support of a DLOM?
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-The analyst tends to understate DLOM and overstate value.
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List the main restricted stock studies.
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-SEC institutional investor study
-Gelman study -Moroney study -Maher study -Trout study -Willamette Mgmt Assoc study -Stryker/Pittock study -Silber study -Hall & Polaceck study -Johnson study -Columbia financial advisors study -Management planning study -FMV opinions study -The Hertzel/Smith study |
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List the main Pre-IPO studies.
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-Robert W. Baird & Co. studies (The Emory studies)
-Willamette Mgmt Assoc study -Emory (Dot-Com) studies -Emory Business Valution, LLC -Hitchner study No. 1 -Hitchner study No. 2 |
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What are the main conclusions reached from the restricted stock & Pre-IPO studies in regards to DLOM?
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-The smaller the company, the larger the DLOM
-Investments of venture capital companies in OTC non-reporting companies closely resemble purchases by CHB owners. -Mean discounts observed should be the starting point -Public companies offer dividends, which CHB's do not -Institutional investors have different risk perception/tolerance than purchasers of CHB stock -Courts usually allow less DLOM than those observed in the empirical studies |
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What is the main feature of the Mandelbaum case?
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-Isolates the size of the DLOM as its only substantial issue.
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What are the 9 factors to consider under Mandelbaum in regards to the DLOM?
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-Financial statement analysis
-Company history, position & economic outlook -Control inherent in transferred shares -Transfer restrictions -Holding period -Redemption policy -Managment -Dividend policy -Public offering costs |
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T/F, the DLOM is often the largest adjustment in determing the estimate of value
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-True
-And it is often the least documented, which is not good according to the courts |
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What is the QMDM?
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-Quantitative Marketability Discount Model
-Develops DLOM at the non-marketable minority interest level. -Developed by Christopher Mercer |
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How is the built-in gains tax considered by the IRS and valuation practitioners?
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-IRS argues against its inclusion in the valuation, because unless a sale is imminent, there is no accurate way to estimate it.
-Generally valuators believe it must be considered, but is left to the judgement of the individual professional. |
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What is an investment company discount?
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-Investment companies (ie real estate holding co's) are usually valued based on underlying assets. The application of an investment company discount would account for the shareholder's indirect ownership of assets and thier inability to force the sale, liquidation or merger of these assets.
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What are the General & Ethical standards?
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-Due professional care
-Understanding & communications with clients -Professional competence -Planning & supervision -Integrity & objectivity -Sufficient relevant data -Financial interest -Acts discreditable -Client interest -Confidentiality |
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Under the general & ethical standards, what is meant by financial interest?
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-Member shall not express conclusion of value or calculated value unless either of the follwing is stated:
1. I (we) have no financial interest or contemplated financial interest in the property that is the subject of this report or.... 2. I (we) have a (specifiy) financial interest or contemplated financial interest in the property that is the subject of this report. |
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What are the Member Services standards? (need acronym)
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-Valuation services: May express either a calculation of value or calculated value.
1. Valuation engagement: apply the valuation approaches or methods deemed appropriate in the circumstances. 2. Calculation engagement: Client and member agree to specific valuation approaches, methods and extent of procedures. 3. Other services may be performed. |
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What are the other services a member may perform?
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-Consulting, fraud & damage determinations, & other non-valuation services. All NACVA standards apply except the Development & Reporting standards.
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What are the Development standards?
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-Identification
-Rule of thumb -Expression of value -DLOM, DLOC & other premiums/discounts -Documentation (workpapers should be retained) -Scope limitations -Use of specialist -Valuation approaches & methods -General (must apply development standards) -Earnings determination -Capitalization/Discount rate -Fundemental analysis -Financial statement adjustments |
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Under the development standards, what is meant by Identification?
