Book of Valuation pdf

JWBT309_FM_pi-xxxiv.qxd 02/04/2011 7:09 PM Page i Aptara JWBT309_FM_pi-xxxiv.qxd 02/04/2011 7:09 PM Page i Aptara Financial Valuation JWBT309_FM_pi-xxxiv.qxd 02/04/2011 7:09 PM Page ii Aptara Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation, and financial instrument analysis, as well as much more For a list of available titles, please visit our Web site at www.WileyFinance.com JWBT309_FM_pi-xxxiv.qxd 02/04/2011 7:09 PM Page iii Aptara Financial Valuation Applications and Models Third Edition with Website JAMES R HITCHNER John Wiley & Sons, Inc JWBT309_FM_pi-xxxiv.qxd 02/04/2011 7:09 PM Page iv Aptara Copyright © 2011 by James R Hitchner All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products, visit our web site at www.wiley.com Library of Congress Cataloging-in-Publication Data Hitchner, James R Financial valuation : applications and models / James R Hitchner – 3rd ed p cm – (Wiley finance series) Includes index ISBN 978-0-470-50687-5 (hardback); ISBN 978-0-470-91522-6; ISBN 978-0-470-91523-3; ISBN 978-0-470-91524-0 Corporations–Valuation I Title HG4028.V3H583 2011 658.15–dc22 2010048924 Printed in the United States of America 10 JWBT309_FM_pi-xxxiv.qxd 02/04/2011 7:09 PM Page v Aptara To my greatest champion, my dad, Earle R Hitchner, Jr Thank you for instilling in me a work ethic and tenacity that keeps me going I miss you To his sister and my godmother, Aunt Thelma You are simply the best and a true inspiration to all who know and love you To the authors: It has truly been one of the highlights of my career to work with such a wonderful group of professionals Thank you for your perseverance in helping to advance the business valuation profession To my mother, Virginia M Hitchner, who passed away during the final days of editing this book Thank you for sticking by me, always I miss you JWBT309_FM_pi-xxxiv.qxd 02/04/2011 7:09 PM Page vi Aptara Contents About the Editor xvi About the Authors xviii Acknowledgments xxx Preface xxxii CHAPTER Introduction to Financial Valuation Who Values Businesses? Purpose of a Valuation Professional Valuation Organizations Standards of Value Fair Market Value Investment Value Intrinsic Value Fair Value (State Rights) Fair Value (Financial Reporting) Premise of Value Principles of Appraisal Practice Dates Approaches to Value Valuation Procedures Summary Addendum 1—Valuation Checklist/Ready Reference (Revenue Ruling 59-60) Addendum 2—International Glossary of Business Valuation Terms 10 18 CHAPTER Standards of Value Introduction How Standard of Value Can Affect the Final “Number” Premises of Value Common Standards of Value Common Operational Premises Underlying the Standard of Value Application of Specific Standards of Value Fair Value in Shareholder Dissent and Oppression Control Premiums Immediately Before Unless Exclusion Would Be Inequitable Extraordinary Circumstances 27 27 29 30 31 36 38 42 43 44 44 45 vi 1 3 5 5 7 8 JWBT309_FM_pi-xxxiv.qxd 02/04/2011 7:09 PM Page vii Aptara Contents Current and Customary Techniques Standard of Value in Divorce Fair Value in Financial Accounting Measurement Conclusion CHAPTER Research and Its Presentation Obtaining Internal Information A Directive from the Internal Revenue Service Research Techniques and Planning the Search Information Sources: Business Financial Databases Economic Research Selected Sources of Economic Information Industry Research Selected Sources of Industry Information Guideline Company and Transaction Research Sources for Publicly Traded Company Data Guideline Transaction Databases Presenting Research in a Report Other Sources of Information Summary Addendum 1—Valuation Information Request (VIR) General Addendum 2—Management Interview–Operations Addendum 3—Management Interview–Financial Review Addendum 4—Industry Research Form CHAPTER Financial Statement and Company Risk Analysis Historical Financial Statement Analysis Length of Financial History to Be Used Spreading Financial Statements in Columnar Format Adjustments to Financial Statements Normalization of Historical Financial Statements Unusual, Nonrecurring, and Extraordinary Items Nonoperating Items Changes in Accounting Principle Nonconformance with GAAP Tax Affecting the Earnings of Subchapter S Corporations and Other Adjustments Degree of Ownership Interest Normalization Adjustments Common Sizing Normalized Financial Statements Ratio Analysis (Quantitative Analysis) Comparative Analysis Risk Analysis (Qualitative Analysis) Macroenvironmental Analysis Addendum 1—Commonly Used Financial Ratios: Application to Ale’s Distributing vii 45 46 52 52 54 55 55 55 57 61 62 63 64 65 66 66 67 68 68 69 70 76 80 83 85 85 86 86 86 89 89 90 90 91 91 92 92 96 103 104 107 114 115 JWBT309_FM_pi-xxxiv.qxd 02/04/2011 7:09 PM Page viii Aptara VIII CHAPTER Income Approach Fundamental Theory Basics of Income Approach—“A Fraction” Income Approach Methodologies Normalization Process Adjustments for Ownership Characteristics Adjustments for GAAP Departures and Extraordinary, Nonrecurring, and/or Unusual Items Adjustments for Nonoperating Assets and Liabilities and Related Income and Expenses Adjustments for Taxes Adjustments for Synergies from Mergers and Acquisitions Determination of Future Benefits Stream (Cash Flows) Defining the Benefit Stream Defining Net Cash Flow Use of Historical Information The Capitalized Cash Flow Method The Discounted Cash Flow Method Terminal Value Capitalized Cash Flow Method (Revisited) Excess Cash Flow Method Conclusion Addendum I—Application of the Direct Equity Method (DEM) and the Invested Capital Method (ICM) Addendum 2—Dealing With Debt CHAPTER Cost of Capital/Rates of Return Three Variables Characteristics of Cost of Capital Investor Expectations as Quantified by the Cost of Capital Cost of Capital Equals Discount Rate Cost-of-Capital Methods More on the Basic Concepts Discount Rate, Capitalization Rate, and Anticipated Growth Growth Relationship Between Risk and Cost of Capital Types of Risk—Another View Risks in a Small Business Methods for Developing Cost of Capital Size Premiums Methods to Articulate Unsystematic Risk Other Issues Capital Asset Pricing Model Method Development of the Weighted Average Cost of Capital