Valuation Approaches - NACVA CVA Questions and Answers

Valuation Approaches - NACVA CVA Questions and Answers A common way to value most acquired internal-use computer software is the Income Approach Method FALSE A fundamental factor to be included in the analysis under the income approach includes Time value of money Andy Analyst has been engaged to value Thingamajig, Inc as of December 31, 2000. Mr. 100% owner wants to transfer 100 of the 500 outstanding shares of common stock to his daughter. THe appropriate valuation methodology that should be applied to this valuation is: Capitalization of earnings; Price to Earnings Ratio; Adjusted net assets Assume Poker Co. has average economic earnings of $347,000, average net tangible assets of $853,000, the industry in which it operates has an average rate of return of 12%, and an approporiate capitalization rate is 20%. Using the Excess Earnings treasury, compute any excess earnings over average annual industry earnings. $244,640 Book value is the floor value of an entity. It cannot be considered an appropriate measure of business value since it represents: Historical shareholder's net equality calculate the purchase price pursuant to ASC 805 to be used by XYZ in the 100% stock acquisition of ABC using the following data: XYZ paid $250 million cash and issued 20,000 shares of restricted stock to ABC at closing. XYZ's restricted stock value on the date of closing was $125/share. Total ABC liabilities assumed by XYZ were $118 million, which includes $35 million of accounts payable and accrued expenses, with the remainder being interest bearing long-term debt. ABC's balance sheet includes $13 million of goodwill as a non-current asset. Additional costs incurred were: $25 million in broker comissions; $25,000 for appraisals of real estate that was owned by ABC and transferred at closing; $110,000 in legal fees, of which $10,000 relate to the issuance of the 20,000 share of restricted stock from XYZ to ABC; $65,0000 in payroll and related costs associated with additional staff hired by XYZ during their due dilig $370,500,000 Choose the best definition for the "theoretical value" of a particular business at any point in time: The present value of the future earnings Determine the intangible value and total value of the Leyland Corporation based on the following factsL 5 year weighted estimate of earnings is $425,000. The Fair Market Value of net tangible assets is $980,000. A reasonable rate of return, based on the composition of the assets is 12%. The capitalization rate for Leyland's excess earnings is 25% The intangible value is $1,229,600 and the total value of the business is $2,209,600 Determining the appropriate valuation method requres an in-depth understanding of: Purpose of the valuation; Standard of value; Premise of value For valuing a medium-sized manufacturing concern, or an interest therein, which of the following would commonly be considered the LEAST reliable market valuation method? Industry Rules of THumb If an analyst determines that the earnings stream of a company is the most appropriate estimate of future benefits, in general, which earnings stream do analysts believe is the most reliable and stable Net income before tax, depreciation, and amortization If the cash flows of a business were the exact same over a trailing five-year period, which of the following income based valuation approaches would be the most appropriate? Capitalization of five-year average earnings using inflationary growth In order to value an intangible asset, the analyst should focus on: Earnings capacity Multi-period earnings method, binomial modeling, and option-pricing models are all examples of which approach to Fair Value under FASB ASC 820 Income approach one primary difference between the capitalization of excess earnings treasury method and the capitalization of excess earnings reasonable rate method is: The treasury method uses an industry return on equity for the return on net tangible assets where the reasonable rate method frequently uses a borrowing cost. Only the income or market approaches to valuation are applicable in a litigation setting FALSE Present value less appropriate allowance is the method used to determinet he Fair Value of what asset Accounts receivable Price/Earnings ratios are sometimes useful in valuing closely-held business. However, an inherent limitation when using P/E ratio can be: Companies have different capital structures Professional practices and small businesses are most commonly valued using a market approach and a valuation multiple FALSE RR 54-187 was superseded by RR 59-60 FALSE RR 59-60 specifically recognizes that the valuation of securities is, in essense, a prophecy as to the future TRUE The Excess Earnings Method is also know as Formula Method; Treasury Method The capitalization of earnings method is an income and asset based approach in valuing a closely held business FALSE They key inputs required under the income approach Forecast of economic income, discount rate, and terminal value The only approach used to value intangibles is an earnings based approach FALSE The terminal value cash flows are Determined by the final year forecasted plus one years growth The three approaches to business valuations are the asset, income, and market approach TRUE The various business valuation formulas included in RR 59-60 were to tied toL Asset values; Earnings; Excess Earnings There is evidence that shows public companies that are larger tend to sell at multiples higher than smaller companies. Studies also validate this occurence is applicable to privately owned enterprises TRUE This approach assumes that we can determine the value of an ownership interest by analyzing recent sales of comparable assets: Market approach Using the Weighted Average Method, with year one weighted 1, year 2 weighted 2, and year three weighted 3, estimate the future benefit for Jennings Baker Company Earnings in: Year 1: $(15,300); Year 2: 32400; Year 3: 89600 53,050 Valuation methods are commonly categorized by asset-based approach, market approach, and income approach. The analyst should average the results of all three approaches so as to come up with the right dollar value for the company. FALSE What is needed to be able to utilize the market approach? Reliable data; Adequate number of market comparables or market transactions What valuation methodologies are generally regarded as theoretically unsound? Rules of Thumb When should one use a Rule of Thumb as a primary valuation method? Never When using the income approach to value a business, a multi-period model is preferable under what circumstances? When the business is either in an unstable condition or is growing at unusually high or variable rates Which of the following approaches matches a benefit stream with a rate of return to determine the present value of a business? Income Approach Which of the following best describes Equity Value? Enterprise value less interest bearing debt plus cash and non-operating assets Which of the following does an analyst NOT consider when deciding which valuation approach or approaches to use: Who the buyer or seller is Which of the following is NOT a generally accepted valuation approach? Cash flow