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-Member must define the assignment & determine the scope of work necessary by identifying:
-Subject to be valued -Ownership size, nature, restrictions and agreements. -Standard of value -Scope limitations -Other factors influencing -Sources of information -Valuation date -Interest to be valued -Purpose and use of valuation -Valuation approaches -Intended users -Premise of value |
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Under the development standards, what is meant by expression of value?
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-Value can be expressed as a single number or a range of values.
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Under the development standards, what is meant by fundemental analysis?
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-For a conclusion of value, member must obtain and analyze information necessary to accomplish the assignment including:
1. Nature and history of the business. 2. Economic outlook 3. Book value of interest to be valued 4. Earning capacity of the business 5. Dividend paying capacity 6. Existence of intangibles 7. Sales of interests and the size of block to be valued. 8. Market price of interest of enterprises in same line of business 9. All other relevant info. |
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What are the Reporting Standards?
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-General (must apply reporting standards)
-Form of report -Contents of report a. Summary report b. Detailed report c. Calculation report d. Statement that report is in accordance with NACVA stds. -Litigation engagements reporting standards |
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Under the Reporting Standards, may the report be either oral or written?
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Yes
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Under the reporting standards, what minimum information should be set forth in a summary report?
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-Pretty much the same as the Identification standard under the Development standards, except the member responsible for the valuation should sign or be identified and contingent fees are disclosed.
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Under the reporting standards, what additional information may be disclosed in a detailed report vs a summary report?
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-Additional information disclosed may include:
-Valuation approaches considered -Projected financials -Non-operating assets & liab -Financial statement adjustments -Description of the fundemental analysis |
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What should be disclosed in a calculation report?
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1. Purpose of the calculation
2. Statement that it is a calculated value 3. Statement that: "This calculation engagment did not include all the procedures required for a conclusion of value. Had a conclusion of value been determined, the results may have been different." |
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How do the reporting standards effect litigation engagements?
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-Litigation engagements are exempt from the reporting standards, whether or not proceeding to trial or a settlement is reached.
-Note: all other NACVA standards apply |
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What are the Other Guidelines & Requirements standards?
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-Members must still comply with other regulatory agencies including:
-Federal & State laws -Appraisel foundation (USPAP) -DOL -FASB -IRS -Courts |
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What is the effective date of the new NACVA standards?
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-Engagements accepted after Jan 1, 2008.
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What glossary of definitions must members adhere to?
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-International Glossary of Business Valuation Terms:
-Developed jointly by the AICPA, ASA, CICBV, IBA & NACVA. |
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Define Arbitrage Pricing Theory (IGBVT)
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-A multivariate model for estimating the cost of equity capital, which incorporates several systematic risk factors.
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Define Beta (IGBVT)
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-Measure of systematic risk of a stock; correlated with changes in a specific index.
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Define Business Risk (IGBVT)
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-The degree of uncertainty of realizing expected future returns of the business resulting from factors other than financial leverage.
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Define CAPM (IGBVT)
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-Model in which the cost of capital for any stock or portfolio of stocks equals a risk-free rate plus a risk premium that is proportionate to the systematic risk of the stock or portfolio.
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Define capitalization (IGBVT)
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-A conversion of a single period of economic benefits into value.
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Define capital structure (IGBVT)
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-The composition of the invested capital of a business, the mix of debt and equity financing.
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Define cost approach (IGBVT)
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-A general way of determining a value indication of an individual asset by quantifying the amount of money required to replace the future service capability of that asset.
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Define fairness opinion (IGBVT)
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-An opinion as to whether or not the consideration in a transaction is fair from a financial point of view.
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Define Financial Risk (IGBVT)
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-The degree of uncertainty of realizing expected future returns of the business resulting from financial leverage.
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Define Internal Rate of Return (IGBVT)
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-A discount rate at which the present value of the future cash flows of the investment equals the cost of the investment.
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Define Investment Risk (IGBVT)
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-The degree of uncertainty as to the realization of expected returns.
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Define Levered Beta (IGBVT)
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-The beta reflecting a capital structure that includes debt.