Price/Earnings Method Adjustments to the Price/Earnings Ratio Arbitrage Pricing Theory Risk Rate Component Model FKA Build-Up Summation Model CONTENTS 121 121 122 123 124 124 127 128 129 130 131 131 132 134 139 143 149 156 157 167 168 175 181 181 182 182 183 183 183 184 184 190 193 194 194 202 209 219 221 228 230 232 235 236 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1272 Aptara 1272 Gift tax valuations, 38 See also Estate/gift/income tax valuations Glossary See Terminology Going-concern appraisals, 343 Going-concern value, 6, 36–37, 343 “Good economics.” See also Engagements how it looks, 976–978 key determinants of, 975 operational keys for, 878–980 Goodwill See also Case study, goodwill/intangible assets definition of, 908 enterprise (entity), 50, 833, 834 partnership investments, 724 personal, 49–50, 833, 834 professional practices, 863, 868–869 rate of return and, 165 Revenue Ruling 59-60 on, 648 valuation, case study, 958 Goodwill, divorce and battleground, goodwill as, 832 defining goodwill, 832 double counting, avoidance of, 883 noncompete agreements and, 840 personal/entity, division of, 835–836 personal goodwill, commercial business, 840–841 personal vs entity (enterprise), 833–835 separation of, factor application, 836–839 state interpretations, marital estate, 833 Goodwill, nature of bargain purchase, gain from, 910 calculation of, full acquisition, 909 calculation of, 100% acquisition, 908 calculation of, partial acquisition, 909–910 intangible assets, impairment test, 910–914 present value technique and, 912 reporting units/annual impairment test, 910, 914–915 Goodwill impairment test, 913–914 INDEX Goodwill Registry, 881 Gordon, Myron J., 139 Gordon Growth Model (GGM), 139, 151–155, 177–178, 419 Gow v Commissioner, 771 GPCM See Guideline Public Company Method Grabowski, Roger J., 215–219, 588–589, 591, 593, 1248 Grabowski model benefits of ownership, 614 compared to other models, 625, 626–627 example of, 615 minority interests, valuation of, 615–616 Modifed Traditional Method, 616–623, 624 other Grabowski models, 622–623 summary of, 623–624 Graham, John R., 202, 251 Green, Robert, 236 Green buildings, 348 Greenfield method, 947 Greenwich Associates, 201 Gross domestic product (GDP), 488–489, 1103, 1224–1226, 1252 Gross method, PTEs and, 577 Gross profit margin, 119 Gross v Commissioner, 575, 771–772, 774, 785 Growth rates, 1252 Growth ratios, 120 Guenther, David, 583 Guideline companies See also Guideline public companies financial/other indicators, 277–278, 280 growth and, 278 industry classifications, 264–265 sample size and, 279 size and, 277–278 sources, other, 266 subject company and, 264 subject company management, 265 Guideline Company Transaction Method (GCTM) advantages/disadvantages of, 269–270 business valuation and, 858–860, 1260 “comps” and, 259 databases of transactions, 1253–1255 for early-stage technology companies, 1051 in healthcare industry, 1121–1122 SIC classifications and, 508 Guideline multiples adjusted multiple and, 304–305 base multiples, adjusting, 306 base multiples, adjusting variations, 306–308 guideline company data, 305 Guideline public companies, 66–67, 378 Guideline Public Company Method (GPCM), 259, 1050–1051, 1223, 1233, 1256–1259, 1260 Hall, Lance S., 393, 409, 410 Hamada, Robert, 225–226 Hamby v Hamby, 47 Hanlin, William A., Jr., 236–237 Harper, John C., Jr., 416 Harris, William, 408–409 Harvey, Campbell R., 202 Healthcare industry attributes acute care hospitals, 1105 aging population/cost containment, 1106–1108 antikickback laws, 1110–1112 asset approach, 1122 basics of valuation, 1116–1117 control premiums/minority discounts, 1122–1124 DLOM and, 1124 fragmentation, 1104–1105 income approach, 1117–1119 investment value and, 1114–1115 IRS private inurement/private benefit, 1113–1114 market approach, 1120–1122 physician factor, 1108–1110 physician services, 1105 size, 1103–1104 standard of value, 1114 Stark Law, 1112–1113 Healthcare industry businesses See also Medical practices; Paulie Hospital valuation; Rocky Surgery Center, L.P considerations, valuation, 1115–1116 industry background/transition, 1100–1103 reimbursements and, 1108, 1118, 1119 terminology in, 1097–1100 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1273 Aptara 1273 Index Healthcare industry niches ambulatory surgery centers, 1128–1130 diagnostic imaging centers, 1120–1132 dialysis centers, 1132–1133 hospitals/health systems, 1125–1127 key issues in, 1123–1125 physicians/physician groups, 1127–1128 private/public services companies, 1133–1135 Hedging strategies, 1044 “Held for sale” security, 909 Held v Held, 50, 872 Herz, Robert, 968, 969 Hidden costs, 228–229 Highest and best use, 344 Hiring/training costs, 937–939 Historical cost, 309–310 Historical data, economic benefits current earnings method, 134 formal projection method, 138–139 simple average method, 134–135 trend line-static method, 136–138 weighted average method, 135–136 Historical financial statement, 85–86, 89, 1242 Hitchner study no 1, 387–388 Hitchner study no 2, 388–389, 390 “H” model, terminal period and, 152, 153 Holbrook v Holbrook, 833 Holding companies built-in gains taxes and, 327–328 as partnerships, 335–338 as S corporations, 333–339 Holman vs Commissioner, 718–719 Hooke, Jeffrey C., Hoovers.com, 67 Horizon risk, 190 Hospital’s acquisition of medical practice, 865–866 Howell v Howell, 834 Hyden, Steve, 895 Hypothetical conditions, 559, 1218 IAS See International Accounting Standards (IAS) IBA See Institute of Business Appraisers (IBA) IBA databases, 67, 267–268 Ibbotson, Roger, 197, 198, 199, 205, 1247 Ibbotson Associates, 197, 205–206 Ibbotson industry risk premia CAPM in a build-up wrapper, 245–246 Duff & Phelps, reconciling, 219, 220 market equity, 247 reporting period for data, 219, 221 using the, 206–209, 1218, 1248, 1250 Ibbotson Industry Risk Rates, 1209 Ibbotson SBBI Valuation Yearbook, 197 Ibbotson Stocks, Bonds, Bills, and Inflation Valuation Yearbook (SBBI), 304 IBD See Interest-bearing debt (IBD) Ibisworld.com, 66 IC See Invested capital (IC) ICM See Invested capital method (ICM) Immediately before, 44 Impairment test, 910, 914–915 Incentive stock option (ISO), 1074–1975 Income approach adjustments, GAAP