BA109 Quiz 7

Business evaluation based on balance sheet methods offers one key advantage: it considers the future earning potential of the business.

False

The most meaningful method of determining the value of an existing business's inventory is its book value.

False

Which of the following statements concerning financing the purchase of an existing business is true?

The buyer should be able to make the payments on the loans out of the company's cash flow.

When a buyer purchases an existing business, she may "inherit" liability for damages and injuries caused by products the company has manufactured or sold in the past.

True

To use an ESOP successfully, a company should have pre-tax profits of at least $100,000 and a payroll exceeding $500,000 a year.

True

An entrepreneur should never purchase a business that is losing money.

False

The adjusted balance sheet method of valuing a business changes the book value of net worth to reflect its actual market value.

True

A toy manufacturer is sued based on the claim of injuries caused by a product it makes. This is an example of a:

product liability lawsuit.

During the acquisition process, the buyer and the seller sign a ________, which spells out the parties' final deal and represents the details of the agreement that are the result of the negotiation process.

purchase agreement

When done correctly, the due diligence process will:

reveal both the positive and negative aspects of an existing business.

An ESOP:

All of these

If a business buyer estimates that 20 percent is a reasonable rate of return for an existing business expected to produce a profit of $27,000, its capitalized value would be:

$135,000.

An entrepreneur who is considering purchasing a business is analyzing a company's accounts receivable. The following table summarizes her findings. How much should this potential buyer be willing to pay for these accounts receivable?

$17,877

A prospective buyer should have an attorney thoroughly investigate all of the assets for sale in a business and their lien status before buying any business.

True

The main reason a buyer purchases an existing business is for:

its future income and profits for earning potential

A creditor's claim against an asset is referred to as lien.

True

Business valuations based on balance sheet methods suffer certain disadvantages, including:

they do not consider the future earning potential of the business.

The ________ approach to valuing a business uses the price-earnings ratios of similar businesses to establish the value of a company.

market

Which of the following is required for the covenant not to compete to be enforceable?

Part of a business sale and reasonable in scope

The rate of return used to value a business is composed of the basic, risk-free return, an inflation premium, and the risk allowance for investing in the particular business.

True

Laurette has entered into a contract with Jackson to purchase his retail music shop. Jackson's lease on the existing building (which is in an excellent location) has five years remaining. If Laurette wants the lease to be part of the business sale:

she should include a clause in the sales contract in which Jackson agrees to assign to her his rights and obligations under that lease and she should notify the landlord of Jackson's assignment of the lease agreement to her are correct.

The capitalized earnings approach determines the value of a business by capitalizing its expected profits using:

the interest rate that could be earned on a similar risk investment.

Which of the following is a drawback of the market approach of evaluation?

It may underrepresent earnings.

Financing the purchase of an existing business usually is easier than financing the startup of a new one.

True

If the corporation, rather than the business seller, signs a restrictive covenant, the seller may not be bound by its terms.

True

Most small businesses have market values that exceed their book value.

True

Neither the balance sheet method nor the adjusted balance sheet method of valuing a business considers the future earning power of the business.

True

One way for a business buyer to avoid being surprised by liens against the assets purchased is to include a clause in the sales contract stating that any liability not shown on the balance sheet at the time of the sale remains the responsibility of the seller.

True

Skimming is the act of taking money from sales without reporting it as income and it is an illegal and unethical practice.

True

The balance sheet technique is one of the most commonly used methods of evaluating an existing business, although it oversimplifies the valuation process because it values a company only on the basis of its net worth.

True

Important factors to investigate regarding the business to be purchased include:

All of these

Next to picking the right buyer, planning the structure of a business sale is one of the most important decisions a seller can make.

True

When evaluating a business as a potential candidate for purchase, an entrepreneur should determine the real reason the current owner wants to sell.

True

The most common reasons owners of small- and medium-sized businesses give for selling their businesses are:

boredom and burnout.

A due-on-sale clause allows an entrepreneur buying a business to "assume" the seller's loan (usually at a lower interest rate).

False

A new owner of an existing business can generally introduce change and innovation almost as easily as if the company were a new business because employees and customers expect change in business practice when there is a change in ownership.

False

According to the discounted future earnings technique, a dollar earned in the future is worth more than a dollar earned today.

False

Ralph buys a software business from Waldo in Columbus, Ohio. As part of the deal, Waldo signs a covenant not to compete by opening another software business anywhere in Ohio for the rest of his life. Such a covenant would be enforceable.

False

The best method for determining a business's worth is the discounted future earnings approach.

False

The practice of taking money from sales without reporting it as income is called sliding.

False

Under the capitalized earnings approach to business valuation, firms with higher risk factors are more valuable than those with lower risk factors.

False

Which of the following is considered an opportunity cost of buying an existing business?

The salary that could be earned working for someone else and the owner's investment in the business

A business buyer should build his or her own pro forma income statement from an existing firm's accounting records and compare it to the same statement provided by the owner.

True

Goodwill is the difference between an established successful business and one that has yet to prove itself.

True

The discounted future earnings approach to valuing an existing business involves estimating the company's net income for several years into the future and then discounting those future earnings back to their present value.

True

The due diligence process in analyzing and evaluating an existing business can be just as time consuming as the development of a comprehensive business plan for a start-up.

True

The reason an entrepreneur should conduct a self-audit of his or her skills, abilities, and interests is to help focus on those businesses that will best "fit."

