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BUSINESS VALUATION
INTERNATIONAL VALUATION
STANDARDS COMMITTEE
A.
B.
I. INTRODUCTION
What is being appraised?
Definitions of Value.
"Fair Market Value" usually the standard of value in the United States of America. It is well defined. "Market
Value", as defined in real property and by IVSC, is the same as Fair Market Value in business appraisal.
Fair market value is considered to represent a value at which awilling buyer and a willing
seller, both beinQ informed of the relevant facts about the business, could reasonably conduct
a transaction, neither person acting under the compulsion to do so.
Although not stated in the definition, it assumes: 1) a cash value; 2) both parties can perform (buyer
has financing and seller has clear title and can deliver); 3) a reasonable time for exposure in the
market; and 4) normal contacts will be signed.
Unusual factors must be explained if not valued.
C. Who Performs Business Valuations
Chartered Financial Analyst (CFA) of the Institute of Chartered Financial Analysts
Accredited Senior Appraiser (ASA) of American Society of Appraisers in Business Valuation
Certified Business Appraiser (CBA) of the Institute of Business Appraisers
Accredited in Business Valuation (ABV) of the American Institute of Certified Public Accountants.
Chartered Business Valuator (CBV) of the Canadian Institute of Chartered Business Valuators.
II. BUSINESS APPRAISAL
STANDARDS
A. International Valuation Standards - 2003, Guidance Note 6.
B. Uniform Standards of Professional Appraisal Practice (USPAP)
Standards 9 and 10 as well as the Preamble
- Standard 9: In developing a business appraisal, an appraiser must be
aware of, understand and correctly employ those recognized methods
and techniques that are necessary to produce a credible appraisal.
- Standard 10: In reporting the results of a business appraisal, an
appraiser must communicate each analysis, opinion and conclusion in a
manner that is not misleading.
C. American Society of Appraisers Business Valuation Standards
D. Institute of Business Appraisers Business Valuation Standards
III. BUSINESS APPRAISAL
ETHICS - IVS-SixthEdition
This is an extract of IVS. Please use entire IVS.
3.3 A Valuer is a person who possesses the
necessary qualifications, abilities, and
experience to execute a valuation.
The Valuer shall be a person of good repute
who:
- Has an appropriate degree
- Has suitable experience
- Understands recognized methods and techniques
IVS Ethics - Cant.
- Is a member of a recognized national professional
valuation body
- Pursues professional learning
- Follows this Code of Conduct
Ethics:
- Honesty
- Integrity
- Conduct
- Conflicts of interest
~ Confidentiality
- Impartiality
IVS Ethics - Cont.
Competence
- Acceptance of Instructions
-Outside Assistance
- Efficiency and Diligence
Disclosure
Reporting of Values
IV. BUSINESS VALUATION
THEORY
A. The value of a business arises from:
- Assets, either Tangible or Intangible; and
- Cash Flow (different definitions of income)
B. The Phases of Business Value
- Orderly Liquidation is often the least value if the
owner has ability to sell the assets
- As cash flow increases, the value of the business
increases from the liquidating value of tangible assets
to the going concern value of tangible assets
- As cash flow increases further, the value of the
business increases to include the value of specific,
identifiable and non-identifiable intangible assets
VALUE=!(INCOME,ASSETS)
Relationship of Value, Income and Assets
Income Level Value
Liquidation Value
9 8
Goodwill
7
Value in Use
6 5 4 3
Company Value
........
....
2
........
........
.....
........
1
........
10
9
8
V
7
a
6
I
5
U 4
e
3
2
1
........
....
0
....
0
Income
c. The Three Basic Approaches
to Value
1. Cost
- Is a balance sheet focused approach (also called Adjusted
Balance Sheet)
- Based on the premise that a prudent buyer will pay no more for a
property than it would cost to replace with a substitute property
with the same utility -- the principal of substitution
- Concept: Value all the assets of a company, subtract the
liabilities, to arrive at the value of FMV stockholders' equity
- Value of each asset may be derived by using any of the three
approaches for valuing those individual assets
- Assets and company may be valued as a going concern or in a
liquidation scenario
COST APPROACH
FAIR MARKET VALUE BALANCE
SHEET
CURRENT ASSETS
WORKING
CAPITAL
FIXED ASSETS
ASSETS
CURRENT
LIABILITIES
LONG TERM DEBT
LIABILITIES + EQUITY
C.
2.
a)
b)
c)
d)
e)
The Three Basic.Approaches
to Value - Continued
Market
Again, principle of substitution.
Comparison between subject property and similar
properties which have recently sold. Normally either
publicly traded shares of similar companies or
acquisitions of similar companies.
May be either balance sheet or income statement
focused
Value the equity or invested capital of a company
through comparison with the pricing of investment in
companies (often as traded in the stock market)
Generally, is a going concern assumption, not
Iiquidation
C. The Three Basic Approaches
to Value - Continued
3. Income
- Based on theory that the value of any asset is the
present value of expected future benefits to be
derived by the ownership of that asset
- Income statement focused
- Value the equity or invested capital of a company by
deriving the present value of the expected flow of
future economic .benefits
- Generally, is a going concern assumption, not
liquidation
- Generally, may take two forms
Discounted cash flow
Capitalization of cash flow
D. Basic Variables Affecting Value
1. Economic conditions
2. Industry Conditions
3. Business Background and Conditions
Earnings history of the firm
Future earning capacity
Balance sheet
Qualitative factors
4. Risk Assessment
Risk free rates of return
General equity risk
Industry specific risk
Company specific risk
a}
b}
c}
d}
e}
f}
g}
h}
5. Revenue Ruling 59-60
The nature of the business and history of the enterprise
The economic outlook in general and condition and outlook of
the specific industry in particular
The book value of the stock and the financial condition of the
business
The earnings capacity of the company
The dividend-paying capacity
Whether or not the enterprise has goodwill or other intangible
value
Sales of stock and the size of the block to be valued
The market prices of stocks of corporations engaged in the
same or similar lines of business whose stocks are actively
traded in a free and open market, either on an exchange or
over-the-counter
v. STEPS OF AN APPRAISAL
A. Engagement Letter
- Define Assignment
- What is the Written Output
- Due Date
- Fee Arrangement
B. Gather Information
- Subject Company Data
- Economic Data
- Industry Data
- Market Data, Le., Transactions in other companies
C. Analyze Information
- Industry/Economic
- Company Qualitative and Quantitative Analys!s
- Market Data
D.
E
.
Do Valuation Approaches, Reconciliation and Conclusion
Write the report documenting what you have done
VI. DATA GATHERING
A. Economic Data and Analysis
B. Industry Data and Analysis
C. Company Data
D. The On Site Interview
E. Market Data
VII. FINANCIAL STATEMENT
ANALYSIS
A. What is the goal of financial analysis?
- Identify unusual items
- Identify what happened and why it happened
- Identify trends and what caused them
- Identify how the company departs from the
industry norm and why
- Comparison with comparable companies to
assist in selection of appropriate valuation
multiples
ANALYSIS - Continued
B. Trend Analysis Over Time - Goal is to identify positive or
negative trends, review past growth or see what is "normal" for
the subject company
1. Five Year Spreadsheet, including latest twelve months
- Income Statement
- Balance Sheet
2. Common Size Spreadsheet
3. Trend of Financial Ratios
- Liquidity and Leverage Ratios
- Profitability and Turnover Ratios
- Return on equity, i.e., Income/Equity
Components of ROE = Profitability x Turnover x Leverage
ROE =Income/Sales x Sales/Assets x Assets/Equity
ANALYSIS - Continued
C. Comparative Industry Analysis
- Sources of Comparative Data
Robert Morris Associates (RMA) Annual Statement Studies
Performance Analysis Reports (PAR) prepared by trade
association
Other industry data compiled by trade associations or trade
periodicals
Similar publicly traded companies
- Balance sheet and income statement common size
compansons
- Comparative financial ratios
VIII. ASSET BASED VALUATION
APPROACHES
A. When are they most appropriate
- Start-up operation; no track record as a going concern
- Holding company, for example, owning primarily securities
(publicly traded or closely held) or real properties
- Asset-heavy businesses where the sale of the company would
involve specific assets
- Company contemplating liquidation
B. Book value - equity as stated on the financial
statements
- Advantage - Simple, widely understood
- Disadvantages - The value of assets and liabilities stated at
historical, depreciated cost may bear no resemblance to current
economic value
C. Adjusted Book Value
1. Purpose - To replace cost of assets and liabilities with current
economic value
2. Typical balance sheet adjustments
- Non-operating assets and liabilities such as excess cash and securities,
excess investment property and related obligations
- Uncollectible receivables
- LIFO or current replacement cost inventory adjustments
- Marketable securities
- Unmarketable securities
- Accelerated depreciation
- Real property per appraisal
- Machinery & equipment per appraisal
- Intangible assets like goodwill, non-compete agreement
- terms on debt
- Contingencies such as lawsuit or pension obligations
- Deferred taxes
D. Liquidation Value
1. Orderly or forced liquidation
2. Consult management, auctioneer, P&M
appraiser, and/or real estate appraiser
concerning appropriate liquidating discounts
3. Consider liquidation costs
- Auctioneer's fees and commissions
- Continued fixed cost and administrative costs during
liquidation period
- Legal, accounting and other professional fees
- Taxes payable by the corporation
E. Market Based Asset
Approaches
1. Price/book value - where do similar companies
stocks sell relative to book value
2. Price/adjusted book value
- Conceptually the best asset approach
- Most applicable when assets consist primarily of:
Inventory - LIFO adjustments to market data
Real Property - Publicly traded Real Estate Investment Trusts
(REITs) for market data
Securities - Publicly traded investment companies
- Advantages - Uses adjusted company data and market data
- Disadvantages - Difficult or impossible to get adjusted asset data
for similar companies. Cannot make valid comparisons.
IX. ADJUSTMENTS TO INCOME
GOAL: REACH NORMALIZED OPERATING INCOME
A.Non-operating Items - Remove effect on income
statement of non-operating assets. Examples include:
- Excess real property - adjust for rental income, property taxes,
depreciation, debt service
- Excess cash and securities - adjust for interest income,gain
(loss) on securities
B. Varying Accounting Treatments
- LIFO/FIFO inventory
- Depreciation (tax lives vs. economic lives)
- Capital versus operating lease
- Pension Accounting
c. Non-recurring Items
1. Gain (loss) on sale of assets
2. Bad debts
3. Professional fees
4. Unusual production costs - labor or materials
5. Start-up costs
6. Discontinued operations
7. Unusual revenues - price or volume
D. Discretionary Items
1. Owner's compensation - Salary &
Bonus & "Toys"
2. Indirect owner's compensation -
Pension, profit sharing, commissions,
director's fees
3. Transactions with related parties, for
example, leases for real property or
equipment
4. Unusual perquisites
IX. ADJUSTMENTS - Continued
E. New Circumstances change expected
Income
- Acquisition
- Divestiture
F. Invested Capital (Debt Free) Methods
x. CAPITALIZATION OF
INCOME
A. Variations of "Income"
- Net income after income tax
- Income before income tax (EBT)
- Operating inco-me or earnings before interest and
taxes (EBIT)
- Earnings before interest, taxes, depreciation and
amortization (EBITDA)
- Cash flow =Net income plus non-cash charges such
as depreciation and amortization
-lnvestedCapital methods
- Which measure is most appropriate will depend on
the specific situation
x. CAPITALIZATIONOF
INCOME - Continued
B. Goal is to identify long term estimate of
current operating earning power
- Start with the adjusted income statement
already developed
- Compare this to adjusted budget for next year
or management's longer term forecast(s)
- Based on the adjusted historical and
budgeted future, arrive at your best estimate
of long term earning power
C. Capitalization Rate
A rate to translate income (or expected income) into
value
Definition: Capitalization rate =required rate of return.
(discount rate) minus expected long term growth
Capitalization Rate =Required Rate of Return - Growth
(For All Non-Zero Growth Rates)
Capitalization Rate =Required Rate of Return
Only If Growth Rate is Zero
Value =Expected Income/Capitalization Rate
VaIue = ____
Required Rate of Return less Growth Rate
C. Capitalization Rate -Cont.
2. Required Rate of Return - One of the most important and most
subjective aspects of business appraisal
Goal is to measure the RISK that the mrnected income will not be achieved
- Operating risk
- Industry/Economic Conditions
- Company Characteristics
Stability of Product Demand
Substitute Products
Competition
Manufacturing problems
Labor
Stability of supplies
Management/key people
- Financial Risk
Fixed charge coverage, leverage
Adequacy of working capital
Access to long term capital - debt or equity
C. Capitalization Rate - Cant.
Methods of developing the required rate of
return
- "Build up" method
Risk-free rate (long term government securities)
Equity Risk Premium
Specific risk premium for subject company
(most important but no hard guidelines)
- Market method - what rates are other people. using
who are actively buying and selling. Great
conceptually, but the data is seldom available
C. Capitalization Rate - Cont.
Growth Rate - based on past history and management's
budget. Final decision based on judgment of appraiser
- Assumes growth in perpetuity so conservative rate is necessary
- Common range of long term growth is 4Jb to 1QOJb
- Example of typical capitalization rate for closely held company
Value = Expected Pretax Income
Required Rate of Return Less Growth Rate
Value = Expected Pretax Income/(25
%
- 50/0)
Value = Expected Pretax Income/20o/0
D. Excess Earnings Method
Blending an asset-based and an income-based valuation
methods
- Conceptual Basis - Goodwill (value above adjusted net asset
value) exists for a company only if the expected income exceeds
the return required on the adjusted tangible net assets
- Step by Step Method
Determine adjusted tangible net asset value
Determine required rate of return on adjusted tangible net assets
Determine aggregate dollar return required
Compare required return to expected income
If expected earnings exceed required rate, capitalize "excess"
earnings at a relatively high rate to determine goodwill
Total value of company = adjusted tangible net asset value plus
goodwill
D. Excess Earnings Method
Adjusted tangible net asset value
Expected pretax income
$ 1,000,000
250,000
Required pretax return on tangible net assets = 180/0
Capitalization'rate on excess earnings = 300/0
Expected Return
Less Required Tangible Return
($1,000,000 x 1 8 ~ )
"Excess Earnings"
Capitalization rate on excess
Goodwill
Value Conclusion
Tangible net assets
Goodwill
Total Value
-
-
250,000
180,000
70,000
30%
$ 233,000
$1,000,000
233,000
$1,233,000
XI. DISCOUNTED FUTURE
RETURNS
A. Conceptually the most accurate way to value
any investment
- Defined as the present value of future expected
benefits/returns
- Present value of future returns, discounted at a
required rate of return
- Can assume either returns in perpetuity or some
terminal value. Identical concept to pricing a bond
- Differs from "Capitalization" method in that return is
estimated in each of multiple future periods rather
than using a single measure of income
c. Projecting Future Returns
- Long term forecast based on adjusted historical results &management's budget
- Best measure of return is free cash flow (available for dividends/distributions)
Net Income
Plus Non-cash expenses such as depreciation, amortization, deferred taxes
Minus Capital expenditures
Minus Debt principal payments
Plus/Minus Working capital needs (deficiency or excess)
- Year by year forecast plus terminal value, five to ten year forecast common
FCF = Free Cash Flow
r = Required Rate of Return
Value = FCF
1
+ . FCF
2
(1 +r)1 (1 +r)2
+ + FCFn
(1 +r)n
- Required rate of return is determined as previously discussed. Differing levels of
risk are associated with differing levels of income.