departures, extraordinary, nonrecurring and/or unusual items, 127–128 adjustments, nonoperating assets and liabilities and related income and expenses, 128–129 adjustments, ownership characteristics, 124–127 adjustments, synergies from mergers & acquisitions, 130 adjustments, taxes, 129–130 benefit stream, defining, 131–132 CCF method, 139–142, 156–157, 1239–1245 conclusion on, 167 control and, 378–380 DCF method, 143–149 early-stage companies and, 1053–1056 ECF method, 158 FLP valuation using, 727–728 four types of analyses of, 133 fundamental theory behind, 121–122 future benefits stream determination, 131 healthcare industry and, 1157 historical information, use of, 134–139 intangible assets and, 966 machinery/equipment, 358 methodologies, 123 net cash flow, defining, 132–133 normalization process for, 124 numerator/denominator and, 122–123 for professional practices, 879–880 for small businesses, 856–857 tax court case and, 778–779 terminal value, DCF and, 149, 151 Income approach, valuation report sample factors affecting capitalization rate selection, 500–502 income capitalization method, 499–500 MCAPM, 503–504 normalized NCF/capitalization rate, derivation of, 502–503 summary of value, 100% minority interest, 505–506 WACC, 504–505 Income capitalization approach, 345–346 Income statements, 1230–1231 Income taxes charitable contributions of property, 677–678 conversion of property, 678–681 pre-personal, 591 S corporations, built-in gains, 681 undervaluation, appraisal penalties, 681–683 valuations for, 676–683 Income tax valuations See Estate/gift/income tax valuations Income vs cash flow, 1244 Indirect gifts, 704 Industry codes, 58 Industry conduct, 110–111 Industry Premia Company List Report, 208 Industry-related risk, 192 Industry research, 64–66, 83 Industry structure analysis, 107–110 Information access/reliability discount, 426 Information display, 281–285 Information technology (IT), 935 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1274 Aptara 1274 Initial public offering (IPO) IPO studies, 382, 389–391, 510, 514–515, 728 restricted stock valuations and, 1041–1042 In-process research and development (IPR&D), 895, 903–904, 951, 952, 953 Input levels, 53 Inputs: observable/ unobservable, 966–967 In re Dissolution of Midnight Star Enterprises, 41, 46 Huff, 51 Marriage of Lopez, 49–50 Institute of Business Appraisers (IBA), 1, 268, 552–553, 843, 859, 860, 1253, 1254–1255 Institutional Investors Study, 660 Intangible assets See also Case study, goodwill/intangible assets; Fair value, intangible assets; Stock options/share-based compensation business combinations, 899–901 definition of, 895–896 difficulty in measuring, 896–897 financial reporting disclosures, 915–916 goodwill (see Goodwill, nature of) identification/classification of, 897–898 measurement of, 898–899 nature of, 897 net tangible assets, 162 real property and, 1012 recognition of, 903 weighted average return on assets (WARA), 959–960 Intangible assets valuation issues See also Valuation of intangible assets acquisition method, 901–903 amortization benefit, 905–906 goodwill (see Goodwill, nature of) in-process R&D, 903–904 present value considerations, 907 returns on/of contributory assets, 906–907 tax effects, 904 Integra Information Benchmarking Data, 65 INDEX Integrated Theory of Business Valuation (ITBV), 607, 608 Intellectual property, 971–974, 1094 Interest-bearing debt (IBD), 155, 168, 175, 178, 321–322, 323–324 Interest rate risk, 190 Internal information, obtaining, 55 Internal rate of return (IRR), 156, 345 Internal Revenue Code (IRC) closely held companies, 639–640 “Investment Company” provisions, 704 IRC chapter 14, FLPs and, 712–719 Section 2036, 740–741, 777 Section 2703 of, 1020 Section 415 limits, 818 Section 754, 336, 337–339, 584, 700 special valuation guidelines, 641 Subchapter K, 335 valuation date, 640 Internal Revenue Service (IRS) See also Revenue Rulings, by number directive from, 55–57 Internal Revenue Bulletins of, 744 valuation industry and, 554 International Accounting Standards (IAS), 351–352 International Accounting Standards Board (IASB), 555 International Financial Reporting Standards (IFRS), 351, 352, 555 International Glossary of Business Valuation Terms, 4, 5, 6–7, 18–25, 380, 545 International Revenue Code of 1954, 363 International Valuation Standards (IVS), 966 International Valuation Standards Council, 896 Internet search strategy, 59–60 Intrinsic value, 5, 34–36 In use value, 342 Inventory, 930 Inventory turnover, 116 Invested capital (IC), 174, 292–293, 1244–1245 Invested capital method (ICM) DEM application and, 168–172, 173–174 iteration processes and, 172–173 overview, 168 Investment, 121–122 Investment, Financing and Valuation of the Corporation, The (Gordon), 139 Investment company discount, 428 Investment value, 5, 33–34, 342 Investment yield, partnerships and, 726 Investor’s discounted cash flow models, 416–417 IPO See Initial public offering (IPO) IPR&D See In-process research and development (IPR&D) IPR&D Practice Aid, 903–904, 954 IRC chapter 14, FLPs and Section 2701, 712–713 Section 2703, 713–715, 717, 719 Section 2704, 715–717 IRR See Internal rate of return (IRR) IRS See Internal Revenue Service (IRS) IRS Appeals Officer Manual, 578 IRS BV guidelines checklist, 565–572 IRS Private Letter Ruling 7905013, 162 IRS Revenue Procedure 77-12, 315 IRS Revenue Rulings, 29 See also Revenue Rulings, by number Irving Levin and Associates Healthcare M&A report, 1121, 1125, 1132 ISO See Incentive stock option (ISO) IT See Information technology (IT) ITBV See Integrated Theory of Business Valuation (ITBV) IVS See International Valuation Standards (IVS) Jalbert, Terrance, 582–583 Janda v Commissioner, 760 J C Shepherd v Commissioner, 777 Jeffrey L Okerlund et al v United States, 754, 767 Johann and Johanna Hess, 750, 765–766, 778–779, 782 Johnson Study, 406 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1275 Aptara 1275 Index Jones v Commissioner, 702–703 Journal of Finance, 421, 1045 Kanjorski, Paul E., 968 Karam, Yassir, 586 Key person, 481 Key person discount, 427–428, 783–784 Keyvaluedata.com, 69 King, David, 215–219, 1248 Knowledge capital, 1058 Knox v Taylor, 1001 Labels, new, 369 Lack of control/marketability