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Define Market Capitalization of Equity (IGBVT)
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-The share of a publicly traded stock multiplied by the number of shares outstanding.
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Define Multiple (IGBVT)
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-The inverse of the capitalization rate.
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Define Premise of Value (IGBVT)
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-An assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation. (eg, going concern, liquidation)
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Define Portfolio Discount (IGBVT)
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-An amount or percentage deducted from the value of a business enterprise to reflect the fact that it owns dissimiliar operations or assets that do not fit well together.
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Define Special Interest Purchaser. (IGBVT)
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-Acquirers who believe they can enjoy post-acquisition economies of scale, synergies or strategic advantages by combining the acquired business interest with their own.
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Define Standard of Value (IGBVT)
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-The identification of the type of value being used in a specific engagement (ie, FMV, Fair Value, Investment Value)
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Define Unsytematic Risk (IGBVT)
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-The risk specific to an individual security that can be avoided through diversification.
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Define WACC (IGBVT)
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-The cost of capital (discount rate) determined by the weighted average, at market value, of the cost of all financing sources in the business enterprise's capital structure.
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True or False: The SEC prohibits auditors of SEC registered companies from providing valuations, appraisals, contributions-in-kind or fairness opinions.
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-True
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What valuation services would impair independence under the AICPA rules?
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-Services that produce results that are material to the financial statements or involve a significant degree of subjectivity.
Certain reports such as acturial valuations of pension plans generally is based on a single formula and is not considered objective. |
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What are the six major steps in defining the valuation engagement?
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-Engagement acceptance (eg, independence assessment or conflicts of interest)
-Define the purpose of the engagement. -Define the ownership interest to be valued. -Ascertain whether or not necessary information is available. -Obtain an engagement letter. -Establish the valuation date. |
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What is the purpose of the engagement letter?
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-Documents and communicates the particulars of the engagement as understood by the client and the valuation analyst.
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What are the three major types of information obtainable in a valuation engagement?
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1. Internal information
2. External information 3. Reference guide information |
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What are the types of internal information used in a valuation engagement?
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-Products, services, markets & competetion.
-History, nature and organization of the company. -Managment & personnel -Location & facilities -Financial position, results of operations and acctg policies. |
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What are the types of external information used in a valuation
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-General economic information
-General industry information -Local and regional economic information -Local and regional industry information -Specific comparable company information |
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What type of information are reference guides used for?
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-External information about the business/industry.
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What is another name for adjusting (normalizing) financial statements?
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-Recasting
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What are the three requirements for adjusted or recast financial statements?
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1. Should, as nearly as possible, represent market values.
2. Should be useful for making meaningful comparisons. 3. Should be useful in making meaningful projections and forecasts. |
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What is a metropolitan/economic study?
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-Looks at the economy in a specific geographic area, specificaly:
1. population 2. personal income 3. earnings and employment 4. how well major industries are doing relative to the overall economy. |
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Read and understand Daubert and Kumho tire case
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-Appendix of module 1
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What is the trend line static mehtod?
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-Statistical calculation to estimate future earnings based on the least squares formula, utilizing historical earnings.
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What is the trend line static mehtod?
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-Statistical calculation to estimate future earnings based on the least squares formula, utilizing historical earnings.
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What is the trend line static mehtod?
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-Statistical calculation to estimate future earnings based on the least squares formula, utilizing historical earnings.
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What is the trend line static mehtod?
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-Statistical calculation to estimate future earnings based on the least squares formula, utilizing historical earnings.
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What is the trend line static method? (see formula in appendix to module 1)
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-Statistical calculation to estimate future earnings based on the least squares formula, utilizing historical earnings.
-Assumes historical trend is expected to continue without changes in earnings, in other words the last year is estimated based on the formula and that is the earnings for all future periods. (ie $100,000 for the next 5 years) |
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What is the trend line projected method?