D. Terminal Value
Constant growth (capitalization equation)
Terminal Value = FCFn+1
r-g
No growth (annuity in perpetuity)
Terminal Value = FCF
n
+
1
r
XII. MARKET DATA
APPROACHES
A. Conceptual Basis - Principle of substitution
B. Get "market" multiples for similar companies that have
recently sold or whose shares are actively traded. Multiple
based on:
- Current earnings and/or cash flow
- Historical average earnings and/or cash flow
- Projected future earnings and/or cash flow
- Revenues - key on comparative profit margins
- Volume (revenue)
- Equity or adjusted equity - key on comparative return on equity
C. Make qualitative and quantitative comparisons between
subject company and market data. Assess comparative growth
and risk characteristics. Should pricing mUltiples for subject
company be above, below or similar to the market norms?
XII. MARKET DATA
APPROACHES
D. Sources of Market Data
- Similar publicly traded companies
- Similar acquired companies
- Industry rules of thumb
- Make sure the comparisons are accurate, Le., make the same
adjustments to the market data that were made to the subject
company
E. Summary
- Do proper company analysis and adjustments
- Adjust data of comparables, if appropriate
- Determine appropriate norms for market multiples
- Determine how the company's multiples should differ from the
market norms
XIII.OTHER CONSIDERATIONS
A. Buy/Sell Agreements
B. History of Past Transactions or Offers to Buy
C. Discounts for Minority Interest (or Lack of
Control) and Lack of Marketability
D. Premium for Control
E. Special Attributes of Control
F. Control or Minority Assignment can largely
dictate appraisal methodology
G. Special rights or privileges, i.e., put options,
preferred stock conversion or redemption
features .
XIV. DISCOUNT FOR LACK
OF MARKETABILITY
A. Lack of Marketability Discount:
- What is the impact of law on transfer?
- Facts and circumstance dominate, as usual.
B. Studies:
- Restricted Stock Studies
- IPO Studies
- PV Type Calculations
C. Fair market value of minority shares in a closely
held company would be, on average, 350/0 to 45k
less than the value of minority shares in a similar
company whose shares were actively traded in the
stock market.
DLOM - Qualitative Factors
11. Robert Moroney wrote a second article (Taxes -- The Tax
Magazine, May 1977, Why 2 5 ~ Discount for NonmarketabHity in
One Valuation, 100
%
in Another?)
a) Are dividends being paid?
b) Is management friendly? Honest?
c) How fast is the subject company growing?
d) Degree of control?
e) Is the industry in a favorable competitive s tuation?
f) In there interest in the industry in buying companies?
g) Prevailing mood of the investing public?
h) What is the financial and business risk in the subject company?
i) What are the particular restrictions on transfer of interests?
xv. LACK OF CONTROL
DISCOUNT
(MINORITY INTEREST DISCOUNT)
A. Theory. It is commonly accepted in the field of
business valuation that the per share value of a
controlling interest is worth more than the per share
value of a minority interest. Control is a valuable asset.
With it the investor has the right to control the Board of
Directors which in turn can determine salaries, benefits,
dividends, the sale of assets, the direction of the
company, liquidation, etc. These rights have value and
investors are willing to recognize that value by paying a
higher price for a controlling block of stock than they
would for a minority block of stock.
DLOC - Qualitative Factors
1. What are the disadvantages of lack of control?
2. How much cash does a shareholder get on an
annual basis?
3. How is management runni.ng the company -- good.
for all, or good for one?
. 4. How fast is the subject company growing?
5. What is the financial and business risk in the subject
company?
6. What is the impact of state law on lack of control?
7. Facts and circumstance dominate, as usual.
DLOC - Quantification
B. The opposite of a control premium is a minority interest
discount.
C. Quantification. In the public marketplace the value of control is
quantified when one company offers to buy all (or a majority of)
the shares of another -- a "tender offer".
D. Calculation. In recognition of the value of control the buyer
typically makes a bid for the stock at a price that exceeds the
marketprice existing at the time. This excess is called the
"tender offer premium" and is believed to be an objective
estimate of the value of control.
- Control Premium Example: if a tender offer of $28 is made fora publicly
traded company that is trading at $20 per share, the value of a
controlling interest is $28, the value of a minority interest is $20 and the
premium for control is 40
%
- The related minority discount' (DLOC) is 29%.

XVI. CONTROL PREMIUM
XVII. LACK OF VOTE
DISCOUNT
A. What is the impact of a lack of a vote?
B. What is the impact of law on lack of control (vote)?
C. Facts and circumstance dominate, as usual.
Quantification: Riding & Jog, "Price Effects of Dual Class
Shares", January/February 1986 issue, Financial
Analysts Journal noted that the average premium for
voting shares traded on the Toronto Stock Exchange
(Canada's largest) was 7% over restricted voting shares
in the same companies, which translates into a discount
equivalent of about 6.5k (i.e., 1.07x 0.935 =1.00).
Houlihan, Lokey, Howard &Zukin found a discount
range of 2k to 40/0 for non-voting common stock.
XVIII. VALUATION
CONCLUSION
A. Briefly review all source documents to see if any
important factors were missed
B. Re-read the appraisal assignment
C. Summarize and compare the conclusions of the
various approaches
D. Recheck methods that give extreme values
E. Determine the relevance of the various approaches
for the particular assignment
F. Arrive at a single point estimate, by either
quantitative or qualitative techniques. Better to
round than to imply a false sense of precision
G. Check the final conclusion against adjusted income
or adjusted equity. Does the answer make sense?
XIX. SMALL BUSINESSES --
SPECIAL FACTORS
A. Market Approach
- Data Bases
- Rules of Thumb
- Multiple of Owners' Discretionary Cash
B. Income Approach
- Replacement compensation for the labor of the owner
is a key consideration
C. Transactions
- What is typically sold
- What is not typically sold
Graduation day
e
INTERNATIONAL
VALUATION STANDARDS
COMMITTEE
BUSINESS VALUATION
By
Gregory A. Gilbert, CFA, FASA, CBA
of
Corporate Valuations, Inc.
Kuala Lumpur, Malaysia
October 21, 2003
BUSINESS VALUATION
This handout is largely stated in tenns of corporations. Many techniques work
equally well with partnerships or sole proprietorships.
I. INTRODUCTION 1
II. BUSINESS APPRAISAL STANDARDS 2
III. BUSINESS APPRAISAL ETHICS. 3
IV. BUSINESS VALUATION THEORY 5
V. STEPS OF AN APPRAISAL 7
VI. DATA GATHERING 8
VII. FINANCIAL STATEMENT ANALYSIS 11
VIII. ASSET BASED VALUATION APPROACHES 12
IX. ADJUSTMENTS TO INCOME GOAL: REACH NORMALIZED OPERATING INCOME 14
XIV. DISCOUNT FOR LACK OF MARKETABILITY
XIX. SMALL BUSINESSES SPECIAL FACTORS
XV. LACK OF CONTROL (MINORITY INTEREST) DISCOUNT
XIII. OTHER CONSIDERATIONS IN DETERMINING FAIR MARKET VALUE
15
18
19
20
21
23
25
26
27
28
Pagei IVSC
X. CAPITALIZATION OF INCOME
XI. DISCOUNTED FUTURE RETURNS
XII. MARKET DATA APPROACHES
XVIII. VALUATION CONCLUSION
XVII. LACK OF VOTE DISCOUNT
I. INTRODUCTION
A. What is being appraised?
1. Stock in a Corporation
a) Common or Preferred Stock
b) Controlling or Minority Interest
2. Partnership Interest - General Partner or Limited Partner
3. Sole Proprietorship
B. Definitions of Value.
1. "Fair Market Value" usually the standard of value in the United States of America.
Well defined. "Market Value", as defined in real property and by NSC, in real
estate appraisal is the same thing as Fair Market Value in business appraisal.
a) Fair market value is considered to represent a value at which a willing buyer
and a willing seller, both being informed of the relevant facts about the
business, could reasonably conduct a transaction, neither person acting
under the compulsion.to do so.
b) Although not stated in the definition, it normally assumes: a cash or cash
equivalent value; both parties can perform (the buyer has financing and the
seller has clear title and can deliver the interest); a reasonable time for
exposure in the market; and that normal contacts will be signed.
c) Unusual factors must be explained. Such factors may be governmental
restrictions like environmental contamination, non-compliance with
Americans with Disabilities Act, or other rules and regulations.
2. Other value definitions. Often even less well defined. Two examples:
a) "Investment Value" is the value of a business to a particular owner.
b) "Intrinsic Value" usually means a long term quasi-market value - what the
value "should be" if the market had no fluctuations.
c) Particular legal jurisdictions have special value definitions.
C. Who Performs Business Valuations
1. Business Valuation Specialists - What To Look For
a) Chartered Financial Analyst (CFA) of the Institute of Chartered Financial
Analysts
b) Accredited Senior Appraiser (ASA) of American Society of Appraisers in
Business Valuation
c) Certified Business Appraiser (CBA) of the Institute of Business Appraisers
d) Accredited in Business Valuation (ABV) of the American Institute of
Certified Public Accountants.
e) Chartered Business Valuator (CBV) of the Canadian Institute of Chartered
Business Valuers.
f) Experience
g) Reputation (References)
Corporate Valuations, Inc. IVSC Page 1
II. BUSINESS APPRAISAL STANDARDS
A. International Valuation Standards - 2003, Guidance Note 6. Copy attached.
B. Uniform Standards of Professional Appraisal Practice (USPAP) Standards 9 and 10 as well
as the Preamble
1. Standard 9
a) In developing a business appraisal, an appraiser must be aware of,
understand and correctly employ those recognized methods and techniques
that are necessary to produce a credible appraisal.
2. Standard 10
a) In reporting the results of a business appraisal, an appraiser must
communicate each analysis, opinion and conclusion in a manner that is not
misleading.
C. American Society of Appraisers Business Valuation Standards
D. Institute of Business Appraisers Business Valuation Standards
III. BUSINESS APPRAISAL ETHICS
A. American Society of Appraisers Code of Ethics (as an example).
1. Primary duty and responsibility.
a) Obligation to determine and describe the kind of value.
b) Obligation to be accurate.
c) Obligation to avoid a false value.
d) Obligation to attain competency and to practice ethically.
2. Obligations to the client.
a) Confidential character of appraisal assignment.
b) Obligation to give competent service.
c) In testimony may not suppress facts, data or opinions.
d) Must document appraisals in report or work files.
e) Only with consent mayan appraiser have more than one client for an
appraisal.
) It is good practice to have a written contract with a client.
3. Appraisal Methods and Practices.
a) The kind of value reached must be described.
b) Methods must be appropriate to the appraisal.
c) Fractional appraisals must be so labeled.
d) Hypothetical appraisals must be so labeled.
e) Contingent and limiting conditions must be stated.
4. Unethical practices.
a) Contingent fees.
b) Percentage fees.
c) Appraisals in which the appraiser has an undisclosed interest.
d) Advocacy.
e) Unsigned appraisal reports. Appraisal reports wherein there was dissent by
an appraiser that was not registered in the report.
) Unconsidered opinions.
g) Misuse of membership designations.
5. Appraisal reports must contain:
a) Description of the property under appraisal.
b) Statement ofthe objectives of the appraisal report.
(1) What is the goal of the appraisal.
(2) Meaning attached to the specific kind of value.
(3) Date ofthe appraisal.
(4) When appropriate, an analysis of the highest and best use of the
property.
c) Statement of contingent and limiting conditions.
d) Description and explanation in the appraisal report of the appraisal
methodes) used.
e) Statement ofthe appraiser's disinterestedness.
) Signatures to appraisal reports and inclusion of dissenting opinions.
B. USPAP ethics are in the Preamble
C. Institute of Business Appraisers' Code of Ethics
IV. BUSINESS VALUATION THEORY
A. The value of a business arises from:
1. Assets, either Tangible or Intangible; and
2. Cash Flow (different definitions of income)
B. The Phases of Business Value
1. Orderly Liquidation is often the least value if the owner has ability to sell the assets
2. As cash flow increases, the value of the business increases from the liquidating
value of tangible assets to the going concern value of tangible assets
3. As cash flow increases further, the value of the business increases to include the
value of specific, identifiable intangible assets
C. The Three Basic Approaches to Value Used in the Appraisal Profession
1. Cost
a) Is a balance sheet focused approach (also called Adjusted Balance Sheet)
b) Based on the premise that a prudent buyer will pay no more for a property
than it would cost to replace with a substitute property with the same utility
-- the principal of substitution
c) Value all the assets of a company, subtract the liabilities, to arrive at the
value ofthe stockholders' equity
d) Value of each asset may be derived by using any of the three approaches for
valuing those individual assets
e) Assets and company may be valued as a going concern or ina liquidation
scenario - either orderly liquidation or forced liquidation
2. Market
a) Again,principle of substitution.
b) Comparison between subject property and similar properties which have
recently sold. Normally either publicly traded similar companies or
acquisitions of similar companies.
c) May be either balance sheet or income statement focused
d) Value the equity or invested capital of a company through comparison with
the pricing of investment in companies (often as traded in the stock market)
e) Generally, is a going concern assumption, not liquidation
3. Income
a) Based on theory that the value of any asset is the present value of expected
future benefits to be derived by the ownership of that asset
b) Income statement focused
c) Value the equity or invested capital of a company by deriving the present
value of the expected flow of future economic benefits
d) Generally, is a going concern assumption, not liquidation
e) Generally, may take two forms
Corporate Valuations, Inc. IVSC PageS
(1) Discounted cash flow
(2) Capitalization of cash flow
D. Basic Variables Affecting Value
1. Economic conditions
a) General
b) Specific
2. Industry Conditions
3. Business Background and Conditions
a) Earnings history of the firm
b) Future earning capacity
c) Balance sheet
d) Qualitative factors
4. Risk Assessment
a) Risk free rates of return
b) General equity risk
c) Industry specific risk
d) Company specific risk
5. Revenue Ruling 59-60
a) The nature of the business and history ofthe enterprise
b) The economic outlook in general and condition and outlook of the specific
industry in particular
c) The book value of the stock and the financial condition of the business
d) The earnings capacity of the company
e) The dividend-paying capacity
f) Whether or not the enterprise has goodwill or other intangible value
g) Sales of stock and the size of the block to be valued
h) The market prices of stocks of corporations engaged in the same or similar
lines of business whose stocks are actively traded in a free and open market,
either on an exchange or over-the-counter
v. STEPS OF AN APPRAISAL
A. Engagement Letter
1. Define Assignment
a) What is to be valued
b) Appraisal Date
c) Purpose of Appraisal
d) Who is the client
2. What is the Appraisal Output
a) Verbal Opinion or Letter
b) Short Report
c) Detailed Report
3. Due Date
4. Fee Arrangement
B. Gather Information
1. Subject Company Data
a) Financial Statements
b) Other Documents
c) Inspect facilities and interview key people
2. Economic Data
3. Industry Data
4. Market Data, Le., Transactions in other companies
C. Analyze Information
1. Industry/Economic
2. Company Qualitative and Quantitative Analysis
3. Market Data
D. Do Valuation Approaches, ReconciHation and Conclusion
E. Write the report documenting what you have done
Corporate Valuations, Inc. IVSC Page?