discount, 745–760, 1259–1260 Lack-of-diversification discount, 430 Lack of marketability (LOM), 1033 Lang, Eva, 1095 Law practices, 866–867, 888–890 Lawson Mardon Wheaton, Inc v Smith, 800, 801, 805 Leadership in Energy and Environmental Design (LEED), 348 LEAPS See Long-term equity anticipation securities (LEAPS) Leased fee estate, 342 Leasehold estate, 342 LeBeau v M.G Bancorporation, Inc., 794 Lee, Mark M., 314 LEED See Leadership in Energy and Environmental Design (LEED) Legal matters See Damages; Litigation LEGGO See Valuation Views (VV) Lev, Baruch, 897, 898 Levels of inputs, 53 Leverage ratios, 117–118, 1236 Lewis, Howard, 552 Lexisnexis.com, 61–62 Liabilities, 52, 315, 321–324, 1232 Licensor/licensee See Intellectual property “Lifing,” 922 LIFO (last in, first out), 90 Limited partnerships, 722–724 Limiting conditions, valuation report, 523–526 Lindquist, J Peter, 416 Liquidation costs discount, 426–427 Liquidation value, 6–7, 37 Liquidity, 368, 381–382 Liquidity ratios, 115, 1233–1234 LiquiStat, 407–408 Litigation, 455, 545, 1013 See also Attorney; Damages; Estate of Litigation services’ engagements, 985–987 LLCs, 576, 582 Local economy, 1227–1228 Logos See Trade names/trademarks LOM See Lack of marketability (LOM) Longstaff, Francis A., 421, 1045–1046 Longstaff upper bound lookback put option model, 421 Long-term debt-to-equity ratio, 118 Long-term equity anticipation securities (LEAPS), 420–421, 1062 “Look-back” approach, 985 Lopez v Lopez, 835 M&E See Machinery and equipment (M&E) M&M theorems, 175 M&TS See Machinery & Technical Specialties Committee (M&TS) Machinery & Technical Specialties Committee (M&TS), 349, 350 Machinery and equipment (M&E), 320 Machinery and equipment (M&E) appraisals assumed earnings, 358–360 construction in progress (CIP), 360 cost approach, 352–353 cost/capacity method, 354 depreciation/obsolescence, 355 direct unit pricing method, 353–354 finding an appraiser, 349–350 identifying/reporting assets to be appraised, 352–353 income approach, 358 in-use or in-exchange value, 931 physical depreciation, 355–358 purpose of, 349 sales comparison (market) approach, 358 SAS 73/101, 360–362 standard/premise of value, 350–352 trending method, 354 Macroenvironment, 114, 192 MACRS See Modified Accelerated Cost Recovery System (MACRS) Maher, Michael J., 396–397 Making money See Three Ms Management See Three Ms Management interview accounting practice, 891–893 law practice, 888–890 medical practice, 884–887 Management interview—financial review, 80–82 Management interview— operations, 76–79 Mandelbaum v Commissioner, 39–40, 755–756 Mard, Michael, 895 Marital dissolution See Divorce valuation Marketability degree of, 369 discounts, controlling interest, 381–382 factors influencing, for investment, 423–425 lack of, discount for, 422–423, 510–513 liquidity and, 368 Marketability discounts, empirical evidence Emory studies, 383–385, 387, 390 Hitchner study no 1, 387–388 Hitchner study no 2, 388–389, 390 IPO studies, 382, 387, 389–391 overall observations of studies, 410–411 restricted stock studies, 391–411 Willamette Management Associates studies, 386–387, 390 Marketable basis, 312–313 Marketable illiquid, 368, 369 Marketable securities, 318, 929–930 Market absorption discount, 428–430 Market approach See also Guideline Company Transaction Method; Guideline Public Company Method JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1276 Aptara 1276 Market approach (Continued) advantages of, 262–263 “comps” and, 272, 279, 291 disadvantages of, 263 equity vs invested capital, 292–293 financial/other indicators, 277–278, 280 financial statement measures, 293–295 guideline companies and, 263–266, 269–270, 1050–1051 guideline multiples, size adjustments, 304–308 healthcare industry and, 1157 implementation, basic, 266 information, displaying of, 281–285 information sources, 267 intangible assets and, 966 overview, 259–261 price to parameter, matching, 296–297 pricing multiples and, 291–292, 297, 298, 301–304 for professional practices, 880–881 publicly traded companies, 270–272, 273–277 sample size matters, 279 stock prices/shares outstanding, 272–273 subject companies and, 280, 286–288 tax court case and, 778 transaction databases, 267–269 valuation multiples and, 296, 297, 299–300 value and, 261–262, 300–301, 308 Market capitalization, 723 Market indices, 191 Marketing See Three Ms Market interest rates, 1025–1026 Market participants, 53 MarketResearch.com, 65 Market risk, 190 Market value added (MVA), 1091 Market value of shareholders’ equity (MVEq), 291, 292 Market value to invested capital (MVIC), 508, 859 Mark-to-market accounting, 968–970 Markowitz, Harry, 221–222 Marshall Valuation Service, 355 Martin Ice Cream v Commissioner, 841 INDEX Master limited partnerships (MLPs), 582 Matter of Slant/Fin Corp v the Chicago Corp., 794 Mattson, Michael J., 584–585, 586–587, 588 Maturity risk, 190 May v May, 50 MCAPM See Modified Capital Asset Pricing Model (MCAPM) “Mean reversion” theory, 199 Measurement of amount of discount for lack of marketability, 422–423 date, damages and, 1003–1004 fair value and, 52–53 principle, fair value and, 919 Medical practices, 864–866, 884–887 See also Healthcare industry businesses Medical Practice Valuation Guidebook (Dietrich), 865 Medicare/Medicaid, 1104, 1107, 1110, 1112, 1118, 1132 Mellinger v Commissioner, 758 Mercer, Z Christopher, 379–380, 417, 418–419, 593 Mercer Capital Management, 69 Mercer model See also Quantitative marketability discount model (QMDM) compared to other models, 625–626 economic distributions greater than tax liability, 609, 611 ITBV and, 607, 608 no distributions/dividends, 609 noncontrolling interests, valuation of, 607–610, 611 qualitative arguments, 606 summary of, 614 value vs proceeds, 606–607 Mergentonline.com, 66 Merger and acquisition activity (M&A), 130, 858, 1100–1102 Mergerstat data sets, 68, 268, 377, 1254 Mergerstat Review, 233, 1121 Merrill Lynch Quantitative Profiles, 201 Michael T Caracci and Cindy W Caracci et al v Commissioner, 786 Microcap quintile, 244 Miles, James A., 226–228 Miles, Raymond, 267, 543, 552 Miles-Ezzell formulas, 226–228 Miller, Merton, 175, 226 Miller, Warren, 213, 1207 Minority cash flow, 1241 See also