Financial Valuation: Applications and Models, Textbook and Workbook

by James R. Hitchner ( )

• ISBN13: 9780471447535
• ISBN10: 0471447536
• Edition: Packaged
• Format: Hardcover
• Copyright: 2003-04-01
• Publisher: WILEY

Summary

The appropriate, defensible way to prepare and present business valuations, with a strong emphasis on applications and modelsFinancial Valuation provides an all-encompassing valuation tome that presents the application of financial valuation theory in an easily understood manner. Delivering valuation theory, the consensus view on application, and the tools to make it happen, James Hitchner's all-star cast of contributors offer numerous examples, checklists, and models to assist in navigating a valuation project. The book contains hundreds of short, easily understandable "Valuation Tips," and covers best practices from the view of these twenty-five experts.

Table of Contents

About the Editor	xiii
About the Authors	xiv
Acknowledgments	xxii
Preface	xxiv
Introduction to Financial Valuation	1	(17)
Who Values Businesses?	1	(1)
Purpose of a Valuation	2	(1)
Professional Valuation Organizations	3	(1)
Standards of Value	3	(1)
Fair Market Value	3	(2)
Investment Value	5	(1)
Intrinsic Value	5	(1)
Fair Value (State Rights)	5	(1)
Fair Value (Financial Reporting)	6	(1)
Premise of Value	6	(1)
Principles of Appraisal Practice	7	(1)
Dates	7	(1)
Approaches to Value	7	(1)
Valuation Procedures	8	(1)
Summary	8	(2)
Addendum	10	(8)
Research and Its Presentation	18	(31)
Obtaining Internal Information	18	(1)
A Directive from the Internal Revenue Service	18	(2)
Research Techniques and Planning the Search	20	(4)
Information Sources: Business Financial Databases	24	(1)
Economic Research	25	(1)
Selected Sources of Economic Information	25	(2)
Industry Research	27	(1)
Selected Sources of Industry Information	27	(1)
Guideline Company and Transaction Research	28	(2)
Presenting Research in a Report	30	(1)
Other Sources of Information	31	(1)
Summary	31	(2)
Addendum 1---Valuation Information Request List	33	(4)
Addendum 2---Management Questionnaire	37	(11)
Addendum 3---Industry Research Form	48	(1)
Financial Statement and Company Risk Analysis	49	(36)
Historical Financial Statement Analysis	49	(1)
Length of Financial History to Be Used	50	(1)
Spreading Financial Statements in Columnar Format	50	(1)
Adjustments to Financial Statements	50	(3)
Normalization of Historical Financial Statements	53	(1)
Unusual, Nonrecurring, and Extraordinary Items	53	(1)
Nonoperating Items	54	(1)
Changes in Accounting Principle	54	(1)
Nonconformance with GAAP	55	(1)
Tax Effecting the Earnings of Subchapter S Corporations	55	(2)
Degree of Ownership Interest	57	(1)
Normalization Adjustments	58	(1)
Common Sizing Normalized Financial Statements	58	(4)
Ratio Analysis (Quantitative Analysis)	62	(7)
Comparative Analysis	69	(3)
Risk Analysis (Qualitative Analysis)	72	(4)
Macroenvironmental Analysis	76	(2)
Appendix---Commonly Used Financial Ratios Application to Ale's Distributing	78	(7)
Income Approach	85	(41)
Fundamental Theory	85	(1)
Income Approach Involves a Numerator	86	(1)
Income Approach Involves a Denominator	86	(1)
Income Approach Methodologies	87	(1)
Normalization Process	87	(1)
Adjustments for Ownership Characteristics	88	(2)
Adjustments for GAAP Departures, Extraordinary, Nonrecurring, and/or Unusual Items	90	(1)
Adjustments for Nonoperating Assets and Liabilities and Related Income and Expenses	91	(1)
Adjustments for Taxes	92	(1)
Adjustments for Synergies from Mergers and Acquisitions	93	(1)
Determination of Future Benefit Stream (Cash Flows)	94	(1)
Defining the Benefit Stream	94	(1)
Defining Net Cash Flow	95	(1)
Use of Historical Information	96	(5)
Discounted Cash Flow Method	101	(8)
Terminal Value	109	(5)
Capitalized Cash Flow Method	114	(2)
Excess Cash Flow Method	116	(9)
Conclusion	125	(1)
