Who issues regulations for Employee Stock Ownership Plan (ESOP)s?
The US Department of Labor
What’s the difference between appraisal and valuation?
Appraisal is for tangible assets. Valuation is for intangible assets.
What are the 3 standards of value?
Fair market value (for tax, ESOPs), fair value (for divorce/litigation, financial statements), and Strategic/investment value (for transactions)
What is the IRS definition of FMV?
{Memorize this!}
The price at which the property would change hands between a willing buyer
and a willing seller, when the former is not under any compulsion to buy and the
latter is not under any compulsion to sell, both parties having reasonable
knowledge of relevant facts.”
What are the 4 premises of value?
- Book value (tangible assets - debt = equity)
- Going Concern value (assume that business will run forever. Use this for FMV)
- Liquidation Value (use this for bankruptcy court, descending shareholder action)
- Replacement value (used in insurance contracts)
What is the investment value principle?
Value = Benefit stream / Required rate of return
What is common-size analysis?
B/S or P/L as a percentage
What are the 4 steps in trend analysis?
- Obtain financial data
- Prep summaries by year for B/S and P/L
- Compute/compare ratios
- Analyze and develop conclusions
What are the 5 categories of financial ratios?
- Internal liquidity ratios
- Operating efficiency ratios
- Operating profitability ratios
- Business risk (operating) analysis ratios
- Financial risk (leverage) analysis ratios
What is the RMA?
Risk Management Association - common source for general industries gathered from financial info submitted to banks
What 4 things will a financial analysis of a business identify?
- Identify strengths/weaknesses of business
- Identify trends
- Analyze historical performance
- Identify areas for potential normalizing adjustments
What 4 pieces of information are necessary for a financial analysis?
- Financial information (historical and prospective) and other similar data on the subject
company - Factual history of the company
- Information about perceived competitors
- Management’s expectations and perceived strengthens and weaknesses
What is the objective for adjusting financial statements of closely held companies?
“To adjust the financial statements or income tax returns of a business to more
closely reflect its true economic financial position and results of operations on a
historical and current basis.”
What is the formula for net cash flow to equity?
Net income \+ Non-cash charges (depr, deferred tax, etc) - Capital expenditures - Additions to net working capital \+ Increased LT debt borrowings - LT debt repayments =Net cash flow to equity - Dividends to preferred shareholders = Net cash flow to common shareholders' equity
What is the formula for net cash flow to invested capital?
Net income (after tax)
+ Non-cash charges (depr, deferred tax, etc)
- Capital expenditures
- Additions to net working capital
+Interest expense (net of tax if using after-tax income)
=Net cash flow to invested capital (after tax)
What is the appropriate discount rate when discounting net cash flow to equity?
The cost of equity
What is the appropriate discount rate when discounting net cash flow to invested capital?
Weighted average cost of capital (WACC)
How do you estimate future earnings for tax valuation or divorce?
Use historical economic income (capitalization of earnings)
What are the 2 primary criteria for determining the capitalization or discount rate?
- The capitalization or discount rate should be essentially the same as the rate of return
(yield) that is currently being offered to attract capital or investment to the type, size, and
financial condition of business that is being valued. - The capitalization or discount rate must be consistent with the “type” of benefit streams to
be capitalized or discounted (e.g., pre-tax versus after-tax, cash flow vs. earnings to
invested capital or equity).
What is the formula for the capitalization rate?
Discount rate - long-term sustainable growth rate
What is a discount rate?
A rate of return used to convert a series of monetary sums into present value
What is a capitalization rate?
Any multiple or divisor used to convert anticipated economic benefits of a single period
into value.
What should you look for in a Capital Asset Pricing Model (CAPM)?
Beta
Is Beta less than 1 or greater than 1 more risky?
Greater than 1 is more risky