Cash flow (CF) Minority interest return, 221 Minority position, limiting risk of appraisal rights, 374 judicial remedies, 374 public market liquidity, 373 rights/restrictions through agreements, 373–374 Minority valuation control adjustments and, 127 Modified Traditional Method, 615, 616–623, 624 Minority vs control cash flows, 1241 MLPs See Master limited partnerships (MLPs) MLS See Multiple Listing Service (MLS) Modified Accelerated Cost Recovery System (MACRS), 925 Modified Capital Asset Pricing Model (MCAPM) vs build-up model, 1245–1246 formula for, 223 income approach and, 880 in sample valuation report, 503–504 simplified relation, 246 unsystematic risk and, 222 Modified Gross Method, 622–623, 624 Modified Traditional Method, 616–623, 624 Modigliani, Franco, 175, 226 Monte Carlo simulations, 422 Moretti v Moretti, 834 Morningstar databases, 67, 205, 730, 736, 738 Moroney, Robert E., 398 Morris, Katherine E., 240–258, 387–389 Morrison, William S., 802, 870 Most advantageous market, 52–53 MPEEM See Multiperiod excess earnings method (MPEEM) MPI restricted stock studies, 402 MRI Radiology Assocs v Kessler, 841–842 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1277 Aptara 1277 Index Multiperiod excess earnings method (MPEEM), 906–907, 921–922, 937, 945, 947, 950, 951, 954–955 Multiple Listing Service (MLS), 259 Munters Corporation v Swissco-Young Industries, Inc., 1001 MVA See Market value added (MVA) MVEq See Market value of shareholders’ equity (MVEq) MVIC, 291, 292, 293, 296, 299 See Market value of invested capital (MVIC) NACVA See National Association of Certified Valuation Analysts (NACVA) NAICS See North American Industry Classification System (NAICS) NAREIT See National Association of Real Estate Investment Trusts (NAREIT) NASDAQ See National Association of Securities Dealers Automated Quotation System (NASDAQ) Nath, Eric, 378 National Association of Certified Valuation Analysts (NACVA), 1, 236, 553–554, 843 National Association of Real Estate Investment Trusts (NAREIT), 731 National Association of Securities Dealers Automated Quotation System (NASDAQ), 244, 270 National Business Valuation Standards, 28 National economic reviews, 63, 1224–1226 NAV See Net asset value (NAV) NCF See Net free cash flow to overall invested capital (NCF) Net asset value (NAV), 732 Net asset value method, 508–509 Net cash flow, 131–133 See also Cash flow (CF) Net fixed assets to equity, 1236 Net free cash flow to overall invested capital (NCF), 500 Net income, 131 Net operating income (NOI), 346 Net operating profit less applicable taxes (NOPLAT), 153, 154 Net realizable value (NRV), 930 Net tangible assets, 162 New York Stock Exchange (NYSE), 191, 223, 244, 270, 1063 NOI See Net operating income (NOI) Noncompete agreements, 779, 840, 941, 944–945, 946, 948–949 Noncontrolling interests, levels of, 374, 375–377 Noncontrolling interests in pass-through entities distributions, amount/timing of, 625 Grabowski model, 614–624 holding period, 625–626 Mercer model, 606–611 minority/marketability discounts, 626 overview of, 593 QMDM, 611–614 retained net income, 625 step-up of basis and, 626–627 summary of, 624–625 tax rates and, 626 Treharne model, 594–598 Van Vleet model, 598–606 Nonhomogeneous assets discount, 430 Nonmarketable basis, 312 Nonoperating assets/liabilities, 289, 1179, 1197, 1241–1242 Nonoperating income/expense, 286–287 Nonoperating items, 90, 128–129, 519 Nonqualified stock option (NSO), 1074, 1075–1076 Nonrecurring clients, 875 Nonrecurring items, 89, 90, 128, 288 NOPLAT See Net operating profit less applicable taxes (NOPLAT) Normalization adjustments, 92–96 “big five,” income approach and, 124 common sizing normalized financial statements, 96–102 depreciation and, 1243 of historical financial statements, 89 North American Industry Classification System (NAICS), 58, 264, 271, 459, 972, 1172 NRC See Nuclear Regulatory Commission (NRC) NRV See Net realizable value (NRV) NSO See Nonqualified stock option (NSO) Nuclear Regulatory Commission (NRC), 487 NYSE See New York Stock Exchange (NYSE) OAR See Overall cap rate Obama administration, 1103, 1108 Obsolescence See Depreciation Okerlund et al v United States Federal Circuit, 765, 781–782 Olson v Neiman’s, Ltd., 1001 Omnibus Budget Reconciliation Act, 712, 1011, 1112 Onesource.com, 62, 67 Open-end funds, 729 Operating companies asset approach and, 312 built-in gain taxes, 326–327, 330–331 Operating expenses, 1231 Operating profit margin, 119 Operating segment, 910 Operational keys, good economics and marketing/sales results, 978 planning/communication, 979 proactivity, 978 Opportunity cost, 123, 1094 Oppressed shareholders, 42–43, 781–782 Option pricing models factors influencing marketability of investment, 423–425 Longstaff upper bound lookback put option model, 421 long-term equity anticipation securities (LEAPS), 420–421 marketability discount and, 419–420 measuring amount of discount for lack of marketability, 422–423 protective put analyses, 421–422 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1278 Aptara 1278 Organization costs, 931 Organizations, business appraisal and, 545 OTC See Over-the-counter (OTC) markets Overall cap rate, 347 Over-the-counter (OTC) markets, 392, 1063 Owners’ compensation, 287–288 Ownership interest, 92, 374, 375–377 Partnership Profiles, 731, 739 Partnerships See also Family limited partnership (FLP) asset approach and, 314 as flow-through entities, 699 holding companies organized as, 335–338 nature of control in, 582 Paschall, Michael, 578 Pass-through entities (PTEs) asset approach and, 314 benefits, summarized, 637 bibliography, 627–630 buildup in basis, benefit of, 625, 636 controlling interests in, 580–582, 589–591 controlling-interest studies, 582–590 debate, status of, 576–580 dividend tax avoidance, 634–635 divorce valuation, 841–842, 845 Grabowski model, 614–624 introduction to, 573–574 Mercer model, 606–611 noncontrolling interests, 593, 624–627 QMDM model, 611–614 questions to consider, 634 standard of value, 574–575 stepped-up basis and, 584, 586 summary approach to, 631–638 taxes and, 578–580, 593 tax rate and, 591–593 Treharne model, 594–598 Van Vleet model, 598–606 Pass-through firms (PTFs), 582 Paulie Hospital valuation