VI. DATA GATHERING
A. Economic Data and Analysis
1. General economic trends that might affect demand
2. Specific economic data in market or region served
3. Allows appraiser to make informed judgment about the risks facing a company
4. Determine how important general economic conditions are to the subject company
B. Industry Data and Analysis
1. Risk oriented
2. The life cycle ofthe industry
3. Competition
4. Growth rate and future expectations
5. New technology
6. Sources of information
a) Standard & Poor's Industry Survey
b) Value Line
c) Trade Journals
d) Trade Associations
e) Business Publications
7. Determine how important industry conditions are to the subject company
C. Company Data
Financials for 5 fiscal years audited
Income tax returns, same 5 fiscal years
Interim financials
Detailed depreciation schedule
Budgets or forecasts
Product and Market Data
Marketing literature, Brochures, etc., price lists
Locations where company operates
Product specifications
Lists of patents, copyrights, trademarks
Customer list and suppliers' list
Profits by divisionlbranch
List of major competitors and their locations
List of trade associations
Survey of geographic market
Distribution Agreements
Organization chart
Brief resume on key personnel
Employment agreements; Covenant not to compete
Union contracts
Compensation schedule for owners
Schedule of life insurance policies on key personnel
Pension and profit sharing plans and employee handbook
For corporation: Articles of Incorporation, Bylaws and Minutes
List of stockholders and/or partners
Any details on prior stock sales
Buy/sell agreements, options, etc.
Shareholder and Board Minutes
Major contracts
Copies of previous appraisals
D. The On Site Interview
1. Main purpose is to assess risk
2. Review Pertinent Documents First
3. Prepare a list of questions
4. Topics to discuss with management
Operations
Financial performance
Key personnel
Plans for future
Competitive environment - Where does the company fit into competitive
scheme
5. Persons to interview might include
Client
Client's attorney
Companypresident
Company chief financial officer
Members of company board of directors
Company's accountant
Company's attorney
Company's banker
6. Areas of questions might include
History and operations of company
Capitalization and ownership of company
Economic and industry factors affecting company
Facilities (location)
Management and employees
Competition and how the company competes
Customer base (backlogs)
Supplier base
Contingent liabilities and assets
Past transactions in interests in the company ownership
Future plans and products (services)
Government regulations
Seasonality and cyclicality
Products and services of company offered and to be offered and sales
breakdown
Company's present and future debt loads
Other information of which the appraiser may not be aware
E. Market Data
1. Similar Publicly Traded Companies - Separated by Standard Industrial
Classification (SIC) number
a) Standard & Poor's
b) Computer data bases
c) Moody's
d) Ask management
e) Identify and get annual report
2. Similar companies which have merged or been acquired (can be either public or
private)
a) Ask Management
b) Merger & Acquisitions Magazine
c) Merger & Acquisition Sourcebook
d) Merrill Lynch Mergerstat Review
e) Trade Associations, Periodicals and Newsletters
VII. FINANCIAL STATEMENT ANALY S I S ~
A. What is the goal of financial analysis?
1. Identify unusual items
2. Identify what happened and why it happened
3. Identify trends and what caused them
4. Identify how the company departs from the industry norm and why
5. Comparison with comparable companies to assist in selection of appropriate
valuation multiples
B. Trend Analysis Over Time - Goal is to identify positive or negative trends, review past
growth or see what is "normal" for the subject company
1. Five Year Spreadsheet, including latest twelve months
a) Income Statement
Volume
Sales
Gross Margin
SG&A Details
Interest Expense
Other Income
Tax Rate
b) Balance Sheet
c) Sources & Uses Statement, ifrelevant
2. Common Size Spreadsheet
a) Best to combine with aggregate dollars
3. Trend of Financial Ratios
a) Liquidity Ratios
b) Leverage Ratios
c) Profitability Ratios
d) Turnover Ratios
e) The most important ratio is the return on equity, i.e., IncomelEquity
Components of ROE = Profitability x Turnover x Leverage
ROE = Income/Sales x Sales/Assets x AssetslEquity
C. Comparative Industry Analysis
1. Sources of Comparative Data
a) Robert Morris Associates (RMA) Annual Statement Studies
b) Performance Analysis Reports (PAR) prepared by trade association
c) Other industry data compiled by trade associations or trade periodicals
d) Similar publicly traded companies
2. Balance sheet and income statement common size comparisons
3. Comparative financial ratios
VIII. ASSET BASED VALUATION APPROACHES
A. When are they most appropriate
1. operation; no track record as a going concern
2. Holding company, for example, owning primarily securities (publicly traded or
closely held) or real properties
3. Asset heavy businesses (for example, heavy machinery and equipment) where the
sale of the company would involve specific assets
4. Company contemplating liquidation
B. Book value equity as stated on the financial statements
1. Advantage Simple, widely understood
2. Disadvantages The value of assets and liabilities stated at cost may bear no
resemblance to current economic value
C. Adjusted Book Value
1. Purpose To replace cost of assets and liabilities with current economic value
2. Typical balance sheet adjustments
a) Separate non-operating assets and liabilities such as excess cash and
securities, excess investment property and related obligations
b) Uncollectible receivables
c) LIFO or current replacement cost inventory adjustments
d) Marketable securities
e) Unmarketable securities
t) Accelerated depreciation
g) Real property per appraisal
h) Machinery & equipment per appraisal
i) Intangible assets like goodwill, agreement
j) Advantageous terms on debt
k) Contingencies such as lawsuit or pension obligations
1) Deferred taxes
D. LiquidationValue
1. Orderly or forced liquidation
2. Consult management, auctioneer, M&E appraiser, real estate appraiser concerning
appropriate liquidating discounts
3. Consider liquidation costs
a) Auctioneer's fees and commissions
b) Continued fixed cost and administrative costs during liquidation period
c) Legal, accounting and other professional fees
d) Taxes payable by the corporation
E. Market Based Asset Approaches
1. Pricelbook value - where do similar companies stocks sell relative to book value
2. Price/adjusted book value
a) Conceptually the best asset approach
b) Most applicable when assets consist primarily of:
(1) Inventory LIFO adjustments to market data
(2) Real Property - Publicly traded Real Estate Investment Trusts
(REITs) for market data
(3) Securities - Publiclytraded investment companies
c) Advantages - Uses both adjusted company data and market data
d) Disadvantages - Difficult or impossible to get adjusted asset data of similar
companies. Cannot make valid comparisons.
IX. ADJUSTMENTS TO INCOME
GOAL: REACH NORMALIZED OPERATING INCOME
A. Non-operating Items - Remove effect on income statement of non-operating assets.
Examples include:
1. E X c ~ s s real property - adjust for rental income, property taxes, depreciation, debt
servIce
2. Excess cash and securities - adjust for interest income, gain (loss) on securities
B. Varying Accounting Treatments
1. LIFO/FIFO inventory
2. Depreciation
3. Capital versus operating lease
4. Pension Accounting
C. Non-recurring Items
1. Gain (loss) on sale of assets
2. Bad debts
3. Professional fees
4. Unusual production costs - labor or materials
5. Start-up costs
6. Discontinued operations
7. Unusual revenues - price or volume
D. Discretionary Items
1. Owner's compensation - Salary & Bonus
2. Indirect owner's compensation - Pension, profit sharing, commissions, director's
fees
3. Transactions with related parties, for example, leases for real property or equipment
4. Unusual perquisites
E. New Circumstances
1. Acquisition
2. Divestiture
F. Invested Capital (Debt Free) Methods
x. CAPITALIZATION OF INCOME
A. Variations of "Income"
1. Net income after income tax
2. Income before income tax
3. Operating income or earnings before interest and taxes (EBIT)
4. Earnings before interest, taxes and depreciation
5. Cash flow = Net income plus depreciation/amortization
6. Invested Capital methods
7. Which measure is most appropriate will depend on the specific situation
B. Goal is to identify a long term best estimate of current earning power
1. Start with the adjusted income statement already developed
2. Compare this to adjusted budget for next year or management's long term forecast
3. Based on the adjusted historical and budgeted future, arrive at a best estimate of
long term earning power
C. Capitalization Rate - A rate for translating income (or expected income) into value
1. Definition: Capitalization rate = required rate of return (discount rate) minus
expected long term growth
Capitalization Rate = Required Rate of Return - Growth
For All Non-Zero Growth Rates
Capitalization Rate = Required Rate of Return
Only If Growth Rate is Zero
Value =Expected Income/Capitalization Rate
Value = Expected Income
Required Rate of Return less Growth Rate
2. Required Rate of Return - One of the most important and most subjective aspects of
business appraisal
a) Goal is to measure the RISK that the expected income will not be achieved
(1) Operating risk
Industry/Economic Conditions
Company Characteristics
Stability ofProduct Demand
Substitute Products
Competition
Manufacturing problems
Labor
Stability of supplies
Managementlkey people
(2) Financial Risk
Fixed charge coverage
Adequacy of working capital
Access to long term capital - debt or equity
b) Methods of developing the required rate of return
(1) "Build up" method
Risk-free rate (long term government securities)
Equity Risk Premium
Specific risk premium for subject company
(most important but no hard guidelines)
(2) Market method - what rates are other people using who are actively
buying and selling. Great conceptually, but the data is seldom
available
(3) Common range of required rates of return for pretax income is 15%-
50%. Many will be in the 20% to 30% range.
(4) Growth Rate - based on past history and management's budget.
Final decision based on judgment of appraiser
(a) Assumes growth in perpetuity so conservative rate is
necessary
(b) Common range oflong term growth is 4% to 10%
(c) Example of typical capitalization rate for closely held
company
Value = Expected Pretax Income
Required Rate of Return Less Growth Rate
Value = Expected Pretax Income/(25% - 5%)
Value = Expected Pretax Income/20%
D. Excess Earnings Method - blending an asset-based and an income-based valuation methods
1. Conceptual Basis - Pay goodwill (value above adjusted net asset value) for a
company only if the expected income exceeds the return required on the adjusted
tangible net assets acquired
2. Step by Step Method
a) Determine adjusted tangible net asset value
b) Determine required rate of return on tangible net assets purchased
c) Determine aggregate dollar return required
d) Compare required return to expected income
e) If expected earnings exceed required rate, capitalize "excess" earnings at a
relatively high rate to determine goodwill
f) Total value of company = adjusted tangible net asset value plus goodwill
3. Example
Common pretax rates of return on tangible net assets is 15% to 20%. Common
pretax capitalization rates for excess assets are 20% to 50%.
Adjusted tangible net asset value
Expected pretax income
Required pretax return on tangible net assets
Capitalization rate on excess earnings
=
=
$ 1,000,000
250,000
18%
30%
Expected Return =
Less Required Tangible Return ($1,000,000 x 18%)=
"Excess Earnings" =
Capitalization rate on excess
Goodwill =
250,000
180,000
70,000
30%
$ 233,000
E.
Value Conclusion
Tangible net assets
Goodwill
Total Value
Owners' Discretionary Cash Methods
=
$1,000,000
233,000
$1,233,000
XI. DISCOUNTED FUTURE RETURNS
A. Conceptually the most accurate way to value any investment
1. Defined as the present value of future expected benefits
2. Present value of future returns, discounted at a required rate ofreturn
3. Can assume either returns in perpetuity or some terminal value. Identical concept to
pricing a bond
B. Differs from "Capitalization" method in that return is estimated in each of multiple future
periods rather than using a single measure of income
C. Projecting Future Returns
1. Long term forecast based on adjusted historical results & management's budget
2. Optimal measure of return is free cash flow which could be used to pay
dividends/distributions. Considers all sources and uses of cash such as:
Net Income
Non-cash expenses such as depreciation,
amortization, deferred taxes
Capital expenditures
Debt principal payments
Working capital needs (deficiency or excess)
3. Year by year forecast plus terminal value
a) Five to ten year forecast is common
FCF =Free Cash Flow
r = Required Rate of Return
Value = FCF1- + FCFl +...... + FCF
n
(l +r) 11+r) 11+r)n
b) Required rate of return is determined as previously discussed. Differing
levels of risk are associated with differing levels of income. Use of
optimistic, best estimate and pessimistic forecasts entails differing discount
rates.
D. Terminal Value
1. Constant growth (capitalization equation)
Terminal Value = FCF
n
+1
r-g
2. No growth (annuity in perpetuity)
Terminal Value =
FCF
n
+1
r -
IVSC Page 18
XII. MARKET DATA APPROACHES
A. Conceptual Basis - Principle of substitution
B. Determine "market" multiples for similar companies that have recently sold or whose
shares are actively traded. Multiple based on:
1. Current earnings and/or cash flow
2. Historical average earnings and/or cash flow
3. Projected future earnings and/or cash flow
4. Revenues - key on comparative profit margins
5. Volume
6. Equity or adjusted equity - key on comparative return on equity
C. Must make qualitative and quantitative comparisons between subject company and market
data. Assess comparative growth prospects and risk characteristics. Should the pricing
multiples for subject company be above, below or similar to the market norms?
D. Sources of Market Data
1. Similar publicly traded companies
2. Similar acquired companies
3. Industry rules ofthumb
4. Make sure the comparisons are accurate, i.e., make the same adjustments to the
market data that were made to the subject company
E. Summary
1. Do proper company analysis and adjustments
2. Adjust data of comparables, if appropriate
3. Determine appropriate norms for market multiples
4. Determine how the company's multiples should differ from the market norms
XIII. OTHER CONSIDERATIONS IN DETERMINING FAIR
MARKET VALUE
A. Buy/Sell Agreements
B. History of Past Transactions or Offers to Buy
C. Discounts for Minority Interest (or Lack of Control) and Lack of Marketability
D. Premium for Control
E. Special Attributes of Control
F. Control or Minority Assignment can largely dictate appraisal methodology
G. Special rights or privileges, i.e., put options, preferred stock conversion or redemption
features
Corporate Valuations, Inc. Ivse Page 20
XIV. DISCOUNT FOR LACK OF MARKETABILITY
A. Lack of Marketability Discount:
1. What is the impact of state law on transfer?
B. Studies:
1. Institutional Investor Study done by the S.E.C. on purchases of restricted stocks by
institutions found a wide range of discounts, with 35% appearing asa typical level
barring unusual circumstances.