Cost of Capital/Rates of Return	126	(58)
Three Variables	126	(1)
Characteristics of Cost of Capital	127	(1)
Investor Expectations as Quantified by the Cost of Capital	127	(1)
Cost of Capital Equals Discount Rate	128	(1)
Cost-of-Capital Methods	128	(1)
More on the Basic Concepts	128	(1)
Discount Rate, Capitalization Rate, and Anticipated Growth	129	(1)
Growth	129	(5)
Relationship Between Risk and Cost of Capital	134	(3)
Types of Risk---Another View	137	(1)
Risks in a Small Business	138	(1)
Methods for Developing Cost of Capital	139	(2)
Size Premiums	141	(4)
Methods of Articulate Unsystematic Risk	145	(5)
Other Issues	150	(1)
Capital Asset Pricing Model Method	151	(5)
Development of the Weighted Average Cost of Capital	156	(3)
Price/Earnings Method	159	(2)
Adjustments to the Price/Earnings Ratio	161	(2)
Arbitrage Pricing Theory	163	(2)
Build-Up Summation Model	165	(1)
Cost-of-Capital Issues Related to Use of the Excess Cash Flow Method	166	(2)
Addendum	168	(16)
Market Approach	184	(48)
Overview	184	(1)
Type of Value Obtained	185	(1)
Advantages and Disadvantages of the Market Approach	186	(1)
Basic Implementation	187	(1)
Sources and Characteristics of Guideline Company Data	188	(1)
Information Sources	188	(1)
Advantages and Disadvantages of the Guideline Company Transaction Method	189	(1)
Publicly Traded Companies	190	(2)
Information Sources for Industry ``COMPS''	192	(1)
Stock Prices and Number of Shares Outstanding	192	(1)
Advantages/Disadvantages of Public Company Data	193	(1)
Characteristics of Publicly Traded Companies	193	(4)
Choosing Guideline Companies	197	(3)
Financial and Other Indicators	200	(3)
Sample Size Matters	203	(1)
Comparable Companies Information Dates	203	(1)
Basic Financial Indicators	203	(1)
Displaying the Information	204	(5)
Adjustments to the Guideline and Subject Companies	209	(1)
Income Adjustments	209	(2)
Balance Sheet Adjustments	211	(2)
Effects of Adjustments on Value	213	(1)
Concluding Remarks on Choosing Comparables	213	(1)
Calculating Standard Pricing Multiples	214	(1)
Equity versus Invested Capital	214	(2)
Financial Statement Measures	216	(2)
Computation of Multiples	218	(1)
Matching Price to Parameter	219	(1)
Dispersion of Pricing Multiples	219	(2)
Applying the Valuation Multiples	221	(2)
Concluding Thoughts on Value	223	(1)
Using the Pricing Multiples for Growth	223	(4)
Adjusting the Guideline Multiples for Size	227	(3)
Summary	230	(2)
Asset Approach	232	(40)
Fundamental Theory	232	(1)
Applicability	233	(2)
Premise of Value	235	(1)
Control versus Minority	235	(1)
Built-In Gains	236	(1)
General Steps in the Asset Approach	236	(1)
Valuation of Individual Assets and Liabilities Example	237	(6)
Liabilities	243	(1)
Unrecorded Assets and Liabilities	244	(1)
Built-In Gain	244	(3)
Conclusion	247	(1)
Addendum 1---Understanding Real Estate Appraisals	248	(11)
Addendum 2---Understanding Machinery and Equipment Appraisals	259	(11)
Addendum 3---Revenue Procedure 77-12	270	(2)
Valuation Discounts and Premiums	272	(70)
Levels of Value	272	(3)
Classifying Discounts	275	(2)
Discounts for Lack of Control and Control Premiums	277	(8)
Discounts for Lack of Marketability	285	(2)
Empirical Evidence of Marketability Discounts	287	(24)
Quantitative Tools	311	(5)
Other Discounts	316	(7)
Discounts and Premiums Summary	323	(1)
Addendum---Tax Court Cases (The Oldies but Goodies)	324	(18)
Report Writing	342	(81)
USPAP Engagements	342	(2)
Types of Valuation Engagements and Related Reports	344	(1)
Complete Valuation Report	344	(8)
Other Business Valuation Reports	352	(1)
Sample Report	353	(1)
Addendum---Sample Valuation Report, Valuation of the Common Stock of Acme Measurement Devices Inc. as of May 31, 2000	354	(69)
Business Valuation Standards	423	(23)
History of Valuation Standards	423	(1)
Government Action	424	(1)
Organization of the USPAP Standards	425	(1)