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-Exactly the same as the trend line static metod, except future period earnings increase at the value of the slope.
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When would the trend line projected method be more appropriate then the weighted or unweighted average methods?
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-When the most recent year’s significantly increases or decreases.
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What is the projected growth rate in earnings method?
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-If data is increasing at a constant rate it is not linear it is an exponential curve. Thus the formula to calcuate future earnings is based on:
1. Annual compounded or average growth rate based on last 5 years earnings. 2. Applied at the same rate to the latest year’s earnings, and continuing over the following four consecutive years. |
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Aubre' Company had the following historical economic net income over the last 5 years.
2002 $110,600 2003 $119,500 2004 $131,700 2005 $135,200 2006 $140,400 Calculate future earnings based on the Trend Line Static Method. |
-$142,540 for year 2006 and all future periods.
X Y Xsquared X*Y 1 110,600 1 110,600 2 119,500 4 239,000 3 131,700 9 395,100 4 135,200 16 540,800 5 140,400 25 702,000 sumX = 15 sumY = 637,400 sumXsquared = 55 sum X*Y =1,987,500 |
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Aubre' Company had the following historical economic net income over the last 5 years.
2002 $110,600 2003 $119,500 2004 $131,700 2005 $135,200 2006 $140,400 Calculate future earnings for the next 5 years based on the Trend Line Projected Method. |
-2007=104,890+(6)(7,530) = $150,070
-2008=104,890+(7)(7,530)=$157,600 -2009=104,890+(8)(7,530)=$165,130 -2010=104,890+(9)(7,530)=$172,660 -2011=104,890+(10)(7,530)=$180,190 Note: $104,890 is the Y intercept & $7,530 is the value of the slope. |
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What is the formula for the trend line static method?
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- Y= ao + bx
Where: ao=(sum Y - b(sum X)) / N And: b = N(sum X*Y)-(sum X)*(sum Y) / N(sum Xsquared)-(sum X)squared / N(sum Xsquared)-(sum X)squared x = Total # of observed years X = The i(th) year, and weighted to be accorded in the i(th) year (xsquared) Y = earnings in the i(th) year N = Number of observations sum = sum of variable |
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Lorenco had the following historical earnings.
2002 $100,000 base 2003 $115,000 15% 2004 $135,000 17% 2005 $160,000 19% 2006 $185,000 16% Avg growth 16.75% Compound growth 16.63% What are the next 5 years future earnings based on the Projected Growth Rate in Earnings Method? |
2007 215,766 (185,000x1.1663)
2008 251,648 (215,766x1.1663) 2009 293,497 (251,648x1.1663) 2010 342,306 (293,497x1.1663) 2011 399,231 (342,306x1.1663) |
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What are the 5 main methods for estimating future earnings?
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-Unweighted historical
-Weigted historical -Trend line static -Trend line projected -Projected growth in earnings |
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How is correlation analysis relevant in relation to estimating future earnings.
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-Coefficient of determination measures how well the estimated equation fits the data, or the goodness of the fit in the regression. Formula is
r(squared) = Unexplained Variance / Total Variance Analyst can then determine how much of the change in earnings from year to year (Y axis) is explained by the mere passage of time (X axis). When r(squared) is greater than 95%, this gives the analyst significant confidence in predicting future earnings. |
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According to Robert L. Green of Prima Facie Software, what ranges of coefficient of determination would correlate with each of the 5 main methods for estimating future earnings?
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.00 - .59 = Unweighted Average
.60 - .69 = Weighted Average .70 - .79 = Trend-Line Static .80 - .89 = Trend-Line Projected .90 - 1.0 = Projected Growth Rate |
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What is a SWOT analysis?
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Strengths: attributes of the organization that are helpful to achieving the objective.
Weaknesses: attributes of the organization that are harmful to achieving the objective. Opportunities: external conditions that are helpful to achieving the objective. Threats: external conditions which could do damage to the business's performance |
