NACVA 6: Valuation Approaches

2.39 Statistical analysis, first and foremost, is performed on a database to help identify:

"Indicators of value" empirically supported by the analysis

2.5 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

1.4 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 appropriate capitalization rate is 20%. Using the Excess Earnings Treasury, compute any excess earnings over average annual industry earnings .

$244,640

2.29 In Geri Co, the five-year weighted average historical pretax economic earnings are $1,250,000 The tax rate is 28%. The hurdle and debt rate are 12.25%. The adjusted net assets from prior year-end is $2,050,000 The cap rate applicable to this kind of company is 25% pretax. Which value of the goodwill is correct using the Reasonable Rate of Return on Assets Method?

$3,995,500

2.8 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

2.41 The approach to value, which is based upon present value theory, is:

Income approach

1.35 When should one use a Rule of Thumb as a primary valuation method?

Never

1.26 The terminal value cash flows are:

Determined by the final year forecasted plus one years growth

1.42 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 Method

1.15 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

2.40 Terminal Value rarely accounts for the largest portion of a company's total present value.

False

2.44 The Modified Capital Asset Pricing Model (MCAPM) and Build-up Methods produce a capitalization rate.

False

2.46 The Capitalization of Earnings Method is usually best used when future performance is expected to differ significantly from past performance, and "discounted methods" are best used when future performance is expected to follow the same pattern as past performance.

False

2.7 ARM 34 says that a business has "goodwill" if it has gross earnings.

False

1.30 This approach assumes that we can determine the value of an ownership interest by analyzing recent sales of comparable assets:

Market approach

1.47 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

2.21 GeriCo has a 10-year history of weighted average profits of $900,000 and a weighted average dividends paid of 3.5%. Comparable companies indicate a weighted average of 6.2%. The calculated value using the Dividend Payout Method is

$508,065

131. Using the Weighted Average Method, with year one weighted 1, year two weighted 2, and year three weighted 3, estimate the future benefit for Jennings Baker Company Earnings in • Year 1 $(15,300) • Year 2 $32,400 • Year 3 $89,600

$53,050 (Number multiplied by weighted, sum them, divide total by total weight)

2.35 It is NOT uncommon for the terminal value to account for ________ of the total present value.

50% to 70%

2.24 If the valuator expects the cash flow of a business to vary significantly in the future, the valuer should use:

A Discounted Future Cash Flow Method

2.25 If using a Discounted Cash Flow Method to determine value, how far in the future should cash flows be projected?

A number of years representative of the period in which the benefit stream is expected to vary followed by a terminal value

1.17 Present value less appropriate allowance is the method used to determine the Fair Value of what asset?

Accounts receivable

1.45 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

2.2 A fundamental relationship exists between rate of return from an investment and the amount of risk in the investment. Therefore:

An investor would expect a higher rale of return from a publicly traded stock compared to a five-year treasury bond.

2.20 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

1.54 What are the three approaches to estimating the value of a company?

Asset, market, and income

1.32 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

1.53 To determine the value of intangible assets, an economic income statement must be generated to ascertain profitability.

False

2.13 Capitalized returns (single period capitalization methods} determine a company's estimated value by dividing cash flow or earnings by a capitalization rate.

False

2.15 Discount rate equals capitalization rate.

False

2.23 If the discrete projected cash flow period is long, then the terminal value will contribute significantly more to the overall valuation.

False

2.17 For the Capitalized Earnings or Discounted Future Earnings Method to be utilized:

Earnings need to contribute significantly to the entity's value

1.49 All of the following are common errors found in valuations related to method use or misuse EXCEPT:

Electing not to use a particular method

1.12 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

1.40 Which of the following is NOT a generally accepted valuation approach?

Cash flow approach

1.18 Price/earnings (P/E) ratios are sometimes useful in valuing closely-held businesses. However, an inherent limitation when using a P/E ratio can be:

Companies have different capital structures

1.46 Which valuation method takes into consideration the residual value as of the end of the projection period?

Discounted Future Earnings Method

1.50 The Bottom-up Method specifically emphasizes:

Distributions (dividends) and proceeds to be realized on the sale of the interest

1.13 In order to value an intangible asset, the analyst should focus on:

Earnings capacity

1.38 Which of the following best describes Equity Value?

Enterprise Value less Interest Bearing Debt plus Cash and Non-operating Assets

1.58 Growth rate should

Equal inflation plus the real volume of growth that can be achieved without additional capital investment

2.36 Net cash flow to equity will result in what type of value?

Equity

2.9 Assuming we are using the DealStats transaction database, which of the following generally would NOT be transferred in a stock sale?

Excess or non-operating assets

1.19 Professional practices and small businesses are most commonly valued using a market approach and a valuation multiple.

False

1.20 Revenue Ruling 54-187 was superseded by Revenue Ruling 59-60.

False

1.23 The Capitalization of Earnings Method is an income and asset-based approach in valuing a closely held business.

False

1.25 The only approach used to value intangibles is an earnings-based approach (capitalization of earnings, discounted earnings, etc)

False

2.37 Net cash flows should represent the most likely value for each projected period.

False

2.6 Although open for debate, the Market Approach is generally considered to provide what standard and premise of value:

Fair Market Value

1.1 A common way to value most acquired internal-use computer software is the Income Approach Method.

False

1.16 Only the income or market approaches to valuation are applicable in a litigation setting.

False

1.24 The key inputs required under the income approach are

Forecast of economic income, discount rate, and terminal value

2.1 A discount rate is most likely applied to which of the following

Forecasted annual future cash flows

1.57 The forecast horizon in the Discounted Cash Flow (DCF) Model include all of the following elements, EXCEPT

Historical rent escalations

1.5 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 equity

1.14 Multi-period earnings method, binomial modeling, and option-pricing models are all examples of which approach to Fair Value under FASB's ASC 820?