Business Valuation Standards	425	(6)
Other Business Valuation Standards and Credentials	431	(3)
Summary	434	(1)
Addendum---Internal Revenue Service Business Valuation Guidelines	435	(11)
Estate, Gift, and Income Tax Valuations	446	(56)
Valuations in Estate and Gift Taxes	446	(2)
Selected Treasury Regulations	448	(3)
Selected Revenue Rulings	451	(15)
Revenue Ruling 77-287	466	(9)
Revenue Ruling 83-120	475	(5)
Revenue Ruling 93-12	480	(3)
Valuations for Income Taxes	483	(1)
Charitable Contributions of Property	484	(1)
Conversion of Property	485	(2)
Addendum---Valuation Checklists/Ready Reference (Revenue Rulings 59-60, 77-287, and 93-12)	487	(15)
Valuation of Family Limited Partnerships	502	(38)
Family Limited Partnership Uses	502	(1)
Tax Advantages	503	(1)
How Family Limited Partnerships Are Formed	504	(1)
Other Characteristics of Family Limited Partnerships	505	(1)
State Law, Property Rights, and Their Importance to the Valuation Process	505	(2)
Improper Formation Can Create Problems for Partners	507	(1)
Valuation of Family Limited Partnership Interests	508	(24)
Illustrative Case Study	532	(8)
Summary of Court Cases Issues	540	(37)
Tax Cases	540	(33)
Civil Cases	573	(4)
Shareholder Disputes	577	(16)
History of Shareholder Disputes	577	(1)
Causes of Action	578	(1)
Standard of Value	579	(3)
Valuation Date	582	(1)
Entire Fairness	583	(1)
Valuation Methodology	584	(2)
Valuation Adjustments	586	(3)
Court Case Caveats	589	(1)
Conclusion	590	(1)
Appendix	591	(2)
Valuation Issues in Employee Stock Ownership Plans	593	(22)
Need for Valuation Services	594	(1)
Securities Laws and ESOPs	595	(1)
How ESOPs Are Used	596	(1)
Differences in Entity Structure	596	(2)
Adequate Consideration: How and Why It Works	598	(1)
Put Rights of Terminating Plan Participants	598	(2)
ESOPs and Plan Contributions	600	(1)
ESOPs that Include Debt	601	(1)
General Considerations for ESOP Loans	602	(2)
Accounting Standards and ESOPs with Debt	604	(3)
Value for ESOP Shares	607	(5)
Writing a Valuation Conclusion	612	(1)
Information Sources	613	(2)
Valuation in the Divorce Setting	615	(18)
Standards of Value in Divorce	615	(2)
Premise of Value---Going Concern	617	(1)
Premise of Value---Liquidation	617	(1)
Goodwill---The Battleground for Divorce Valuations	618	(1)
Defining Goodwill	618	(1)
State Interpretations on Including Goodwill in the Marital Estate	618	(1)
Personal versus Entity Goodwill	619	(1)
Dividing Goodwill into Personal and Entity Components	620	(2)
Applying the Factors to Separate Goodwill	622	(3)
Role of Noncompete Agreements in Determining Personal versus Entity Goodwill	625	(1)
Personal Goodwill in Commercial Businesses	626	(1)
Restrictions on Data	627	(1)
Ranges versus Specificity	627	(1)
Professional Standards in a Divorce Settlement	627	(1)
Role of the USPAP	627	(1)
AICPA Standards	628	(1)
Other Standards	628	(1)
Daubert Challenges in Divorce	628	(1)
Valuation Methodology and the Application of Discounts in Divorce Valuations	629	(1)
Avoid Double Counting	629	(1)
When an Interest Is Considered Control in a Divorce Setting	629	(1)
Family Aggregations in Divorce Settings	630	(1)
Partnerships, LLCs, LLPs, and Family Entities in a Divorce Setting	630	(1)
Liquidity Myth in Pass-Through Entity	631	(1)
Divorce Valuation and Bankruptcy	631	(1)
Summary	632	(1)
Valuation Issues in Small Businesses	633	(13)
What Is a Small Business?	633	(2)
Financial Statement Adjustments	635	(3)
Qualitative Factors Affecting Value	638	(1)
Valuation Methods	639	(5)
Reasonableness Tests	644	(1)
Summary	645	(1)
Valuation Issues in Professional Practices	646	(31)
Types of Practices	647	(2)
Purpose of Valuation	649	(1)
Professional Goodwill and Practice Goodwill	649	(2)
Select Case Law for Marital Dissolution	651	(3)
Factors Affecting Value	654	(4)
Financial Statement Adjustments	658	(3)
Valuation Methods	661	(4)