asset approach, 1169–1170 engagement, 1156–1159 income approach, 1167, 1169 market approach, 1159–1167 value indication, 1167, 1168 INDEX PCAOB See Public Company Accounting Oversight Board (PCAOB) PCE See Personal consumption expenditures (PCE) P/E multiples, 1258 Pension Protection Act of 2006 (PPA), 682–683 Personal consumption expenditures (PCEs), 489 Personal goodwill, 49–50 See also Goodwill Peters, Jerry O., 233–234 Peterson, Brian K., 414 Peter S Peracchio, 747–749 PFI See Prospective financial information (PFI) PGI See Potential gross income (PGI) Phillips, John R., 587–588, 614 Physical deterioration, machinery, 355 Pinkerton, Keith, 214 PIPE See Private investment in public equity (PIPE) Pittock, William F., 395–396 Pittsburgh Terminal Corporation v The Baltimore and Ohio Railroad, 44 Planning, 979 PLRs See Preliminary loss reports (PLRs) Polacek, Timothy G., 393 Porter, Michael, 107, 192, 209 Porter Model, 107–110, 483–484 Portfolio diversification, 724 Potential gross income (PGI), 346 PP&E, 351 PPA See Pension Protection Act of 2006 (PPA) Practice Aide Series, 1058 Pratt’s Stats, 67, 267, 268, 587, 588, 589, 858, 859, 860, 1121, 1253, 1254 Preferred stock approach to valuation, 668–669 early stage companies, 1034, 1051 features of, 1028–2030 illustration: Yaboo, Inc., 1033–1034, 1035–1038 introduction to, 1027–1028 issues, other, 1032–1033 tax court case and, 784 valuation methods, 1030–1032 Preliminary loss reports (PLRs), 68 Premise of value asset approach, 312 machinery & equipment (M&E), 350–352 real estate appraisal, 342–344 sample valuation report, 471 standards of value, 30 types of value, 6–7 Premiums See Valuation discounts/premiums Prepaid expenses, 319, 320, 930 Pre–personal income taxes, 591 Presentation of information, 281–285 Pretax Discount Rate method, 622, 623 Price determination of, 38–39, 52 parameter and, 296–297 Price/earnings (P/E) method cap rates, discount rates, P/E multiple, 230–232 market-derived P/E multiples, 232 Price/earnings (P/E) ratio, adjustments to company-specific adjustments, 233 growth/size factors, 233–234 public company adjustments, 232–233 size/company-specific risk adjustments, 234–235 Pricing multiples calculation of standard, 291–292 dispersion of, 297, 298 Pricing multiples, growth and adjusted multiple, calculating, 303–304 blended growth, computing, 302–303 growth estimates, 301–302 income approach, reconciliation, 304 mathematics behind adjustment, 301 Principal market, 52–53 Principles of Corporate Governance, 42, 44 Private investment in public equity (PIPE), 408 Privately held stock options, 1073–1076 Professional practices accounting, 867, 891–893 architecture/engineering firms, 867 asset approach, 879 dental, 866 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1279 Aptara 1279 Index excess cash flow (earnings) method, 882 factors affecting (see Professional practices, factors affecting value) financial statements (see Professional practices, financial statement adjustments) goodwill, professional/practice, 863, 868–869 income approach, 879–880 law, 866–867, 888–890 marital dissolution and, 869–872, 883 market approach, 880–881 medical, 864–865, 884–887 overview, 863–864 purpose of valuation, 868 rules of thumb, 882 summary of, 882–883 Professional practices, factors affecting value age/health of professional, 873 clients/patients, types, 874–875 earnings and/or cash flow, 872 location, 875 professionals/competition, supply of, 875 qualifications/work habits, 873 referrals/client persistence and, 874 specialty/fees schedule, 873 summary of, 875–876 transfer of clients, 875 workforce, trained/assembled, 873–874 Professional practices, financial statement adjustments accounts payable/accruals, 878 accounts receivable, 876–877 contingent liabilities, 879 deferred liabilities, 878 equipment, 877 inventory, 877 long-term debt, 878–879 unrecorded assets, other, 877–878 Professional valuation organizations, Profitability ratios, 118–119, 1236–1237 Profit margin, 977 Promissory notes, 823 Prospective financial information (PFI), 925 Protective put analyses, 421–422 PTEs See Pass-through entities (PTEs) PTFs See Pass-through firms (PTFs) Public Company Accounting Oversight Board (PCAOB), 969 Public company valuations changing face of, 1007–1008 financial reporting requirements, 1008–1013 litigation services, 1013 management consulting, 1012–1013 tax planning/compliance, 1010–1012 Publicly traded companies advantages/disadvantages, data and, 273 characteristics of, 273–277 data sources, 66–67 financial statement data on, 270–271 periodicity of data, 272 restatement of data, 272 standardization of data on, 271 stock prices/shares outstanding, 272–273 Public-market returns, 592 Purina Mills, LLC v Less, 1000 Put rights, 822–824 QMDM See Quantitative marketability discount model (QMDM) Qualifications, analyst/appraiser, 527 Qualitative analysis (risk analysis), 107–113 Quality improvement, 980 Quantifying Marketability Discounts, 417 Quantitative analysis (ratio analysis), 103–104 Quantitative marketability discount model (QMDM), 417–419, 607, 611–614, 728 Quantitative tools investor’s discounted cash flow models, 416–417 option pricing models, 419–420 quantitative marketability discount model (QMDM), 417–419 Quasi-controlling position, 375 Quick (acid-test) ratio, 115, 1234 Radio broadcasting industry, 1184–1190 Rate of return See also Cost of capital asset/entity risk and, 143 intangible assets and, 899, 932–933, 955 Rate of return ratios, 119–120 Rate spread, change in, 196–197 Rate structure, 976–977 Ratio analysis (quantitative analysis), 103–104 Raymond J Martin et al., 762–763 Real estate, 1225–1226, 1227 Real estate appraisals cost approach, 344–345 direct capitalization analysis, 346 discount rate determination, 346–348 finding an appraiser, 341 highest and best use, 344, 931 income capitalization approach, 345–346 intangible assets and, 1012 interests, types of, 341–342 sales comparison approach, 345 standard/premise of value, 342–344 USPAP, reports under, 340–341 valuation standards/regulations, 340 Real estate investment trusts (REITs), 731, 749–750, 1033–1034, 1035–1038 Real estate limited partnerships (RELPs), 731 Real estate/real property, 320 Real Estate