Questions and Answers
What are the two highest areas of risk?
What are the two lowest areas of risk?
What is the value of an interest in a closely held business typically considered to be equal to?
the future benefits what will be received from the business discounted at present at the appropriate discount rate
What is a valuation?
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What is the first step in any valuation engagement?
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Fair market value is the focus of this class.
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What are the three types of standards of value?
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What is the IRS definition of FMV?
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A valuation takes into account both _____ and _____ tangible business being valued.
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What are examples of intangible elements of Going Concern Value?
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What is the definition of Going concern value?
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What is the replacement value?
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What does the I stand for in 'I measure drugs'?
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What is the discounted cash flows method projected for?
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Book value is a proper basis for business valuation.
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What is the Capitalization Rate?
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What is discounting?
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Match the following valuation concepts with their definitions:
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Study Notes
Valuation Concepts
- Value of an interest in a closely held business equals future benefits discounted at the appropriate rate.
- A valuation process establishes a value of an entire or partial interest in a business.
- Valuations account for both quantitative and qualitative aspects of the business.
Standards of Value
- Fair market value (FMV) is the key focus for valuations.
- Three types of standards of value: FMV, Fair Value, and Strategic/Investment Value.
- FMV defined by IRS as the price at which property changes hands between a willing buyer and seller without compulsion.
Valuation Processes
- First step in a valuation engagement is determining the purpose of the valuation.
- Selection of standard and premise of value is required in all valuations.
- Four principal premises of value: going concern value, book value, liquidation value, and replacement value.
Distortions and Adjustments
- Book value defined as total net assets minus total liabilities; not an appropriate basis for business valuation.
- Distortions in financial statements arise from accounting principles leading to inaccurate economic status representation.
- Normalizing financial statements adjusts for anomalies that may distort financial results.
Liquidation and Replacement Value
- Liquidation value is the net amount realized if the business closes and assets are sold piecemeal, can be orderly or forced.
- Replacement value is the current cost to acquire similar new property providing equivalent utility, commonly linked to property insurance.
Investment Valuation Principles
- Direct relationship exists between investment price, expected return, and anticipated risks.
- Investment valuation depends on benefit stream, risk of principal, and management expectations.
- Two highest-risk areas include venture capital and small business stocks; lowest-risk areas are U.S. treasury obligations and corporate bonds.
Cash Flow Considerations
- Net cash flows (NCF) are favored as they represent what investors seek in the valuation process.
- Historical versus projected income analysis considers accuracy and relevance to the purpose of the valuation.
- Projected cash flows are assessed using various methods, including discounting and capitalization techniques.
Terminal Value and Discounting
- Terminal value represents the company's value at the end of the projection period, calculated as capitalized earnings reduced to present value.
- Discounting determines present value of future income streams over a finite number of periods, critical for accurate valuation.
Capitalization Rate
- Capitalization rate is derived from the discount rate minus long-term sustainable growth rate.
- When there is no growth, the capitalization rate equals the discount rate.
Key Financial Variables for Valuation
- The I in "I measure drugs" stands for the identification of an appropriate benefit stream.
- Adjustments for owner compensation, warranty liabilities, and inventory valuation are crucial for accurate business assessment.
- Special considerations are necessary when dealing with shareholder loans and allowances for doubtful accounts.
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Description
Test your knowledge of business valuation concepts with these flashcards. Each card presents key terms and definitions related to the valuation of closely held businesses. Enhance your understanding of this critical financial process.