Summary	665	(2)
Appendix 1---Management Interview Medical Practice	667	(4)
Appendix 2---Management Interview Law Practice	671	(3)
Appendix 3---Management Interview Accounting Practice	674	(3)
Valuation of Healthcare Service Businesses	677	(72)
Industry Background and Transition	679	(1)
Healthcare Industry's Unique Attributes	680	(11)
Overview of Considerations for Valuing Healthcare Entities	691	(1)
Valuation Process	692	(4)
Income Approach Discounted Cash Flow Method: Developing a Discount Rate	696	(3)
Minority Discounts	699	(1)
Discounts for Lack of Marketability	700	(1)
Key Person Discount	700	(2)
Valuation Issues for Specific Healthcare Industry Niches	702	(9)
Publicly Traded Healthcare Services Companies by Niche	711	(3)
Addendum 1---Tara Surgery Center, L.P.	714	(20)
Addendum 2---Valuation of Ashley Hospital	734	(15)
Valuation of Intangible Assets	749	(72)
What Are Intangible Assets?	751	(1)
Why Are Intangible Assets So Difficult to Measure?	752	(1)
Nature of Intangible Assets	753	(1)
Identification and Classification of Intangible Assets	753	(1)
Measurement of Intangible Assets	754	(1)
Fair Value	755	(1)
SFAS No. 141, Business Combinations	756	(1)
SFAS No. 142, Goodwill and Other Intangible Assets	757	(2)
Nature of Goodwill	759	(1)
Goodwill, Indefinite-Lived Intangible Assets, and the Impairment Test	760	(3)
Transition: Previously Recognized Goodwill	763	(1)
Financial Reporting Disclosures under SFAS Nos. 141 and 142	764	(1)
In-Process Research and Development	765	(5)
Tax Effects	770	(1)
Transfer Pricing	770	(2)
Returns on and of Contributory Assets	772	(1)
Discount Rate Considerations for Intangible Assets	773	(1)
Case Study: Determining Goodwill and Other Intangible Assets in a Business Combination	774	(14)
Valuation of Intangible Assets	788	(6)
Assembled Workforce	794	(5)
Trade Name	799	(1)
Noncompete Agreement	800	(10)
In-Process Research and Development	810	(3)
Valuation of Goodwill	813	(1)
Allocation of Purchase Price	814	(3)
Appendix---Intellectual Property	817	(4)
Marketing, Managing, and Making Money in a Valuation Services Group	821	(13)
Purpose and Overview	821	(1)
What Good Economics Looks Like	821	(3)
Operational Keys for Good Economics	824	(2)
Key Engagement Principles	826	(1)
Engagement Acceptance Process	827	(1)
Fees, Retainers, Billing, and Collection	828	(2)
Engagement Control	830	(1)
Litigation Services Engagements	831	(2)
Conclusion	833	(1)
Business (Commercial) Damages	834	(16)
Role of the Law and Financial Experts	834	(1)
Legal Principles Governing Damages	835	(1)
Daubert and Admissibility of Expert Opinions	836	(1)
Measure of Damages: Diminution of Value or Lost Profits	837	(2)
Differences Between Damage Computations and Business Valuations	839	(9)
Can Business Damages Exceed the Fair Market Value of the Business?	848	(1)
Conclusion	849	(1)
Other Valuation Services Areas	850	(105)
Valuation Issues in Mergers and Acquisitions	850	(11)
Valuations for Public Companies and/or Financial Reporting	861	(6)
Valuation Issues in Buy-Sell Agreements	867	(8)
Valuation Issues in Pass-Through Entities	875	(10)
Valuing Debt	885	(5)
Valuation Issues in Preferred Stock	890	(7)
Restricted Stock Valuation	897	(12)
Valuation of Early-Stage Technology Companies	909	(8)
Valuation Issues Related to Stock Options	917	(19)
Real Option Valuations	936	(5)
Maximizing Shareholder Value	941	(14)
Valuation Views and Controversial Issues: An Illustration	955	(44)
The Report	955	(2)
Introduction	957	(6)
National Economic Outlook	963	(2)
Regional Economic Data (as of December 8, 1999)	965	(2)
Local Economy	967	(1)
Industry Outlook	967	(1)
Financial Analysis of the Company	968	(9)
Appraisal of Fair Market Value	977	(19)
Lack of Marketability Discount	996	(1)
Correlation of Values	997	(1)
Total Conclusion of Value on a Nonmarketable, Control Basis	998	(1)
Index	999