2. Robert E. Moroney, Taxes, March, 1973, examined discounts paid by funds
investing in restricted securities.
3. J. Michael Maher, Taxes, September, 1976, examined discounts paid by funds
investing in restricted securities.
4. Thomas A. Solberg, Journal of Taxation, September, 1979, examined 15 court
cases in which restricted securities were valued. The median discount in his study
was 38.9%.
5. John D. Emory, "The Value of Marketability As TIlustrated In Initial Public
Offerings Of Common Stock," Business Valuation Review, December, 1986,
examined 21 initial public offerings (IPOs) that took place between January 1, 1985
and June 30, 1985. Mr. Emory found that the median discount from the public
offer price was 43% for the transactions taking place within five months ofthe IPO.
Mr. Emory has updated his article several times, with the results as noted below:
Study
1985 - 1986
1987 - 1989
1989 - 1990
1990 - 1992
1992 - 1993
1994 - 1995
1995 - 1997
1997 ~ 2 0 0 0
1980 - 2000 Recap
Median Discount
43%
45%
40%
40%
44%
45%
42%
54%
47%
The usefulness of the data from these IPO studies is more questionable than that
from the restricted stock studies, primarily for two reasons. One is that the pre-IPO
private transactions do not always occur at arms' length fair market value prices.
The second is that the. IPO prices do not necessarily represent fair market value
either. Often, public market trading subsequent to the IPO suggests that the market
"values" the shares differently than the IPO price which was determined by the
investment banker takiI;J.g the company public. However, the data still is of interest.
6. In an effort to correct some of the problems with the IPO studies, Mary Ann Lerch,
writing in the BVR, June 2000 issue, "Measuring Lack of Marketability Discounts
for IPO Pricing ~ The Graphic Approach IPO Data: November 1995 ~ April 1997",
noted that after correction for biases, her data showed.that the.discount for lack of
marketability remained in the 20% to 30% range.
7. Writing in the December 2000 BVR, "Marketability Discounts and Risk in
Transactions Prior to Initial Public Offerings", Philip Saunders, Jr. indicated that
the Emory studies were sound, and that the minimum discount was "around 25%"
plus an additional discount of 15 to 20 basis points for every day until the public
offering. He estimated that an offering that was five months off would justify a
discount of 50% to 55%.
8. John J. Kania, in the March 2001 BVR, "Evolution of the Discount for Lackof
Marketability", reviewed various studies on lack of marketability, and argued that
discounts had actually decreased to about 20%, with 14% appropriate after
consideration ofthe "information cost discount".
9. Various authors have attempted to use regression analyses to analytically reach
improved estimates of the discount for lack of marketability. All of the studies
suffer from problems, in our view, that removes them from consideration.
10. Summary: Based on these studies and discussions presented above, we believe a
reasonable average discount for lack of marketability is 35% to 45% for minority
shareholdings when the beginning value assumes the liquidity of the public market.
All other things being equal, the fair market value of minority shares in a closely
held company would be, on average, 35% to 45% less than the value of minority
shares in a similar company whose shares were actively traded on an exchange or
over the counter. The difference can be either thought of as a discount to the value
of the closely held interests or a premium for the liquidity afforded by the public
market.
The magnitude of the discount for lack of marketability applicable to a specific
investment is affected by many factors. One of the factors is an overlapping issue;
the less control a specific investment has over management of the entity, the less
marketable that interest is. Of particular importance regarding marketability
discounts for closely held interests is the issue of when a sale of those interests
might be possible, or other form of realization of the value of the interests. Such
realization could be provided by liquidation of the entity, sale of the entity, sale of
the particular interest because of put rights or buy/sell provisions, or an IPO of the
entity. This impacts the discount for lack of marketability because it impacts the
time the investment is likely to be held prior to the receipt of any return on the
investment. Tied to this impact is that of the entity's dividend or distribution policy
and history. If dividends or distributions are expected, the discount for lack of
marketability would be reduced because the investor would be receiving some
return on a regular basis, quarterly for example, and not have to wait for sale or
liquidation for the total return on the investment. Generally to a lesser extent, the
nature and history of the entity, its financial condition and its outlook impact the
marketability of investments in that entity. If the entity appears stable and the
outlook appears favorable, an investor may assign less importance to the issue of
immediate liquidity because the eventual return at time of sale would appear more
certain and, perhaps, higher. Clearly, restrictions on the transferability of an
investment would decrease its marketability.
11. Robert Moroney wrote a second article (Taxes -- The Tax Magazine, May 1977,
Why 25% Discount for Nonmarketability in One Valuation, 100% in Another?) on
the discount for lack of marketability in which he noted the factors that affect the
size of the discount. These factors can be classified into a relatively few categories:
a) Are dividends being paid?
b) Is management friendly? Honest?
c) How fast is the subject company growing?
d) Degree of control?
e) Is the industry in a favorable competitive situation?
t) In there interest in the industry in buying companies?
g) Prevailing mood ofthe investing public?
h) What is the financial and business risk in the subject company?
i) What are the particular restrictions on transfer of int.erests?
xv. LACK OF CONTROL (MINORITY INTEREST)
DISCOUNT
A. Theory. It is commonly accepted in the field of business valuation that the per share value
of a controlling interest is worth more than the per share value of a minority interest.
Control is a valuable asset. With it the investor has the right to control the Board of
Directors which in turn can determine salaries, benefits, dividends, the sale of assets, the
direction of the company, liquidation, etc. These rights have value and investors are
willing to recognize that value by paying a higher price for a controlling block of stock
than they would for a minority block of stock.
1. What are the disadvantages of lack of control?
2. How much cash does a shareholder get on an annual basis?
3. How is management running the company -- good for all, or good for one?
4. How fast is the subject company growing?
5. What is the financial and business risk in the subject company?
6. What is the impact of state law on lack of control?
B. The opposite of a control premium is a minority interest discount.
C. Quantification. In the public marketplace the value of control is quantified when one
company offers to buy all (or a majority of) the shares of another -- a "tender offer".
D. Calculation. In recognition of the value of control the buyer typically makes a bid for the
stock at a price that exceeds the market price existing at the time. This excess is called the
"tender offer premium" and is believed to be an objective estimate ofthe value of control.
1. Control Premium Example: if a tender offer of $28 is made for a publicly traded
company that is trading at $20 per share, the value of a controlling interest is $28,
the value of a minority interest is $20 and the premium for control is 40%.
2. Control premiums in the public stock market are normally inversely related to the
level of the public market in general. When the stock market is high based on
underlying fundamentals such as earnings, control premiums tend to decline.
Conversely, control premiums tend to be higher when the stock market is
conservatively valued. This implies that the long term value of a company based on
its underlying economic fundamentals is not as volatile as the stock price, as the
latter can change markedly over relatively short periods.
3. Data Sources.
a) Mergerstat Review, published annually Merrill Lynch Business Advisory
Services Division.
b) Houlihan, Lokey, Howard & Zukin, Inc. (HLHZ) control premium study
published quarterly.
(1) The HLHZ premiums are consistently above those suggested by the
Merrill Lynch data because of differences in the method of
computing the "premium". Merrill Lynch's pre-tender price is
rigidly defined as the price five business days prior to the formal
tender offer announcement. Because of inside information, the stock
price has often already crept up by this time in anticipation of the
announcement. The control premiums thus computed are biased
downward. HLHZ takes a more subjective approach in determining
the pre-tender price.
4. Minority Discount Example. In the example previously cited, the control premium
of 40% would be synonymous with a minority interest discount of 28.6%, i.e.,
($20/$28 = 0.714 and 1.0-0.714=0.286).
E. 50:50 interests.
F. Swing vote interests.
A. What are the advantages of control?
B. How fast is the subject company growing?
C. Is the industry in a favorable competitive situation?
D. In there interest in the industry in buying companies?
E. What is the financial and business risk in the subject company?
F. What is the impact oflaw on control?
XVII. LACK OF VOTE DISCOUNT
A. What is the impact of a lack of a vote?
B. What is the impact oflaw on lack of control (vote)?
C. Facts and circumstance dominate, as usual.
D. Quantification: An article titled "Price Effects of Dual Class Shares" by Riding & Jog,
published in the January/February 1986 issue of the Financial Analysts Journal noted that
the average premium for voting shares traded on the Toronto Stock Exchange (Canada's
largest) was 7% over restricted voting shares in the same companies, which translates into
a discount equivalent of about 6.5% (i.e., 1.07 x 0.935 =1.00).
E. A later study of voting and non-voting common stock and the value differential,
undertaken by Houlihan, Lokey, Howard & Zukin found a discount range of 2% to 4% for
non-voting common stock.
XVIII. VALUATION CONCLUSION
A. Briefly review all source documents to see if any important factors were missed
B. Re-read the appraisal assignment
C. Summarize and compare the conclusions of the various approaches
D. Recheck methods which give extreme values
E. Determine the relevance of the various approaches for the particular assignment
F. Arrive at a single point estimate, by either quantitative or qualitative techniques. Better to
round than to imply a false sense of preciseness
G. Check the final conclusion against adjusted income or adjusted equity. Does the answer
make sense?
XIX. SMALL BUSINESSES -- SPECIAL FACTORS
A. Market Approach
1. Data Bases
a) Business Brokers
b) IBA Data Base
c) BizComps Data Base
d) Be careful to know what is considered in the value reported in the data base
2. Rules of Thumb
a) Business Brokers
b) Desmond Books
c) Be careful to know what is considered in the value reported in the rule of
thumb and what causes the rule to vary between businesses.
3. Multiple of Owners' Discretionary Cash
a) Pretax Income plus
b) Owners salary, distributions, perqs, expense allowances over cost, etc. plus
c) Interest Payments plus
d) Depreciation and amortization plus
e) Non-necessary, non-economic expenses
B. Income Approach
1. Replacement compensation for the labor of the owner is a key consideration
C. Transactions --What is Typically Sold (and what is not sold)
1. What is typically sold
a) Inventory
b) Equipment, Fixtures
c) Real Estate (owned or leased)
d) Goodwill
2. What is not typically sold
a) Cash
b) Accounts Receivable
c) Account Payable and other Debt or Liabilities
CORPORATE VALUATIONS, INC.
6645 NE 78
fJl
Court, Suite C-6
(503) 235-7777 FAX # (503) 235-3624
Portland, Oregon 97218 USA
email ggilbert@corpval.com
GREGORY A. GILBERT, CFA, FASA, CBA
Occupation
Areas of
Specialization
Expert Witness
Education
Professional
Designations
Instruction
Experience
Offices
President, Corporate Valuations
Principal, VALPOINT, Inc.
Valuation of business interests including closely held corporations, publicly traded corporations,
partnerships and sole proprietorships; intangibles; and damages to business interests.
Idaho Maine Oregon Texas Washington [Federal, State, Tax, Property Tax and Bankruptcy Courts].
Directory of Experts, The Best Lawyers in America, 1990-1993.
Tax Court Cases: Beaver Bolt, Inc. v. Commissioner, T.e. Memo 1995-549.
Estate of Joseph W. Giselman, deceased, Harry W. Giselman, personal representative,
v Commissioner, T.C. Memo 1988-391
Bachelor of Arts in Economics, 196;4, Yale University.
Master of Science in Business, 1966, M.LT.
CFA - Chartered Financial Analyst.
FASA - Fellow, American Society of Appraisers
ASA - Accredited Senior Appraiser.
CBA - Certified Business Appraiser.
At various times has headed development/teaching/grading of Courses, Seminars and Exams for American
Society of Appraisers, and have regularly taught courses BV-201, BV-202, BV-203 and BV-204. Taught
courses and seminars on Business Valuation through colleges, universities, appraisal, legal, accounting and
other professional groups, in the USA and abroad.
1983-Present: President, Corporate Valuations.
1991-Present: Principal, VALPOINT, Inc.
1978-1983: Vice President and Associate Director of Research, Willamette Management Assoc.
1976-1977: Furman, Selz, Mager, Dietz and Birney, NYSE, providing research to institutions.
1966-1976: Monness, Williams & Sidel, a NYSE member firm providing research to institutions.
2003-2006: Member, Nominating and Awards Committee, American Society of Appraisers.
1993-2006: Co-USA-Member, International Valuation Standards Committee.
2003-2004: Member, International Relations Committee, American Society of Appraisers.
1990-2004: Member, Editorial Review Board, Business Valuation Review
2001-2003: Past Chair, Business Valuation Committee, American Society of Appraisers.
1997-2002: Member, Admission & Membership Committee, American Society of Appraisers.
2000-2002: Member, Strengths Weaknesses Opportunities Threats Profession Consolidation Committee
1999-2002: Co-Founder, Director and President, Center for Advanced Valuation Studies.
1999-2001: Chairman, Business Valuation Committee, American Society of Appraisers.
1993-200I: Chairman, International Valuation Confederation, American Society of Appraisers.
1998-2001: Member, Business Valuation Profession Task Force
1997-2001: Member, Business Valuation e.L.A.R.E.N.C.E. Task Force
1998-2000: Education Commission, Valuation 2000
Member
Gregory A. Gilbert - Continued
Offices Continued
1997-1999: Vice Chairman, Business Valuation Committee, American Society of Appraisers.
1997-1999: Member, Uniform Standards ofProfessional Appraisal Practice Issues Resource Panel.
1997-1998: Chairman, Admission & Membership Committee, American Society of Appraisers.
1994-1996: Member, Appraiser Qualifications Board, The Appraisal Foundation.
1993-1993: Vice Chairman, Business ValuationCommittee, American Society of Appraisers.
1993-1993: Chairman, Education Committee, American Society of Appraisers.
1991-1993: Education Committee, American Society ofAppraisers.
1987-1993: Business Valuation Committee, American Society of Appraisers.
1992-1993: Regional Governor, Institute of Business Appraisers.
1992-1993: Chairman, International Development Committee, Am. Society of Appraisers.
1989-1992: Chairman, Education Committee for Business Valuation, Am. Society of Appraisers.
1991-1992: Chairman, Advanced Seminar Committee, Am. Society of Appraisers.
1990-1991: Chairman, Regional and Chapter Seminar Committee, Am. Society of Appraisers.
1986-1990: Northwest Regional Governor, American Society of Appraisers.
1987-1990: Budget & Finance Committee, American Society of Appraisers.
1989-1990: Treasurer, Political Action Committee, American Society of Appraisers.
1984-1986: President, Portland Chapter, American Society of Appraisers.
1983-1984: Vice President, Portland Chapter, American Society of Appraisers.
American Society of Appraisers - Business Valuation; Association of Investment Management and Research;
The Institute of Chartered Financial Analysts; Portland Society ofFinancial Analysts; Financial Analysts
Federation; ESOP Association; Institute of Business Appraisers.