Income approach

1.37 Which of the following approaches matches a benefit stream with a rate of return to determine the present value of a business?

Income approach

1.10 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

2.42 The BIZCOMPS database is most commonly used as a reference for:

Is based on business broker reported data

2.43 The burden of proof:

Is on the valuator to prove the "market approach" is reflective of the value of the subject company/interest in a specific engagement

1.55 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

1.11 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

2.4 A valuator, using the Discounted Cash Flow Method, 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 of value produced under these facts is:

Non-controlling, marketable value

2 .11 BIZCOMPS database can be searched by any of the following variables EXCEPT:

Number of company employees

2.19 Future damages should be discounted to:

Present value

2.28 In applying the Guideline Transaction Method, which of the following is correct:

Requires a review of the nature and background of the subject company, the industry, the economic outlook, etc.

1.34 What valuation methodologies are generally regarded as theoretically unsound?

Rules of thumb

2.31 In the Capitalization of Earnings Method, what is the most appropriate treatment for non-operating assets?

Should be added to the Conclusion of Value at Fair Market Value

1.44 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 adjust for differences such as risk, comparability, and lack of marketability to arrive at values for our subject company

1.7 Choose the best definition for the theoretical value" of a particular business at any point in time:

The present value of the future earnings

1.41 Which of the following is NOT true about the Capitalization of Earnings Method to valuing a business?

Theoretically most correct

1.2 A fundamental factor to be included in the analysis under the income approach includes:

Time value of money

1.56 Each of the following is a reason to value intangible assets, EXCEPT:

To assist in determining tangible asset values

1.48 The three basic methods for valuing non-controlling interests are:

Top down, horizontal, and bottom-up

1.21 Revenue Ruling 59-60 specifically recognizes that the valuation of securities is, in essence, a prophecy as to the future.

True

1.27 The three approaches to business valuation are the asset approach, income approach, and market approach.

True

1.29 There is evidence that shows public companies that are larger tend to sell at multiples higher than smaller companies. Studies also validate this occurrence is applicable to privately owned enterprises.

True

2.14 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

2.18 For the income approach to be utilized, earnings capacity needs to contribute significantly to value.

True

2.3 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

2.33 It is essential that a projected or forecasted economic benefit stream be clearly defined and that the discount rate used in the calculation be appropriate for that definition of economic benefit.

True

2.34 It is essential that the economic income stream that is projected is clearly defined and that a discount rate appropriate for that definition of economic income be used in the analysis.

True

2.45 The Capitalization of Earnings Method assumes that all of the assets, tangible or intangible, are indistinguishable parts of the business and does NOT attempt to separate the values of the two.

True

2.10 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

1.36 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 rales

1.39 Which of the following does an analyst NOT consider when deciding which valuation approach or approaches to use:

Who the buyer or seller is

1.28 The various business valuation formulas included in Revenue Ruling 59-60 were tied to:

a. Asset values b. Earnings c. Excess earnings d. All of the above

1.3 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

a. Capitalization of earnings b. Price/earnings ratio c. Adjusted net assets e. All methods listed above could be an appropriate method to value Thingamajig, Inc.

2.32 In valuing equity, which are included in the cash flow to equity calculation?

a. Changes in long-term debt b. Capital expenditures c. Adjustments to net working capital e. All of the above

2.12 Capitalization/discount rates are used to convert a defined stream of earnings, income or cash flow to an indicated present value. Incorporated 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(are} an element of risk associated with privately-held companies?

a. Competition b. Management depth and ability d. Both a and b

1.43 Which of the following statement(s) concerning Capitalized Returns Methods (single period capitalization methods) is (are) true?

a. Depending on the benefit stream, the Capitalized Returns Methods can calculate the market value of invested capital or equity b. Capitalized Returns Methods determine company's value by dividing cash flow or earnings by a capitalization rate c. Capitalized Returns Methods tend to be the most appropriate method when a company's current operations are indicative of its future operations e. All of the above

1.22 The "Excess Earnings" Method is also known as:

a. Formula Method c. Treasury Method e. Both a and c

1.9 Determining the appropriate valuation method requires an in-depth understanding of:

a. Purpose of the valuation b. Standard of value C. Premise of value e. All of the above

1.33 What is needed to be able to utilize the market approach?

a. Reliable data b. Adequate number of market comparables or market transactions e. Both a and b

2.22 Historical earnings are often used to estimate future income when:

a. The economic forecasts for the area of domicile do not adversely affect the subject company b. Industry changes are minimal or don't affect the subject company and it is mature c. History represents future operations and the future benefit stream is linear d. All of the above

1.52 Under the Excess Earnings/Treasury Method:

a. The tangible assets are measured based on Generally Accepted Accounting Principles (GAAP) c. The rate of return used on net assets is the same as the capitalization rate used on the excess earnings d. Both a and b

2.30 In order to estimate present value, you need:

b. A numerator representing the expected dollar amount of return c. A denominator representing the discount rate or cost of capital e. Both b and c

2.16 Examples of multiples for valuing either common equity or invested capital are:

b. Price/Cash flow c. Price/Earnings before interest, taxes, depreciation, and amortization (EBITDA) Both b and c

2.26 If using a Discounted Earnings Method to determine value, how far into the future should earnings be projected?

b. Through the year after a stabilized level of operations is reached c. Until profit margins return to normal after a period of unusually high or low earnings e. Both b and c

2.27 In a discounted cash flow analysis, ____________ projections are often used as the basis for much of the remainder of the model.

revenue