Research Corporation (RERC), 347 Real option valuations DCF, limitations of, 1081 financial options, 1084–1086 flexibility, 1082–1083 introduction to, 1080–1081 other techniques used in, 1086–1087 real options defined, 1083 uncertainty, 1082 Real property, 705 See also Real estate appraisals Reasonable knowledge, 40 Recognition Principle, fair value and, 919 Recruiting costs, 937 Recurring clients, 875 Regional economic data, 1226–1227 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1280 Aptara 1280 Regulatory environment, healthcare, 1110–1115 Reilly, Robert F., 922, 934, 935 REITs See Real estate investment trusts (REITs) Relationship checking process, 982 Relief from royalty method, 950–951 RELPs See Real estate limited partnerships (RELPs) Remaining useful life analysis, 922 Reporting exemption, 560 Reporting unit impairment test and, 914–915 intangible assets, goodwill and, 910–914 Report writing See also Valuation report sample sections in report, 453–462 USPAP engagements, 451–452 valuation engagements/related reports, 452–453 Representation, 521–522 RERC See Real Estate Research Corporation (RERC) Research and development (R&D), 903–904 Research/presentation of economic research, 62–64 guideline company/ transaction research, 66–68 industry research, 64–66, 83 information sources, other, 68–69 internal information, obtaining, 55 IRS directive, 55–57 management interview— financial review, 80–82 management interview— operations, 76–79 techniques/search plan, 57–61 valuation information request, 70–75 in valuation report, 68 Resource flexibility, 979 Restaurant industry, 1202–1212 Restricted securities, 660–661 Restricted Securities Trading Network (RSTN), 407 Restricted stock(s) attributes of, 512 definition/types of, 1039–1040 registering/monetizing of, 1044–1045 INDEX Revenue Ruling 77-287 and, 380 valuation, 662–668 Restricted stock studies Arneson, 399–401 Columbia Financial Advisors, Inc (CFAI), 406–407 criticism of, 409–411 definition of, 382 detailed studies, 411–416 discounts, lack of marketability, 515–516 factors with most explanatory power, 402–403 factors with some explanatory power, 404–405 FMV Opinions Study, 405 Gelman, 397–398 Hall and Polacek, 393 Johnson, 406 Maher, 396–397 Moroney, 398 MPI restricted stock studies, 402 restricted stock studies, other, 392–393 restricted stock valuation, 391 Revenue Ruling 77-287, 391–392, 511–512 revenue rulings and, 1041 SEC institutional investor study, 392 Silber, 394–395 Stryker and Pittock, 395–396 Trout, 398–399 Trugman Valuation Advisors, Inc (TVA), 408–409 Willamette Management Associates study, 401 Restricted stock valuation documents/factors to consider, 1042–1043 dribble-out period, 1045 introduction to, 1034 methodologies for, 1043–1045 reasons for, typical, 1041–1042 Rule 144 restrictions, 1040–1041 stock price volatility and, 1045–1046 Restricted Use Appraisal Report, 452, 550 Restrictions, 560 Restrictive agreement discount, 425–426 Restrictive agreements, Revenue Ruling 59-60, 651–659 Retainers, 982–983 Return-on-assets ratio, 1237 Return on equity, 119 Return-on-equity ratio, 1237 Return on invested capital (ROIC), 154, 1091 Return on investment, 119 Return on shareholders’ equity model, 112 Return on total assets, 120 Revenue Procedure 77-12, 363–364 Revenue Reconciliation Act of 1993, 1074 Revenue Ruling 59-60 asset approach and, 310–311, 313 book value/financial conditions, 647 capitalization rates, 650–651 checklists for valuation, 10–17 closely held stock valuation, 1222–1223 company stock, past sales, 648–649 dividend-paying capacity, 648 earning capacity of company, 647–648 economic/industry outlook, 646–647 external data and, 56–57 factors, average of, 651 factors, weight accorded to, 650 factors to consider, 646–649 fair market value and, 4, 162 future financial performance, 645 information to be considered, 645 intangible assets, 648 investment company discount, 428 key person/thin management, 427 market approach, closely held companies, 646 market price of stocks of guideline publicly traded companies, 649 nature/history of business, 646 restrictive agreements, 651–659 risk assessment, 455–456, 459, 645–646 sample valuation report, 464, 471, 472 standard of value, 644–645 valuation, approach to, 644 Revenue Ruling 68-609, 159–160 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1281 Aptara 1281 Index Revenue Ruling 69-545, 1113 Revenue Ruling 77-287 marketability and, 380 overview of, 659–660 restricted securities, facts/circumstances material to, 661 restricted securities, securities industry practice in, 660–661 restricted security types, 1039 restricted stock studies, 511–512 restricted stock valuation, facts/circumstances material to, 662–668 restricted stock valuations and, 1042 Revenue Ruling 83–120 common stock and, 669–673 introduction to, 668 preferred stock and, 668–669, 1030, 1031 Revenue Ruling 93-12, 674–676 Revenues, 1230–1231 Revised Model Business Corporation Act (RMBCA), 42, 46, 792 Ridgely v U.S., 41 Right fit, 977 Risk beta and, 190–191 in construction industry, 1180–1181 cost of capital and, 190–193 definition of, 190 in radio broadcasting, 1190 in restaurants/bars/nightclubs, 1214–1215, 1206–1207 Revenue Ruling 59-60 and, 455–456, 459 types of, 193–194 Risk analysis (qualitative analysis) DuPont Model, 111–112 McKinsey 7-S Model, 110–111 other company considerations, 113 Porter Model, 107–110 S.W.O.T Analysis, 112 Risk-free rate (Rf), 195–196, 1246, 1247 Risk Management Association (RMA), 103, 459, 1195 Risk premiums, 1247–1249 Risk rate component model FKA, 236–237 RMA See Risk Management Association (RMA) RMBCA See Revised Model Business Corporation Act (RMBCA) Robak, Espen, 407 Robertson v Commissioner of Internal Revenue, 786 Robert T and Kay F Gow v Commissioner, 756 Rocky Surgery Center, L.P asset approach, 1153 discounts, 1153–1155 engagement, 1136–1141 income approach, 1141–1151, 1152 market approach, 1151, 1152–1153 reconciliation, 1153 ROE Model, 112 ROIC See Return on invested capital (ROIC) Ross, Stephen, 1068 Royalty payments, 950–951 Royalty rates, 921, 940, 971–974 See also Intellectual property RSTN See Restricted Securities Trading Network (RSTN) Rubinstein, Mark, 1068 Rule 144/144A Columbia