Published
9-30-2003
"Price/Sales Ratios", Business Valuation News (6/86).
Leveraged ESOP Valuation", Business Valuation News (9/85).
"Business Appraisal- Who, Why & When", Daily Journal of Commerce (4/84).
"Discount Rates and Capitalization Rates--Where Are We?", Business Valuation Review, (9/90).
"Valuing The Business", Advising Oregon Businesses, 1991 and 1995, OR State Bar Continuing Legal Ed.
"Discounted Future Benefit Method--An Income Approach", Handbook ofBusiness Valuation,
Wiley 1992.
CASE STUDY
May 21, 2003
Appraisal of Runckel Distribution, Service & Supply, Inc.
Sample Case Data and Brief Explanation of Appraisal
Description of Assignment
Pursuant to a request by Mr. Gerald Runckel, we reached an opinion of the fair market value of a 30%
interest in Runckel Distribution, Service & Supply, Inc. (''the Company") as of April 30, 2003. The
purpose of the appraisal is to .assist with Christopher Runckel's sale of stock to Blake Runckel. No other
purpose is intended or should be inferred.
Sources of Information
Greg Gilbert and Pat Jordan of Corporate Valuations inspected the offices and facilities of Runckel
Distribution, Service & Supply, Inc. on May 12, 2003. Management interview held at the same time as
the inspection, as well as telephone conversations, management provided descriptions as to general and
specific information related to the Company. A list of documents reviewed is contained in the full report.
Scope of Assignment
There are numerous factors that should be considered in determining the value of a business or business
interest. Among these are the previously described factors outlined by the Internal Revenue Service in
Revenue Ruling 59-60. Additional specific factors must also be examined depending on the
circumstances. In the course of this appraisal we did consider and examine all necessary information.
Valuation
There are many techniques that can be used to value a business or any other type of asset. The three
general approaches used by appraisers of real property, machinery and equipment, personal property, etc.
are the cost approach, the income approach and the market approach. With some modification, business
valuation approaches also fit into one of these three general categories. In many cases, more than one
approach is used and the resulting value conclusions are contrasted. The appraiser then explains why
some approaches are more relevant than others in the specific situation and reconciles the different value
estimates to a single opinion of value.
In business valuation, the "cost approach" is often termed an adjusted net asset approach. This approach
values the equity of a company by valuing its individual assets and liabilities at their respective fair
market values. An adjusted asset approach is generally most appropriate when valuing "holding
companies" or operating companies which are capital intensive, have highly unpredictable earnings or are
contemplating liquidation. The existence and value of intangible assets should be considered in an
adjusted asset approach.
An "income approach" is generally preferred when valuing an "operating company" which is expected to
continue as a going concern. In this approach the value of a company is the present value of its projected
future income (or cash flow). The approach is applied by either discounting a long term forecast of future
cash flows to the present by a required rate of return or, alternatively, by capitalizing the company's
Appraisal of Runckel Distribution, Service & Supply, Inc. Page 2
income generating capacity by a capitalization rate, the latter defined as the required rate of return less a
long term growth rate.
The third approach is the "market approach". This approach values the subject property by comparisons
with similar properties which have known values based on recent transactions. The market approach can
be based on comparisons of income, cash flow, net assets, sales, dividends or other financial variables.
The market approach is often the most convincing way to determine fair market value. The practical
problem with applying a market approach is in finding market "comparables" which are similar enough to
the subject property to provide valid conclusions.
All three approaches were examined in the course of valuing 100% of the equity of the Company. Before
applying these approaches both the income statement and balance sheet were examined for relevant
adjustments. In addition to the three approaches both the Shareholders Agreement and the Excalibur
Corporation's - General Procedures for Agency to Agency Changeover were also considered.
Conclusion
In all, 11 appraisal methods were examined in arriving at an opinion of the fair market value of 100% of
the stock of Runckel Distribution, Service & Supply, Inc. The value conclusions from the various
methods are summarized in Table VII.
Based on the appraisal approaches employed, it is our opinion that the value of the Company was
$1,172,000. The value of $1,172,000 was for the combined companies as a whole. The subject of the
valuation was Blake Runckel's 30% interest. A 30% interest in the Company is not a controlling interest
and therefore requires a discount for lack of control. In addition shares in the Company are not actively
traded, and there is no established market for the stock. In order to account for the difficulty and time
involved in selling privately held stock (if it can be sold at all), investors typically apply a discount for
lack of marketability. In our analysis we applied separate discounts of 15% for lack of control and 20%
lack of marketability. .
In conclusion, after adjustment for lack of control and lack of marketability, it is our opinion that the fair
market value of a 30%, closely-held interest in Runckel Distribution, Service & Supply, Inc was $239,080
as of April 30, 2003.
Our appraisal was prepared in accordance with the Uniform Standards ofProfessional Appraisal
Practice (HUSPAP''). In this case study it is not being reported in the detail required for it to be in
compliance with Standard 10 of the USPAP and the International Valuation Standards - 2003. The
original appraisal report upon which this sample case is based contained 85 pages ofexplanatory text.
It is in compliance with the standards set forth in the Institute of Business Appraiser's Code of Ethics, the
American Society of Appraisers' Standards of Practice and Code of Ethics and the International Valuation
Standards - 2003. As part of those standards we certify that to the best of our knowledge and belief:
The statements of fact contained in the letter and tables are believed to be true and correct.
However, during the course of our analysis, we relied upon financial statements and related
operational data as fairly presenting the operating results and financial position of Runckel
Distribution, Service & Supply, Inc. We have not audited this information and therefore
we express no opinion or other form of assurance regarding its accuracy or the fairness of
presentation.
We relied in part on management's analysis of past operations and on management's
assessment of expected future business conditions.
The reported analyses, opinions and conclusions are limited only to the reported
assumptions and limiting conditions, and are our personal unbiased professional analyses,
opinions and conclusions.
Appraisal ofRunckel Distribution, Service & Supply, Inc. Page 3
We are independent of the management, owners and agents of Runckel Distribution,
Service & Supply, Inc.
We have no present or prospective interest in the property that is the subject of this report,
and we have no personal interest or bias with respect to the parties involved. In the event
that a gift is contemplated, we confirm that no one employed by CVI is: 1) a donor or
donee of the property under appraisal: 2) a family member of a donor or donee, or 3) is
employed by a donor, donee or member of the family of either.
Our engagement or compensation for this assignment was not contingent upon the
development or reporting of a predetermined value or direction in value that favors the
cause of the client, the amount of the value opinion, the attainment of a stipulated result, or
the occurrence of a subsequent event directly related to the intended use of this appraisal.
The analyses, opinions and conclusions were developed in conformity with the Uniform
Standards of Professional Appraisal Practice. As noted above, at the request of the client,
the level of detail in the reporting ofthe valuation does not meet USPAP standards.
In addition, the American Society of Appraisers and the Institute of business Appraisers
both have mandatory recertification programs for all of their designated appraisers.
Gregory A. Gilbert is in compliance with the requirements of those programs. Mr. Gilbert
holds himself out to the public as an appraiser who performs appraisals on a regular basis.
Mr. Gilbert by virtue of his education, experience, background and membership in
appraisal organizations, is qualified to make appraisals of the type of property being
valued. His ASA and CBA designations are in Business Valuation.
Patrick Jordan provided significant professional assistance to the preparer of the report.
Thank you for allowing Corporate Valuations to serve your business valuation needs. Please do not
hesitate to call if we can answer questions or be of further assistance.
Sincerely,
Gregory A. Gilbert, CFA, FASA, CBA
President
TABLE I
RUNCKEL DISTRIBUTION, SERVICE AND SUPPLY, INC.
COMPARATIVE INCOME STATEMENTS
Compound
YEARS ENDED SEPTEMBER30, Weighted Growth
2002 2001 2000 1999 1998 5 Yr. Avg. 5 Yr. Avg. Rates
$ % $ % $ 0/0 $ % $ % $ % $ % %
Net Sales 4,595,848 100.0 4,626,567 100.0 4,971,454 100.0 3,953,834 100.0 3,277,478 100.0 4,285,036 100.0 4,505,668 100.0 8.8
Cost ofGoods Sold 3,557,419 77.4 3,395,056 73.4 3,583,528 72.1 2,845,513 72.0 2,451,132 74.8 3,166,530 73.9 3,350,671 74.4 9.8
Gross Profit 1,038,429 22.6 1,231,511 26.6 1,387,926 27.9 1,108,321 28.0 826,346 25.2 1,118,507 26.1 1,154,997 25.6 5.9
Operating Expenses 772,815 16.8 852,673 18.4 841,233 16.9 705,398 17.8 572,601 17.5 748,944 17.5 785,458 17.4 7.8
Net Operating Profit 265,614 5.8 378,838 8.2 546,693 11.0 402,923 10.2 253,745 7.7 369,563 8.6 369,539 8.2 l.l
Other Income (Expense)
Interest Expense (5,539) (0.1) (1,300) (0.0) (3,934) (0.1) (8,216) (0.2) (13,833) (0.4) (6,564) (0.2) (4,997) (0.1) NfM
GainlLoss on Sale ofAsset 0 0.0 0 0.0 4,883 0.1 8,117 0.2 5,507 0.2 3,701 0.1 2,426 0.1 (100.0)
Rental Income 42,000 0.9 30,000 0.6 19,200 0.4 13,700 0.3 14,400 0.4 23,860 0.6 28,627 0.6 30.7
Interest and Other Income 4,235 0.1 13,02 0.3 15,910 0.3 7,273 0.2 8,271 0.3 9,764 0.2 9,617 0.2 (15.4)
Total Other Income (Expense) 40,696 0.9 41,832 0.9 36,059 0.7 20,874 0.5 14,345 0.4 30,761 0.7 35,672 0.8 29.8
Income Before Tax 306,310 6.7 420,670 9.1 582,752 11.7 423,797 10.7 268,090 8.2 400,324 9.3 405,211 9.0 3.4
Source: Company Financial Statements.
Other Financial Data:
Inputs
Depreciation & Amortization 2,601 0.1 5,082 0.1 11,201 0.2 20,976 0.5 34,343 1.0 14,841 0.3 9,549 0.2 (47.5)
Owners' Compensation 72,276 1.6 72,322 1.6 70,890 1.4 73,789 1.9 67,563 2.1 71,368 1.7 71,899 1.6 1.7
Interest Expense 5,539 0.1 1,300 0.0 3,934 0.1 8,216 0.2 13,833 0.4 6,564 0.2 4,997 0.1 (20.5)
Number of Shares Outstanding 200 200 200 200 200 200 200 0.0
Weighted Average Shares Outstanding 200 200 200 200 200 200 200 0.0
Outputs:
Operating Cash Flow 308,911 6.7 425,752 9.2 593,953 11.9 444,773 11.2 302,433 9.2 415,164 9.7 414,760 9.2 0.5
Earnings Before Interest and Taxes 311,849 6.8 421,970 9.1 586,686 11.8 432,013 10.9 281,923 8.6 406,888 9.5 410,209 9.1 2.6
Earnings Before Depreciation,
Interest, and Taxes 314,450 6.8 427,052 9.2 597,887 12.0 452,989 11.5 316,266 9.6 421,729 9.8 419,758 9.3 (0.1)
Owners' Discretionary Cash Flow 386,726 8.4 499,374 10.8 668,777 13.5 526,778 13.3 383,829 11.7 493,097 11.5 491,656 10.9 0.2
TABLE II
ADJUSTED INCOME STATEMENTS
CompouDl
YEARS ENDED SEPTEMBER30, Weighted Growth
2002 2001 2000 1999 1998 5 Yr. Avg. 5 Yr. Avg. Rates
$ 0/0 $ % $ % $ % $ % $ % $ % %
let Sales 4,595,848 100.0 3,199,606 100.0 3,895,219 100.0 3,376,319 100.0 3,009,938 100.0 3,615,386 100.0 3,815,060 100.0 11.2
ncome Before Tax 306,310 6.7 294,600 9.2 539,684 13.9 391,721 11.6 247,887 8.2 356,040 9.8 357,355 9.4 5.4
.djustments
Shareholders' Salary 72,276 1.6 60,000 1.9 59,076 1.5 61,513 1.8 61,425 2.0 62,858 1.7 64,204 1.7 4.2
Adjusted Compensation (240,000) (5.2) (240,000) (7.5) (240,000) (6.2) (240,000) (7.1) (240,000) (8.0) (240,000) (6.6) (240,000) (6.3) NIM
GainlLoss on Sale of Asset 0 0.0 0 0.0 (4,883) (0.1 ) (8,117) (0.2) (5,507) (0.2) (3,701) (0.1) (2,426) (0.1) NIM
Non-Recurring Sales To Fred Meyer 0 0.0 0 0.0 (250,000) (6.4) (150,000) (4.4) 0 0.0 (80,000) (2.2) (70,000) (1.8) NIM
Contributions 4,434 0.1 1,421 0.0 1,574 0.0 2,081 0.1 1,090 0.0 2,120 0.1 2,522 0.1 42.0
'otal Adjustments (163,290) (3.6) (178,579) (5.6) (434,233) (11.1) (334,523) (9.9) (182,992) (6.1) (258,723) (7.2) (245,700) (6.4) NIM
.djusted Income Before Tax 143,020 3.1 116,021 3.6 105,451 2.7 57,198 1.7 64,895 2.2 97,317 2.7 111,655 2.9 21.8
ource: Company Financial Statements.
therFinanciai Data:
Inputs
Depreciation & Amortization 2,601 0.1 5,082 0.2 11,201 0.3 20,976 0.6 34,343 1.1 50,121 1.4 14,841 0.4 (51.8)
Owners' Compensation 240,000 5.2 240,000 7.5 240,000 6.2 240,000 7.1 240,000 8.0 240,000 6.6 240,000 6.3 0.0
Interest Expense 7,061 0.2 13,716 0.4 19,530 0.5 7,273 0.2 10,777 0.4 10,339 0.3 11,671 0.3 (39.9)
Number of Shares Outstanding 200 200 200 200 200 200 200 0.0
Weighted Average Shares Outstanding 200 200 200 200 200 200 200 0.0
Outputs:
Operating Cash Flow 145,621 3.2 121,103 3.8 116,652 3.0 78,174 2.3 99,238 3.3 127,792 3.5 132,620 3.5 11.7
Earnings Before Interest and Taxes 135,959 3.0 102,305 3.2 85,921 2.2 49,925 1.5 54,118 1.8 108,062 3.0 116,401 3.1 25.8
Earnings Before Depreciation,
Interest, and Taxes 138,560 3.0 107,387 3.4 97,122 2.5 70,901 2.1 88,461 2.9 114,356 3.2 121,263 3.2 19.4
Owners' Discretionary Cash Flow 392,682 8.5 374,819 11.7 376,182 9.7 325,447 9.6 350,015 11.6 381,228 10.5 383,978 10.1 2.2
TABLE III
COMPARATIVE BALANCE SHEETS
AS OF SEPTEMBER30, Weighted Compound
2002 2001 2000 1999 1998 1997 5 Yr. Avg. 5 Yr. Avg. Growth
Assets $ % $ % $ % $ % $ % $ % $ % $ % Rates
Current Assets
%
Cash 369,063 26.1 343,830 28.6 323,046 25.4 91,661 7.9 36,782 4.0 18,421 2.1 232,876 19.5 293,992 23.3 78.0
Accounts Receivah1e 434,508 30.7 377,113 3\.4 471,815 37.0 546,493 47.3 388,232 4\.7 336,411 38.0 443,632 37.1 438,510 34.7 2.9
Inventories 525,002 37.1 375,619 3\.2 386,523 30.4 430,591 37.2 398,801 42.9 373,321 42.2 423,307 35.4 436,469 34.5 7.1
Bad Deht Reserve (1,000) (0.1) (1,000) (0.1) (1,500) (0.1) 0 0.0 0 0.0 0 0.0 (700) (0.1) (900) (0.1) N/M
Prepaid Expenses 45,198 3.2 34,927 2.9 25,009 2.0 21,264 \.8 16,881 \.8 15,739 \.8 28,656 2.4 33,342 2.6 27.9
Total Current Assets 1,372,771 97.0 1,130,489 94.0 1,204,893 94.6 1,090,009 94.3 840,696 90.4 743,892 84.1 1,127,772 94.3 1,201,414 95.1 13.0
Fixed Assets
Office Equipment 23,991 \.7 63,507 5.3 65,757 5.2 76,537 6.6 76,537 8.2 78,833 8.9 61,266 5.1 53,391 4.2 (25.2)
Machines and Equipment 63,507 4.5 23,991 2.0 23,991 \.9 26,578 2.3 26,578 2.9 26,728 3.0 32,929 2.8 37,680 3.0 24.3
Automobiles and Trucks 0 0.0 16,871 \.4 16,870 1.3 74,204 6.4 157,797 17.0 222,006 25.1 53,148 4.4 28,287 2.2 (100.0)
Leasehold Improvements 100,232 7.1 100,232 8.3 100,232 7.9 100,232 8.7 100,232 10.8 100,232
---.!!1....