approach Which of the following is NOT true about the Capitalization of earnings method to valuing a business? Theoretically most correct Which of the following methods would NOT be appropriate to use when a business has reported net losses each of the past five years? The capitalization of earnings methods Which of the following statement(s) concerning Capitalized REturns Methods (single period capitalization methods) is(are) true? Depending on the benefit stream, the capitalized returns methods can calculate the market value of invested capital or equity; capitalized returns methods determine company's value by dividing cash flow or earnings by a capitalization rate; Capitalized returns methods tend to be the most appropriate method when a company's current operations are indicative of its future operations Which of the following statements is true regarding the fact that almost all of our data, methodology, and theory is based on perfect markets? Since our information is based on perfect markets, we then adjustfor differences such as risk, comparability, and lack of marketability to arrive at values for our subject company Which valuation method does NOT address the operating earnings of the business and would be inappropriate to use to value intangible assets such as patents or copyrights that are typically valued based on some type of operating earnings? Adjusted Net Asset Method Which valuation method takes into consideration the residual value as of the end of the projection period? Discounted Future Earnings Method XYZ Company has five-year weighted average profits of 120,000. The weighted average dividend payout over this same period of time is 25%. The weighted average dividend yield rate of five comparable companies is 8%. What is the value of the company? 375,000 The three basic methods for valuing non-controlling interests are: Top down, horizontal, and bottom-up All of the following are common errors found in valuations related to method use or misuse EXCEPT: Electing not to use a particular method All of the following are common errors found in valuations related to method use or misuse EXCEPT Electing not to use a particular method The bottom-up method specifically emphasizes: Distributions (dividends) and proceeds to be realized on the sale of the interest A company has five year weighted average after-tax net cash flows of 125,000. It has been determined that the company's discount rate is 19%, its expeced short-term growth is 11%, and its long-term sustainable growth is 3%. The valuator has also determined that the company has excess cash of 25,000. What is the value of the company based on the capitalization of after-tax cash flows? 829,687 Under the Excess Earnings/Treasury Method: The tangible assets are measured based on GAAP; The company's collective intangible value (goodwill) is quantified by capitalizing earnings which exceed a reasonable rate of return on the GAAP net assets To determine the value of intangible assets, an economic income statement must be generated to ascertain profitability FALSE What are the three approaches to estimating the value of a company? Asset, market, income If a subject company has negative or marginally positive projected income results in its terminal year, what method of valuing the company may be most appropriate? Net Asset (adjusted) method Each of the following is a reason to alue in tangible assets, EXCEPT To assist in determining tangible asset values The forecast horizon in the DCF model include all of the following elements, EXCEPT historical rent escalations Growth rate should: Equal inflation plus the real volume of growth that can be achieved without additional capital invest A discount rate is most likely applied to which of the following: Forecasted annual future cash flows A fundamental relationship exists between rate of return from an investment and the amont of risk in the investment. Therefore: An investor would expect a higher rate of return from a publicly traded stock compared to a five-year treasury bond A sustainable growth rate is defined as 1) an earnings retention rate (plow-back ratio) multiplied by 2) the company's return on equity. TRUE A valuator, using the DCFM, finds the pre-discount value of a non-controlling interest in a company to be 500,000. Though the valuator knows the control shareholder takes out excessive compensation, no normalization adjustment was made. The level produced under these facts is: Non-controlling, marketable value ABC Company has projected the following cash flows: Year 1: 85,000; Year 2: 105,000; Year 3: 109,000; Year 4: 115,000. THe valuator has determined an appropriate discount rate is 26% and the long-term growth rate is 2%. Using the Gordon Growth Model, what is the present value of the company's terminal value 193,936 Although open for debate, the market approach is generally considered to provide what standard and premise of value: fair market value ARM 34 says that a business has goodwill if it has gross earnings FALSE Assume the use of invested capital multiples is recommended and appropriate, we would most likely use them to derive a value in the following situation: 75% interest in a business Assuming we are using deal stats transaction database, which of the following generally would NOT be transferred in a stock sale? Excess or non-operating assets Bell Landscape Company has the following historical earnings: Year 1 earnings 75,500; Year 2 earnings 65,200; Year 3 earnings 87,600; Year 4 earnings 90,500; Year 5 earnings 53,900. Which method of projecting earnings would appear most appropriate to estimate future benefits? Unweighted Average Method BIZCOMPS database can be searched by any of the following variables EXCEPT: Number of company employees Capitalization/discount rates are used to convert a defined stream of earnings, income or cash flow to an indicated present value. Incoporated in these rates are components that reflect the risk elements associated with an investment in a privately-held company and the likelihood of realizing the defined stream of earnings, income, or cash flow. Which of the following is(are0 an element of risk associated with privately-held companies? Competition; Management depth and ability Capitlized returns (single period capitalization methods) determine a company's estimated value by dividing cash flow or earnings by a capitalization rate TRUE Conceptually, discounting net cash flow by the cost of capital is appropriate to owners or investors because of the options available to reinvest its distribution TRUE Discount rate equals capitalization rate FASLE Examples of multiples for valuing either common equity or invested capital are: Price/Cash flow; Price/EBITDA For the capitalized earnings or Discounted future earnings method to be utilized: Earnings need to contribute significantly to the entity's value For the income approach to be utilized, earnings capacity needs to contribute significantly to value TRUE Future damages should be discounted to: Present value Future earnings, estimated by the analyst, are a key ingredient of capitalization of earnings. Therefore, the analyst should treat factory floor equipment: As indistinguishable as a part of the business, generating income