True

When buying a business, an entrepreneur can usually purchase equipment and fixtures at prices well below their book value.

True

With an existing business, the new owner can depend on employees to help him make money while he is learning the business.

True

Which of the following statements about valuing a business is true?

Business valuation is partly art and partly science.

During the acquisition process, the potential buyer usually must sign a ________, which is an agreement to keep all conversations and information secret and legally binds the buyer from telling anyone any information the seller shares with her.

covenant not to compete

Which method of business valuation relies on three forecasts of future earnings: optimistic, pessimistic, and most likely?

Discounted future earnings

Which of the following valuation techniques is best suited for determining the value of service businesses?

Discounted future earnings approach

A(n) ________ allows owners to "cash out" by selling their companies to their employees as gradually or as quickly as they choose.

ESOP

________ gives owners the security of a sales contract but permits them to stay at the "helm" for several years.

Earn-out

The most common reasons that owners of small businesses give for selling are the intensity of competition and an inability to raise sufficient cash to continue to grow.

False

A due-on-sale clause is a loan contract provision that prohibits a seller from assigning a loan arrangement to the buyer and instead, the buyer is required to finance the remaining loan balance at prevailing interest rates.

True

A due-on-sale clause requires a buyer to pay the full amount of the remaining balance on a loan or to finance the balance at prevailing interest rates.

True

A letter of intent is a nonbinding document stating that a business buyer and a seller have reached a sufficient "meeting of the minds" to justify the time and the expense of negotiating a final agreement.

True

A nondisclosure document is an agreement between a business buyer and a seller that requires the buyer to maintain strict confidentiality of all records, documents, and information he receives during the parties' negotiations.

True

A principal advantage of buying an existing business is the purchaser's ability to rely on the previous owner's experience.

True

A restrictive covenant prohibits the seller of an existing business from opening a competitive business within a specific time period and geographic area of the existing one.

True

Although selling the business outright is the cleanest exit path for an entrepreneur, it may have negative tax consequences, and it often excludes the option of "staying on" and exiting gradually.

True

An earn-out is an exit strategy in which an entrepreneur can increase his or her payout by actively participating in the business to make sure the company hits specific performance targets.

True

If a business has a lien against any of its assets at the time of the sale, the buyer must assume them and is financially responsible for them.

True

The hidden market of companies -those companies that might be for sale and are not advertised-is one of the richest sources of top quality businesses to purchase.

True

The reliability of the discounted future earnings approach to valuing a business depends on making accurate forecasts of future earnings and on choosing a realistic present value rate.

True

Under the capitalized earnings approach to valuing an existing business, most normal-risk businesses use a rate-of-return factor ranging from 20 to 25 percent.

True

A valuation method that is more realistic than the balance sheet technique, because it adjusts book value to reflect actual market value, is the:

adjusted balance sheet method.

The first step an entrepreneur should take when buying an existing business is to:

analyze his or her skills, abilities, and interests in an honest self-audit.

The process of investigating the details of a company that is for sale to determine the strengths, weaknesses, opportunities and threats facing it is known as the:

due diligence process.

Use the following information to answer the question(s) below. Baubles and Bells, a small business, is up for sale. The book value of its assets is $397,650, and its liabilities have a book value of $148,500. After adjusting for market value, total assets are worth $386,475, and total liabilities are $153,600. The business is considered to be a "normal risk" venture. The new owner (if he buys) plans to draw a salary of $28,000. Estimated earnings for the upcoming year are $88,400. Complete net earnings estimates for the next five years are: Using the adjusted balance sheet technique, what is the business worth?

$386,475

se the following information to answer the question(s) below. Baubles and Bells, a small business, is up for sale. The book value of its assets is $397,650, and its liabilities have a book value of $148,500. After adjusting for market value, total assets are worth $386,475, and total liabilities are $153,600. The business is considered to be a "normal risk" venture. The new owner (if he buys) plans to draw a salary of $28,000. Estimated earnings for the upcoming year are $88,400. Complete net earnings estimates for the next five years are: Using the excess earnings method, what is the company's "goodwill"?

$6,543

Sources of potential legal liabilities for the buyer of an existing business include all but which of the following?

Errors and omissions

Use the following information to answer the question(s) below. Baubles and Bells, a small business, is up for sale. The book value of its assets is $397,650, and its liabilities have a book value of $148,500. After adjusting for market value, total assets are worth $386,475, and total liabilities are $153,600. The business is considered to be a "normal risk" venture. The new owner (if he buys) plans to draw a salary of $28,000. Estimated earnings for the upcoming year are $88,400. Complete net earnings estimates for the next five years are: The valuation approach that considers the value of goodwill is the:

excess earnings method.

To avoid a stalled deal, a buyer should:

go into the negotiation with a list of objectives ranked in order of priority.

The due diligence process of analyzing and evaluating an existing business:

All of these

To ensure a smooth transition when buying an existing business, a buyer should:

All of these

When evaluating the financial position of a business he or she is considering buying, an entrepreneur should examine:

All of these

Which of the following is a disadvantage of the market approach to valuing a business?

All of these

Which of the following is a potential disadvantage of purchasing an existing business?

All of these

When evaluating the assets of an existing business, the inventory:

should be judged on the basis of its market value, not its book value.

When valuing inventory for a business sale, the most common methods used are:

cost of last purchase and replacement value of inventory.