100,232 8.4 100,232 7.9
~
Total Gross Fixed Assets 187,730 13.3 204,601 17.0 206,850 16.2 277,551 24.0 361,144 38.8 427,799 48.4 247,575 20.7 219,590 17.4 (15.1)
Accumulated Depreciation 182,925 12.9 194,473 16.2 191,641 15.0 247,024 21.4 306,959
~
329,227 37.2 224,604 18.8 204,563
~ --!.!l:.!L
Net Fixed Assets 4,805 0.3 10,128 0.8 15,209 1.2 30,527 2.6 54,185 5.8 98,572 11.1 22,971 \.9 15,027 \.2 (45.4)
Notes Receivable 0 0.0 0 0.0 0 0.0 0 0.0 5,500 0.6 19,000 2.1 1,100 0.1 367 0.0 (100.0)
Deposits 38,345 2.7 62,267 5.2 53,398 4.2 35,535 3.1 30,022 3.2 22,825 2.6 43,913 3.7 46,805 3.7 6.3
Total Assets 1,415,921 100.0 1,202,884 100.0 1,273,500 100.0 1,156,071 100.0 930,403 100.0 884,289 100.0 1,195,756 100.0 1,263,612 100.0 11.1
Liabilities & sm Equity
Current Liabilities
Notes Payable 0 0.0 0 0.0 0 0.0 82,574 7.1 63,732 6.8 93,717 10.6 29,261 2.4 15,259 \.2 (100.0)
Current Portion ofLong Tenn Debt 0 0.0 0 0.0 0 0.0 0 0.0 12,100 \.3 20,500 2.3 2,420 0.2 807 0.1 (100.0)
Accounts Payable 290,770 20.5 195,611 16.3 321,084 25.2 380,796 32.9 276,592 29.7 210,308 23.8 292,971 24.5 282,515 22.4 \.3
Accrued Pa)Toll & Pa)Toll Taxes 24,043 \.7 22,048 1.8 24,624 \.9 38,430 3.3 29,800 3.2 43,713 4.9 27,789 2.3 25,929 2.1 (5.2)
Other Accrued Expenses 6,142 0.4 6,584 0.5 7,646 0.6 7,490 0.6 6,124 0.7 4,568 0.5 6,797 0.6 6,739 0.5 0.1
Deterred Income Taxes Payable 10 0.0 20 0.0 2,173 0.2 3,387 0.3 10 0.0 4,269 0.5 1,120 0.1 896 0.1 __0._0_
Total Current Liabilities 320,965 22.7 224,263 18.6 355,527 27.9 512,677 44.3 388,358 4\.7 377,075 42.6 360,358 30.1 332,145 26.3 (4.7)
0
Long Term Debt 0 0.0 0 0.0 0 0.0 0 0.0 7,553 0.8 23,242 2.6 1,511 0.1 504 0.0 (100.0)
0
Stockholders' Equity 0
Connnon Stock 3,000 0.2 3,000 0.2 3,000 0.2 3,000 0.3 3,000 0.3 3,000 0.3 3,000 0.3 3,000 0.2 0.0
Paid-In Surplus 35,469 2.5 35,469 2.9 35,469 2.8 35,469 3.1 35,469 3.8 35,469 4.0 35,469 3.0 35,469 2.8 0.0
Retained Earnings 1,056,487 74.6 940,152 78.2 879,502
~
604,925 52.3 496,514 53.4 440,249 49.8 795,516
~
892,528 70.6 20.8
Total Stockholders' Equity 1,094,956 77.3 978,621 81.4 917,971 72.1 643,394 55.7 534,983 57.5 478,718 54.1 833,985 69.7 930,997 73.7 19.6
Total Liabilities & 8m Equity 1,415,921 100.0 1,202,884 100.0 1,273,498 100.0 1,156,071 100.0 930,894 100.1 879,035 99.4 1,195,854 100.0 1,263,645 100.0 11.1
0 0 2 0 (49lij= 5,254 (98)
Other Financial Data
Net Working Capital 1,051,806 74.3 906,226 75.3 849,366 66.7 577,332 49.9 452,338 48.6 366,817 4\.5 767,414 64.2 869,269 68.8 23.5
Long Tenn Debt 0 0.0 0 0.0 0 0.0 0 0.0 7,553 0.8 23,242 2.6 1,511 0.1 504 0.0 (100.0)
Interest Paying Debt 0 0.0 0 0.0 0 0.0 0 0.0 19,653 2.1 43,742 4.9 3,931 0.3 1,310 0.1 (100.0)
Invested Capital 1,094,956 77.3 978,621 8\.4 917,971 72.1 643,394 55.7 554,636 59.6 522,460 59.1 837,916 70.1 932,307 73.8 18.5
Tangible Equity 1,094,956 77.3 978,621 8\.4 917,971 72.1 643,394 55.7 534,983 57.5 478,718 54.1 833,985 69.7 930,997 73.7 19.6
TABLE IV
RATIO ANALYSIS
YEARS ENDED SEPTEMBER 30, 5 Year
2002 2001 2000 1999 1998 Ratio Avg.
Liquidity Ratios
Current Ratio (x) 4.3 5.0 3.4 2.1 2.2 3.4
Quick Ratio (x) 2.5 3.2 2.2 1.2 1.1 2.1
Leverage Ratios
Long Tenn DebtlEquity (%) 0.0 0.0 0.0 0.0 1.4 0.3
Interest Bearing Debt/Total Capital (%: 0.0 0.0 0.0 0.0 3.5 0.7
Equity/Total Capital (%) 100.0 100.0 100.0 100.0 96.5 99.3
Equity/Total Assets (%) 77.3 81.4 72.1 55.7 57.5 68.8
Interest Coverage (x) NM NM NM NM NM NM
4 Year
Activity Ratios Ratio Avg.
Average Collection Period (days) 32 33 37 43 NA 36
Accounts Receivable Turnover (x) 11.3 10.9 9.8 8.5 NA 10.1
Working Capital Turnover (x) 4.7 5.3 7.0 7.7 NA 6.2
Inventory Turnover (days) 46 40 41 52 NA 45
Inventory Turnover (x) 7.9 8.9 8.8 6.9 NA 8.1
Gross Fixed Asset Turnover (x) 23.4 22.5 20.5 12.4 NA 19.7
Net Fixed Asset Turnover (x) 615.5 365.2 217.4 93.3 NA 322.9
Total Asset Turnover (x) 3.5 3.7 4.1 3.8 NA 3.8
Profitability Ratios
Pretax Return on Tangible Equity (%) 13.8 12.2 13.5 9.7 NA 12.3
Pretax Return on Assets (%) 10.9 9.4 8.7 5.5 NA 8.6
EBIT Return on Invested Capital (%) 13.1 10.8 11.0 8.3 NA 10.8
5 Year
Ratio Avg.
Gross Profit Margin (%) 22.6 26.6 27.9 28.0 25.2 26.1
Operating Profit Margin (%) 5.8 8.2 11.0 10.2 7.7 8.6
Pretax Profit Margin (%) 3.1 3.6 2.7 1.7 2.2 2.7
4 Year
Growth Rates Ratio Avg.
Sales (%) (0.7) (6.9) 25.7 20.6 NA 9.7
Pretax Income (%) 23.3 10.0 84.4 (11.9) NA 26.4
Total Assets (%) 17.7 (5.5) 10.2 24.3 NA 11.6
Working Capital (%) 16.1 6.7 47.1 27.6 NA 24.4
Miscellaneous Ratios
Accum.Depr.l Gr. Fix.Assets (%) 97.4 95.0 92.6 89.0 85.0 93.5
Owners' Compensation/Sales (%) 5.2 7.5 6.2 7.1 8.0 6.5
VALUATION INPUT DATA
Sales -- Latest 12 Months
Pretax Operating Earnings
Latest Fiscal Year
5 YearWtd. Avg.
5 Year Avg.
Latest Fiscal Year Gross Cash Flow
Equity-Latest Balance Sheet
MARKET APPROACH
Bizcomps
Company Data
Company Valuation Ratio
Value Estimate
Current Assets
Liabilities
Value Estimate
Pratt's Stats
Company Data
Company Valuation Ratio
Value Estimate
Reconcile Market Approach
RECONCILIATION
TABLE VII
VALUATION SUMMARY
Latest Schilt
INCOME APPROACH Fiscal Year 5 Year 5 Year Discount
2002 Avg. wtd.Avg. Rate
Government Bonds 4.4% 4.4% 4.4% 4.4%
4,595,848 Ibbotson Equity Risk Premium 3.3% 3.3% 3.3%
Specific Company Adjustment 2.0% 2.0% 2.0% 11.0%
Discount rate - NCF 9.7% 9.7% 9.7%
143,020 Adjust to Pretax Income 5.9% 5.9% 5.9%
111,655 Discount Rate - Pretax 15.6% 15.6% 15.6% 15.4%
97,317 Growth Rate 3.0% 3.0% 3.0%
145,621 Capitalization Rate 12.6% 12.6% 12.6%
Company Data 143,020 97,317 111,655
1,094,956 Value Estimate 1,133,016 770,953 884,541
Reconciled Income Approach Value %1,000
Methods Based on Acqnisition Data Latest
Valuation Multiple Based On COST APPROACH Fiscal Year
2002
Tangible Equity 1,094,956
Sales SDCF Tangible Rate of Return 17.0%
4,595,848 392,682 Tangible Equity Return 186,143
0.12 1.22
551,502 479,072 Latest 12 Months Pretax 143,020
1,372,771 1,372,771 Tangible Equity Return (186,143)
(320,965) (320,965) Intangible Income NIM
1,603,308 1,530,878 Capitalization Rate 22.6%
Intangible Asset value NIM
Latest Latest Tangible Asset Value 1,094,956
Fiscal Yr. Fiscal Yr. Cost Approach Value 1,095,000
Sales Earnings Cash Flow
4,595,848 143,020 145,621
0.30 9.43 9.84 Shareholders Agreement Formula
1,378,754 1,348,679 1,432,911 Pre-Tax Income Unadjusted 306,310 Life
Multiple 3.00 Insnrance
1,459,000 Total 918,930 Proceeds
Value Per 50% Interest 459,465 465,000
Fair Market Value of Company 1,172,000 Excalibur Corp General Procednre for Agency to Agency Changeover
Ownership Interest of
Value in Event of Sale of Entire Company
Discount Lack of Control
Discount Lack of Marketability
Fair Market Value Interest
15.0%
20.0%
30.0%
351,600
85.0%
80.0%
239,088
Inventory - Runckel- Maximum
Other Current Assets _Combined
Less: Liabilities - Combined
Value of Company
Value of 50% Interest Pro Rata
459,192
913,579
(320,965)
1,051,806
525,903
TABLE V
Acquisitions of Similar Companies
Seller's Price to Sellers Net Price to Price to
Selling Fiscal Year Fiscal Year Fiscal Year Sales Profit Earnings Gross
Price Sales Earnings Cash Flow Multiple Margin Multiple Cash Flow
Date Seller SIC $ $ $ $ X % X X
Dec-98 5046 $ 6,240,000 20,460,000 439,000 567,000 0.30 2.1% 14.2 11.0
Apr-99 5046 $ 14,600,000 43,500,000 1,199,000 1,335,000 0.34 2.8% 12.2 10.9
Aug-99 5046 $ 9,800,000 30,264,000 1,194,000 1,287,000 0.32 3.9% 8.2 7.6
Dec-99 5046 $ 14,250,000 35,600,000 1,624,000 1,697,000 0.40 4.6% 8.8 8.4
Joo-99 5087 $ 114,000 335,936 24,156 24,156 0.34 7.2% N/A N/A
Aug-96 5141 $ 3,250,000 4,550,539 Df N/A 0.71 Df Df N/A
Joo-Ol 5141 $ 2,101,000 1,612,000 50,000 190,000 N/A 3.1% N/A 11.1
Jan-03 5141 $ 114,000 335,936 N/A N/A 0.34 N/A N/A N/A
Jan-03 5199 $ 425,000 1,157,865 N/A N/A 0.37 N/A N/A N/A
Mean 0.39 4.0% 10.8 9.8
Median 0.34 3.5% 10.5 10.9
Gilbert 4,595,848 143,020 145,621 3.1%
Source: Pratt's Stats
CHARTA
Price/Sales Ratios vs. Profit Margins
0.45,-------------------------------------------,
0.40
0.35
+
+
L----
0.30 ;--------------'+"---------------------------------______j
0.20
s
i 0.25
';
COl
'C
=--
Price/Sales Ratios
Regression
Runckel
0.15 --------------
0.10
0.05 +-----------
9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0%
0.00 +----...,-------.,..------,----,..-----r------r-----.,.----,-------l
0.0%
Profit Margins
CHARTB
Price/Sales Ratios vs. Profit Margins
Price/Sales Ratios
--Regression
Runckel
%
--_.. ~ - ~ ~ ~ - - - - _ . _ ~ - - - , - - - - - - - - - -
/
7
.
- ~ - - - - - - - , . -
-
~
~ ~ ;
--
% 10.0% 20.0% 30.0% 40.0% 50.0% 60 P
1.00
0.80
0.00
O.
(0.20)
0.60
~
0
;:l
"
~
.; 0.40
v.I
G:i
Col
C
~
0.20
Profit Margins
TABLE VI
BIZCOMPS ACQUISITION DATA 2002
mI]]NAICS # I SP/REV ~ SDCF/REVISP/SDCF I INVENTORY I BUSINESS TYPE IANN. REV[QE] SALES DATE ISALE PRI % DOWNI TERMS
5046 42144 Distr-Expresso Machines 467 124 8/8/97 200 77 0.43 26.6% 1.61 50
5046 42144 Distr-Food Serv Equipment 385 170 7/31/96 190 23 5 Yrs @11% 0.49 44.2% 1.12 25
5046 42144 Distr-Ice/Juice Machines 564 240 7/31/97 525 100 0.93 42.6% 2.19 30
5046 42144 Distr-Restaurant Equip 260 110 9/30/96 195 51 0.75 42.3% 1.77 0
5046 42144 Distr-Scales 2,391 409 8/1/99 1,350 33 10Yrs@9% 0.56 17.1% 3.30 150
5046 42144 Restaurant Equipment Sales 573 265 8/23/01 390 100 0.68 46.2% 1.47 80
5046 42144 Whsle-Restaurant Supplies 3,640 220 5/1/96 125 54 7Yrs@8% 0.03 6.0% 0.57 400
5046 42144 Whsle-Restaurant Supplies 1,750 210 7/3/97 261 66 0.15 12.0% 1.24 85
5064 42162 Distr-Appliance Parts 890 63 9/30/95 35 80 1 Yr@O% 0.04 7.1% 0.56 150
5064 42162 Distr-Appliances 8,090 500 10/1/99 140 9 10Yrs@8.5% 0.02 6.2% 0.28 1,040
Maximum 8,090 500 1,350 0.93 46.2% 3.30 1,040
Mean 1,901 231 341 0.41 25.0% 1.41 201
Median 732 215 198 0.46 21.8% 1.36 83
Minimum 260 63 35 0.02 6.0% 0.28 0
Gilbert 4,596 393 8.5% 525
SIC = Standard Industrial Classification code that divides all companies into industries
Ask = Asking Price, ($000)
Sales = Sales volume, revenues, ($000)
SDCF = Sellers Discretionary Cash Flow: Pretax profits + owner's compensation + depreciation + interest + perqs + non-business expenses, ($000)
Date = Date the transaction closed
Price = SP = Sales Price, ($000)
% Down = Percent of the sales price paid at closing
Terms = Terms of the note received for the non-down payment portion of the sales price
SP/Rev = Sales Price/Revenues, a type of price/sales multiple that relates the sales price to the revenues of the business
SDCF/Rev = SDCF/Revenues, a profit margin
SP/SDCF = Sales Price/SDCF, a type of price/earnings multiple that relates sales price to the earnings of the business
Inv.= Inventory, ($000)
FFE = Furniture, fixtures and equipment, ($000)
Rent = Rent
Intangibles = Intangible assets, ($000) = Sales Price minus FFE
Value calculated using these ratios does not include current assets or total liabilities
BUSINESS VALUATION
THE EUROPEAN PERSPECTIVE
GEORGE BADESCU - ROMANIA
21 OCT 2003 PEPS/ISM SEMINAR
VALUATION IN EUROPE
1066 in UK valuation for tax purpose
1523 in UK first valuation book
, 1834 in UK first appraisal organization
1868 in UK RICS
1977 in Europe TEGOVOFA "Blue Book"
2000 TEGOVA EVGN-7 "Business Valuation"
2001 FEE "Business Valuation: A Guide for
SME"
EUROPEAN PROFESSIONAL
ORGANIZATIONS
TEGOVA (former TEGOVOFA) - .The
European Group of Valuers Associations
FEE - Federation des Experts Comptables
Europeens
RICS - Royal Institute of Chartered
Surveyors
VALUATION STANDARDS-l
INTERNATIONAL
- IVSC: GN 1 Real Property
- IVSC: GN 5- Business Valuation
- IVSC: GN.. - Valuation of Specialized Trading
Property
EUROPEAN
- TEGOVA: GN 2-Valuations of Special Properties
- TEGOVA: GN 7 - Business Valuation
VALUATION STANDARDS-2
- FEE: Business Valuation: a Guide for Small
and Medium Sized Enterprises
- FEE: Procedure to be followed by Accountants
in valuing an Undertaking as a Going Concern
RICS -Red Book 2003
- GN 1- Trade-Related Valuation and Goodwill
SPECIALIZED TRADING
PROPERTY
A particular class of assets which are
generally bought and sold in established and
active markets as operational business units
having regard to their trading potential
include: hotels, leisure properties, petrol
stations, healthcare properties,permanent
plantations, and other labor-intensive
operations.
VALUATION APPROACH
REAL PROPERTY
- income capitalization
- sales comparison
- cost
BUSINESS
- income capitalization
- market comparison
- asset based
COMPONENTS of
BUSINESS VALUE
Real property: land and buildings
Personal property: trade fixture, fittings,
furniture, furnishings and other equipment
Working capital
Intangible assets:
- location- attached to the real property
- operational- attached to personal property
- personal- attached to ownership
ALLOCATION PROCESS
Market value for whole business
not necessary market value for the
components
principle of contribution
principle of substitution
opportunity cost
BASES of VALUATION
Type of ownership
Market value
Value in use
TEGOVA definitions are the same as Ivse
definitions
HOTEL
BUSINESS and REAL PROPERTY
Sophisticated labor-intensive operating
business which have "real property" as the
single largest investll1ent in their capital
structure
Managell1ent of the hospitality business is the
source and key to generate revenues froll1
which the net incoll1e services the investment
in real estate used by the hotel business
TANGIBLE ASSETS
Real property: land and buildings
personal property: furniture, fixture and
equipment
operating supply: inventory, administrative
supply
cash and similar (net value)
INTANGIBLE ASSETS
Contract related:
- management agreements
- franchise license agreements
- advance reservation contracts
- operating permits and licenses
INTANGIBLE ASSETS
WORKFORCE
- trained workforce in place
REPUTATION
- trade name
- association with firms providing other business
servIces
OTHER
- pre-opening cost
HOTEL VALUATION
The asset based (cost) approach:
- market value of the land
- depreciated replacement cost of the buildings
and land improvements
- depreciated replacement cost of the FF&E
- actual amount of working capital
- value of identified intangible assets-not
goodwill
HOTEL VALUATION
Sales comparison approach
- hotel are essentially dissimilar as location,
operation, quality of the buildings, financing
- numerous adjustments difficult to quantify
- market information is not always available or is
incomplete
- multiples as PAR or POR are merely indicative
HOTEL VALUATION
Income capitalization approach
- direct capitalization method when the hotel
operation achieved a stabilized level
- discounted cash flow method - in every
circumstances and only method for start-ups
most used in practice and reflects the
investor behavior
VALUATION of
the COMPONENTS
Most difficult task
used for:
- accounting
- property taxation
- lease estimation
two approaches:
- income allocation- HVS model
- component asset allocation- "bridge" model
INCOME ALLOCATION
MODEL-HVS
Total revenues/year
minus operating expenses
minus real property reserves for
replacements
minus net income attributable to personal
property (return of and on invested capital)
minus net income attributable to intangibles
NET INCOME from
INTANGIBLES
Management fee
amortization of start-up cost (retumof and
on capital invested)
economic profit (if any)
equal income generated by real property
capitalized by real property r.ate
equal real property value
VALUE ALLOCATION
"BRIDGE" MODEL
Net operating income for business
capitalized by business rate
equal business value
minus FF&E market value
minus net working capital
minus intangibles value
equal real property value
INTANGIBLES VALUATION
break-up method
Management contract/chain affiliation by
capitalization of incremental net income from
rooms revenue
pre-opening organizational and marketing cost by
market comparison
reservation contracts by capitalization of
incremental net income generated
reputation by capitalization of the lease-up period
reduced income
INTANGIBLE VALUATION
direct method
DCF technique
present value of the cash flow for a
stabilized operation
present value of the cash flow untill the
operation is stabilized discounted at a
higher rate
the difference is the value of all intangibles
INTANGIBLE VALUATION
100
90
80
70
w
:E
0
60
0
~
C
w
50
:lI
..J
~ 40
U)
tf.
30
20
10
0
1 2 3 4 5 6
YEAR
III INCOME LOSS
IllI ACWAL INCOME
EUROPEAN VIEW
RICS -ONI:
- exclude personal goodwill
- average competent operator
- established trading potential
VALUATION
- earnings multiplier approach
- DCF method
EUROPEAN VIEW
ALLOCATION
- valuers are reluctant to do it
- preferred method to estimate intangibles is
multiplying the adjusted net profit (1 to 1.75)
- often the intangible generating income is said to
be 50% of total net operating income
- lenders do not require the allocation
CASE STUDY
100 rooms 3 star hotel with restaurant, bar,
conference room and fitness club
easy accessible
good parking facilities
affiliated to Best Eastern chain
no mortgage on it
BASIC DATA
stabilized occupancy -75%
stabilized room rate ==$80
inflation rate ==2.5%
hotels cost of equity capital -14.5%
working capital and FF&E cost of capital
==18%
management fee -5% revenues
HVS MODEL APPLIED
Business net operating income $998,000
FF&E and working capital income =$129,600
Management fee==$50,000
Start-up amortization cost==$195,000
Income to real property $623,400
Capitalization rate==12%
Value of real property=$5,195,OOO
"BRIDGE" MODEL APPLIED
Intangibles valuation (break-up method)
- management contract-$130,000
- pre-opening cost==$460,000
- advanced reservations==$120,000
- reputation-$320,000
- TOTAL==$1,030,000
Intangible valuation (direct method)
- cash flow present value for stabilized operation
discounted at 14.5% rate
-$7,080,000
_. cash flow present value untilloperation is
stabilized discounted at 16% rate
. ==$5,842,000
- total intangibles value==$1,238,000
Reconciliation=$l, 100,000
Total business market value==$7,080,000
FF&E market value-$500,000
Net working capital==$200,000
Intangibles value==$l, 100,000
Real property value-$5,260,000
RESULTS COMPARISON
ALLOCATION INCOME MODEL BRIDGE MODEL
BUSINESS VALUE $7,080,000
FF&E $500,000
WORKING CAPITAL $200,000
INTANGIBLES $1 ,185,000
REAL PROPERTY $5,195,000
$7,080,000
$500,000
$200,000
$1,100,000
$5,260,000
DEBATE CONTINUES
Appraisal Institute held a debate in June
1998 and has a new education (Course 800)
IVSC have prepared an ON Exposure Draft
Many papers in Appraisal Journal (5 in
2001-2002) or presented in conferences
EUROPEAN RESEARCH
RIes will publish in late 2003 an
information paper
new papers (Hutchison a.o.ERES June
2003)
IYSC -NEW GUIDANCE NOTE
Defines "specialized trading property"
explains how it is valued according IVS1
highlights the facts to be considered
insists on "average efficient operator" and
on exclusion of the ''personal goodwill"
guides on "assumptions and limiting
conditions" and other disclosures
OUR DEBATE
impact of the ownership type
real property or intangibles valuation-
which is first
market value or value in use
which model to adopt
CASE STUDY
START-UP SCENARIO Base Year Base +1 Base +2
~
Base +4 Base +5 Base +6
sw-
Base +8 Base +9 Base +10
1 2 3 5 6 7 9 10 11
Number of Rooms 100 100 100 100 100 100 100 100 100 100 100
Occupancy 60.0% 65.0% 70.0% 73.0% 75.0% 75.0% 75.0% 75.0% 75.0% 75.0% 75.0%
Average Rate $ 65.00 $ 73.95 $ 78.08 $ 80.03 $ 82.03 $ 84.63 $ 86.74 $ 88.91 $ 91.13 $ 93.41 $ 95.75
Days Open 365 365 365 365 365 365 365 365 365 365 365
Rooms Occupied 21900 23725 25550 26645 27375 27375 27375 27375 27375 27375 27375
Revenues $(000) $(000) $(000) $(000) $(000) $(000) $(000) $(000) $(000) $(000) $(000)
Rooms $ 1,068 $ 1,316 $ 1,496 $ 1,599 $ 1,684 $ 1,737 $ 1,781 $ 1,825 $ 1,871 $ 1,918 $ 1,966
Food $ 374 $ 407 $ 442 $ 468 $ 490 $ 502 $ 515 $ 527 $ 541 $ 554 $ 568
Beverages $ 37 $ 40 $ 44 $ 46 $ 48 $ 49 $ 51 $ 52 $ 53 $ 55 $ 56
Telephone $ 21 $ 24 $ 26 $ 27 $ 29 $ 30 $ 30 $ 31 $ 32 $ 33 $ 33
Rentals and Other Income $ 85 $ 91 $ 97 $ 102 $ 106 $ 109 $ 111 $ 114 $ 117 $ 120 $ 123
Total Revenue $ 1,585 $ 1,878 $ 2,105 $ 2,242 $ 2,357 $ 2,427 $ 2,488 $ 2,549 $ 2,614 $ 2,680 $ 2,746
Departmental Expenses
Rooms $ 320 $ 339 $ 359 $ 375 $ 389 $ 399 $ 409 $ 419 $ 429 $ 440 $ 451
Food & Beverages $ 247 $ 260 $ 274 $ 285 $ 295 $ 302 $ 310 $ 318 $ 326 $ 334 $ 342
Telephone $ 8 $ 9 $ 10 $ 10 $ 10 $ 11 $ 11 $ 11 $ 11 $ 12 $ 12
Rentals and Other Income $ 38 $ 40 $ 42 $ 44 $ 115 $ 46 $ 47 $ 48 $ 50 $ 51 $ 52
Total Departmental Expenses $ 613 $ 648 $ 685 $ 714 $ 739 $ 758 $ 777 $ 796 $ 816 $ 837 $ 857
Departmental Income $ 972 $ 1,230 $ 1,420 $ 1,528 $ 1,618 $ 1,669 $ 1,711 $ 1,753 $ 1,798 $ 1,843 $ 1,889
Undistributed Operating Expenses
Administrative & General $ 119 $ 125 $ 131 $ 136 $ 140 $ 144 $ 147 $ 151 $ 155 $ 159 $ 163
Human Resources $ 32 $ 33 $ 34 $ 35 $ 36 $ 37 $ 38 $ 39 $ 40 $ 41 $ 42
Infonnation Systems $ 32 $ 33 $ 34 $ 35 $ 36 $ 37 $ 38 $ 39 $ 40 $ 41 $ 42
Security $ 32 $ 33 $ 34 $ 35 $ 37 $ 38 $ 38 $ 39 $ 40 $ 41 $ 42
Marketing $ 40 $ 42 $ 44 $ 45 $ 47 $ 48 $ 49 $ 50 $ 52 $ 53 $ 54
Franchise Fees $ $ $ $ $ $ $ $ $ $ $
Transportation $ 40 $ 41 $ 43 $ 44 $ 46 $ 47 $ 48 $ 49 $ 50 $ 52 $ 53
Prop. Oper. & Maintenance $ 71 $ 75 $ 78 $ 81 $ 84 $ 86 $ 88 $ 91 $ 93 $ 95 $ 98
E;nergy Costs $ 55 $ 57 $ 59 $ 61 $ 63 $ 64 $ 66 $ 67 $ 69 $ 71 $ 73
TotalUDOEs $ 421 $ 439 $ 457 $ 472 $ 489 $ 501 $ 512 $ 525 $ 539 $ 553 $ 567
Income Before Fixed Charges $ 551 $ 791 $ 963 $ 1,056 $ 1,129 $ 1,168 $ 1,199 $ 1,228 $ 1,259 $ 1,290 $ 1,322
Fixed Charges
Management Fee $ $ $ $ $ $ $ $ $ $ $
Property Tax $ 32 $ 33 $ 33 $ 34 $ 35 $ 36 $ 37 $ 38 $ 39 $ 40 $ 41
Insurance $ 8 $ 8 $ 8 $ 9 $ 9 $ 9 $ 9 $ 9 $ 10 $ 10 $ 10
Reserve for Replacement $ 82 $ 98 $ 109 $ 117 $ 123 $ 126 $ 129 $ 133 $ 136 $ 139 $ 143
Total Fixed Charges $ 122 $ 139 $ 150 $ 160 $ 167 $ 171 $ 175 $ 180 $ 185 $ 189 $ 194
Net Income $ 429 $ 652 $ 813 $ 896 $ 962 $ 997 $ 1,024 $ 1,048 $ 1,074 $ 1,101 $ 1,128
0 Base Year Base +1 Base +2 Base +3 Base +4 Base +5 Base +6 Base +7 Base +8 Base +9 Base +10
1 2 3 4 5 6 7 8 9 10 11
Number of Rooms 100 100 100 100 100 100 100 100 100 100 100
OCCupancy 75.0% 75.5% 75.0% 75.0% 75.0% 75.0% 75.0% 75.0% 75.0% 75.0% 75.0%
Average Rate $ 80.00 $ 82.00 $ 84.05 $ 86.15 $ 88.31 $ 90.51 $ 92.78 $ 95.09 $ 97.47 $ 99.91 $ 102.41
Days Open 365 365 365 365 365 365 365 365 365 365 365
Rooms OCcupied 27375 27558 27375 27375 27375 27375 27375 27375 27375 27375 27375
Revenues $(000) $(000) $(000) $(000) $(000) $(000) $(000) $(000) $(000) $(000) $(000)
Rooms $ 2,190 $ 2,260 $ 2,301 $ 2,358 $ 2,417 $ 2,478 $ 2,540 $ 2,603 $ 2,668 $ 2,735 $ 2,803
Food $ 767 $ 790 $ 805 $ 825 $ 846 $ 867 $ 889 $ 911 $ 934 $ 957 $ 981
Beverages $ 77 $ 79 $ 81 $ 83 $ 85 $ 87 $ 89 $ 91 $ 93 $ 96 $ 98
Telephone $ 44 $ 45 $ 46 $ 47 $ 48 $ 50 $ 51 $ 52 $ 53 $ 55 $ 56
Rentals and OtIler Income $ 175 $ 180 $ 184 $ 189 $ 193 $ 198 $ 203 $ 208 $ 213 $ 219 $ 224
Total Revenue $ 3,253 $ 3,354 $ 3,417 $ 3,502 $ 3,589 $ 3,680 $ 3,772 $ 3,865 $ 3,961 $ 4,062 $ 4,162
Departmental Expenses
Rooms $ 657 $ 675 $ 690 $ 708 $ 725 $ 743 $ 762 $ 781 $ 800 $ 821 $ 841
Food & Beverages $ 506 $ 520 $ 532 $ 545 $ 558 $ 572 $ 587 $ 601 $ 616 $ 632 $ 648
Telephone $ 18 $ 18 $ 18 $ 19 $ 19 $ 20 $ 20 $ 21 $ 21 $ 22 $ 22
Rentals and OtIler Income $ 79 $ 81 $ 83 $ 85 $ 87 $ 89 $ 91 $ 94 $ 96 $ 99 $ 101
Total Departmental Expenses $ 1,260 $ 1,294 $ 1,323 $ 1,357 $ 1,389 $ 1,424 $ 1,460 $ 1,497 $ 1,533 $ 1,574 $ 1,612
Departmental Income $ 1,993 $ 2,060 $ 2,094 $ 2,145 $ 2,200 $. 2,256 $ 2,312 $ 2,368 $ 2,428 $ 2,488 $ 2,550
Undistributed Operating Expenses
Administrative & General $ 244 $ 250 $ 256 $ 283 $ 269 $ 276 $ 283 $ 290 $ 297 $ 305 $ 312
Human Resources $ 65 $ 67 $ 68 $ 70 $ 72 $ 74 $ 75 $ 77 $ 79 $ 81 $ 83
Infonnation Systems $ 65 $ 67 $ 68 $ 70 $ 72 $ 74 $ 75 $ 77 $ 79 $ 81 $ 83
Security $ 65 $ 67 $ 68 $ 70 $ 72 $ 74 $ 75 $ 77 $ 79 $ 81 $ 83
Marketing $ 81 $ 83 $ 85 $ 88 $ 90 $ 92 $ 94 $ 97 $ 99 $ 102 $ 104
Francl1ise Fees $ $ $ $ $ $ $ $ $ $ $
Transportation $ 81 $ 83 $ 85 $ 88 $ 90 $ 92 $ 94 $ 97 $ 99 $ 102 $ 104
Prop. Oper. & Maintenance $ 146 $ 150 $ 154 $ 158 $ 162 $ 166 $ 170 $ 174 $ 178 $ 183 $ 187
Energy Costs $ 114 $ 117 $ 120 $ 123 $ 126 $ 129 $ 132 $ 135 $ 139 $ 142 $ 146
Total UDOEs $ 861 $ 884 $ 904 $ 930 $ 953 $ 977 $ 998 $ 1,024 $ 1,049 $ 1,077 $ 1,102
Income Before Fixed Charges $ 1,132 $ 1,176 $ 1,190 $ 1,215 $ 1,247 $ 1,279 $ 1,314 $ 1,344 $ 1,379 $ 1,411 $ 1,448
Fixed Cllarges
Management Fee $ $ $ $ $ $ $ $ $ $ $
Property Tax $ 65 $ 67 $ 68 $ 70 $ 72 $ 74 $ 75 $ 77 $ 79 $ 81 $ 83
Insurance $ 16 $ 17 $ 17 $ 18 $ 18 $ 18 $ 19 $ 19 $ 20 $ 20 $ 21
Reserve for Replacement $ 169 $ 174 $ 178 $ 182 $ 187 $ 191 $ 196 $ 201 $ 206 $ 211 $ 216
Total Fixed Charges $ 250 $ 258 $ 263 $ 270 $ 277 $ 283 $ 290 $ 297 $ 305 $ 312 $ 320
Netlncome $ 882 $ 918 $ 927 $ 945 $ 970 $ 996 $ 1,024 $ 1,047 $ 1,074 $ 1,099 $ 1,128
HOTEL VALUE
START-UP
Value of the Property
Cash Flows for IRR Cales
Total Property
Proof of Value
$(000) IRR
$ 5,841,974 16.00%
Year 0 1 2 3 4 5 6 7 8 9 10
$ (5,841,974)$ 429,000 $ 652,000 $ 813,000 $ 896,000 $ 962,000 $ 998,000 $ 1,022,950 $ 1,048,524 $ 1,074,737 $ 9,439,910
Total Property Present Value
Net Income PV Factor @ Discounted
Year Before D.S. 16.0% Cash Flow
1 $ 429,000 0.862069 $ 369,828
2 $ 652,000 0.743163 $ 484,542
3 $ 813,000 0.640658 $ 520,855
4 $ 896,000 0.552291 $ 494,853
5 $ 962,000 0.476113 $ 458,021
6 $ 998,000 0.410442 $ 409,621
7 $ 1,022,950 0.353830 $ 361,950
8 $ 1,048,524 0.305025 $ 319,826
9 $1,074,737 0.262953 $ 282,605
10 $ 9,439,910 0.226684 $ 2,139,873
Total Property Value $ 5,841 ,974
Year 10 Cash Flow Calculations Year 10 net income of $
plus reversion of $
1,101,605
8,338,304
Reversion Calculations for Proof Year 11 Netlncome of $1129145
capitalized at 13% equals $ 8,685,734
Less: Selling Expenses
Equals: Net sales price $ 8,338,304
HOTEL VALUE
STABILIZED
Value of the Property
Cash Flows for IRR Cales Year
$(000)
$ 7,080,087
o
IRR
14.50%
2 3 4 5 6 7 8 9 10
Total Property $ (7,080,087) $ 882,000 $ 918,000 $ 927,000 $ 945,000 $ 970,000 $ 998,000 $ 1,022,950 $ 1,048,524 $ 1,074,737 $ 9,439,910
Proof of Value Total Property Present Value
Net Income PV Factor @ Discounted
Year Before D.S. 14.5% Cash Flow
1 $ 882,000 0.873362 $ 770,306
2 $ 918,000 0.762762 $ 700,215
3 $ 927,000 0.666168 $ 617,537
4 $ 945,000 0.581806 $ 549,806
5 $ 970,000 0.508127 $ 492,884
6 $ 998,000 0.443779 $ 442,892
7 $ 1,022,950 0.387580 $ 396,475
8 $ 1,048,524 0.338498 $ 354,923
9 $ 1,074,737 0.295631 $ 317,726
10 $ 9,439,910 0.258193 $ 2,437,322
Total Property Value $ 7,080,087
Year 10 Cash FlowCalculations Year 10 net income of $
plus reversion of $
1,101,605
8,338,304
Reversion Calculations for Proof Year 11 Net Income of $1129145
capitalized at 13% equals $ 8,685,734
Less: Selling Expenses
Equals: Net sales price $ 8,338,304
mSallmanns Group
Intangible Assets Valuation
Sallmanns (Far East) Limited
Vincent Chong
1
Types of Corporate Assets
Tangible Assets
Fixed Assets
Current Assets
Liquid Assets
2
Intangible Assets
Goodwill
Trademarks
Patent Rights
Concessions
Documented
procedures
rn Sallmanns Group
What are Intangible Assets
"Assets which do not have physical substance,
but manifest themselves by economic
properties and grant rights and privileges to
their owner."
- adopted from the International Valuation
Standard Committee
mSallmanns Group
3
Definition of Business Valuation
"Business Valuation is the act or process of
determining the value of a business
enterprise or ownership interest therein."
- adopted from the American Society of Appraisers
mSallmanns Group
4
Components of Total Business
Value
Total Business = Tangible +
Value Asset Value
5
Intangible
Asset Value
mSallmanns Group
, Recotds as
Representation of Business
Value
xu
Liabilities
Acquir ed
Intangibles ItXX
eu r r en t
ASSETs
BalanceSheet

FIXED ASSETs Equity
xxx
L---
6
Net Tangible Assets
Business Valuation as a means
to realize Intangible Asset Value
--
Iltclnglbh.:
A ~ s e h
_______ -- J
------ -
-
~ - ~
Valuation
Net Tangible Assets
7
: Intangible
A t
: ... Lsse s
m Sallmanns Group
When is a Business Valuation
required?
Fund raising / IPO
Accounting reference
Public announcement
Sale & acquisition
mSallmanns Group
8
Nature of Intangible Assets
Identify intangible assets separately
Vintage of intangibles
Maintenance of intangibles
mSallmanns Group
9
Applications of Intangible Asset
Valuation
Case: New World Infrastructure (Restructuring)
Intangible assets involved:
- Concession Rights
- Management goodwill
Value realized: HK$10 Billion
mSallmanns Group
10
Valuation
Case: Tsingtao Beer
(Initial Public Offering)
- Brand name "Tsing Tao"
Value realized: HK$490 Million (1993)
mSallmanns Group
11
Valuation
Case: ExxonMobil
(Acquisition Reference)
E'k0nMobii
- Marketing assets & management efficiency
Value difference: HK$1.6 Billion
mSallmanns Group
12
Valuation
Case: Media Asia Group
(Sale & Purchase Reference)
- Film Library (91 titles)
Valuation: HK$85.1 Million
mSallmanns Group
13
Valuation
Case: HC International
(Accounting Reference)
sin = net
t i 1 B ~ M 1
- Information Database (21 million records)
Valuation: RMB 22 Million
mSallmanns Group
14
Valuation
Case: Storage Provider
(Sale & Purchase Reference)
STORAGEPROVIDER
- Documented Operational Process
Valuation: US 1.2 Million
mSallmanns Group
15
mSallmanns Group
Equipment Valuation
Sallmanns (Far East) Limited
Mario Maninggo
1
Methods of Valuation
(Strengths and Weaknesses)
The Market Approach
The Income Approach
The Cost Approach
2
Cost Approach Application
Reproduction Cost vs Replacement Cost
"Replacement cost is the current cost of a property with
utility equivalent to the subject property"
"Reproduction cost is the current cost of an exact replica of
the property."
3
Cost Estimates Techniques
- Detailed Estimate
- Cost Indexing
4
- Estimating Costs by Scaling
')
- Other Engineering Methods of Cost
Estimation
6
Sequence of Depreciation
Step 1: Reproduction Cost New Less Excess
Capital Cost = Replacement Cost New (RCN)
Step 2: RCN Less Physical Deterioration =
RCNLPD
7
Sequence of Depreciation
Step 3: RCNPD Less Functional
Obsolescence = RCNPDFO
Step 4: RCNPDFO Less Economic
Obsolescence = Replacement Cost New
Less All Forms of Appraisal Depreciation
8
Depreciation in Cost Approach
Physical Deterioration
Functional Obsolescence
9
Depreciation in Cost Approach
Economic Obsolescence
Where capacity A
capacity B
n
10
rated or design capacity
actual production
exponent or scale factor
Typical Procedure in Plant &
Machinery Valuation
Verif or develo asset list
Confirm or'compile brand, model, serial nD.,
descri tion, confi uration, condition, 'etc.
Note s ecialfeaJures, modifications
Typical Procedure in Plant &
Machinery Valuation
Research new machiner costs

Seminar On Business Valuation (Property Related) Ism

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- The related minority discount' (DLOC) is 29%.

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