Financial Advisors and, 406–407 in detailed studies, 411, 412, 413 dribble out provisions, 515, 1045 LiquiStat, 407–408 restrictions, 1040–1041, 1053 Rules of thumb, 295, 559, 860, 882, 985, 1183, 1210–1211, 1216 S&L See Savings and loan (S&L) crisis SAAR See Seasonally adjusted annual rate (SAAR) Sales comparison (market) approach, 345, 358 Sales to net working capital, 116 Sanders, Jack R., 67 Sarbanes-Oxley Act (SOX), 1008 SAS See Statement of Accounting Standards (SAS) Savings and loan (S&L) crisis, 543 SBBI Valuation Yearbook, 204, 208, 245 Schapiro, Mary, 969 Scholes, Myron, 1065 Schweihs, Robert P., 922, 934, 935 S corporation economic adjustment (SEA), 601–602 S corporation income stream (NEBS), 601–602 S corporations asset approach and, 314 built-in gains for, 681 Congressional establishment of, 576 divorce valuation, 841–842 ESOPs and, 810–811, 823 FLPs and, 699 holding companies organized as, 333–339 tax-affecting, 91–92, 1220 Tax Court cases, 579–580, 773–774 valuation of, 573 S corporation equity adjustment multiple (SEAM), 601–606 SDC Platinum, 68 SEA See S corporation economic adjustment (SEA) Seagate Technology, Inc., v Commissioner, 786 SEAM See S corporation equity adjustment multiple (SEAM) Seaman, Ronald M., 420 Search strategy, Internet, 59–60 Sears, Gerald A., 401 Seasonally adjusted annual rate (SAAR), 489 SEC See Securities and Exchange Commission (SEC) Section 197 amortization, 925 Section 415, 818 Section 754 election, 336, 337–339, 584, 700 Securities and Exchange Commission (SEC) ESOPs and, 810 fair value and, 6, 52 Institutional Investor Study, 392, 1042 restricted securities and, 660 Rule 144/144A, 406–407, 411, 412, 413 Web site, 270 Security Analysis on Wall Street: A Comprehensive Guide to Today’s Valuation Methods (Hooke), Self-Contained Appraisal Report, 452 Self-developed assets, 907 7-S Model, McKinsey and Company’s, 110–111 SFAS See Statements of Financial Accounting Standards (SFAS) JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1282 Aptara 1282 SFAS 109, Accounting for Income Taxes, 905 SFAS 141/141R, 899–900, 910 SFAS–142/142 valuation, 360 SFAS 157, 52, 53, 961, 1008–1009 SFAS 96, 905 Shannon, Donald S., 584–585, 586–587, 588 Share-based compensation See Stock options/share-based compensation Shareholder agreements, 51 Shareholder disputes causes of action, 790–792 court case, recent, 802–804 court case caveats, 804–805 “entire fairness” concept, 795–797 fair value and, 42–43 future appreciation/ depreciation, 795 history of, 789–790 oppressed shareholder and, 781–782 standard of value and, 792–794 valuation adjustments, 799–802 valuation date and, 795 valuation methodology, 797–799 Shareholder-level discounts, 50–51, 369, 370–371 Shareholder value maximization accounting measures of value, 1091–1092 doing more for less, 1092 Economic Value Added (EVA), 1088–1091 introduction to, 1088 value drivers, 1092–1093 Sharpe, William, 222 SIC See Standard Industrial Classification (SIC) codes Silber, William L., 394–395 Simple average method, 134–135 Simpson, David W., 375–377, 380–381 “Single period earnings” method, 121 Single-tax firms, 583 Size premium (RPs), 202 Size premiums beta criteria, 205 company-specific risk premium (RPu), 206 equity risk premium and, 1247–1248 Ibbotson data and, 206, 247 INDEX Ibbotson industry risk premia, 206–209 liquidity and, 205 market segment choices and, 204 smaller companies and, 202–204 Standard and Poor’s, 247 Sliwoski, Leonard, 314, 326–331, 332–339 Small business access to capital, 851 asset approach and, 311, 856 definition of, 849–851 excess cash flow (earnings) method, 861 financial statements (see Small business financial statements) income approach, 856–857 management depth and, 849 market approach (see Small business valuation, market approach) operational characteristics, 851 qualitative factors, value and, 855 reasonableness tests, 861–862 risks in, 194 rules of thumb, 860–861 Small business financial statements assets, unrecorded, 853 assets/liabilities, nonoperating, 854 comparability, adjustments to improve, 854 GAAP and, 849–850, 852 liabilities, unrecorded, 853–854 normalization adjustments, 853 owner items, discretionary, 855 unreported cash revenues, 852–853 Small business valuation, market approach guideline company transactions method, 858–860 guideline public company method, 857–858 past transactions in company’s stock, 860 Small-company risk discount, 430–431 Small-stock premium, 202 Software, acquired, 933–935 SOP 93-6 (Statement of Position 93-6), 815–816, 817–818 SOX See Sarbanes-Oxley Act (SOX) Special industry valuations bar/nightclub industry, 1213–1216 cable TV, 1191–1202 construction, 1171–1184 radio broadcasting, 1184–1190 restaurant industry, 1202–1212 Specific company risk (RPU), 210, 252 SSAE See Statement on Standards for Attestation Engagements (SSAE) SSVS See Statement on Standards for Valuation Services No (SSVS) Staff chargeable hours, 976–977 Staffing, 979 Standard & Poor’s, 246–249 Standard & Poor’s Bond Guide, 257 Standard & Poor’s compustat.com, 67 Standard & Poor’s (S&P) 500, 191, 199, 223 Standard and Poor’s Industry Surveys, 59, 65 Standard Industrial Classification (SIC) codes, 58, 208, 264, 271, 459, 972, 1172 Standards of value common, 3, 31–36 control premiums, 43 current/customary techniques, 45–46 defining a standard, 27–28 in divorce, 46–49, 829–831 estate/gift tax valuations, 641, 644–645 every appraisal as unique, 28–29 extraordinary circumstances, 45 fair value in financial accounting, 52 final number and, 29–30 in healthcare industry, 1114 immediately before, 44 machinery and equipment (M&E), 350–352 measurement and, 52–53 premises of value, 30 premises underlying, 36–37 PTEs and, 574–575 real estate appraisal, 342–344 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1283 Aptara 1283 Index Revenue Ruling 59-60 and, 471 for shareholder disputes, 792–794 shareholder dissent/oppression, 42–43 specific applications, 38–41 unless exclusion would be inequitable, 44 in valuation view, 1222–1223 Standards of Value: Theory and Applications (Fishman, Pratt, and Morrison), 802, 870, 871 Standards Rule 10-2(a), 551 Stark Law, 1112–1113 Statement 157, 969 Statement of Accounting Standards (SAS) No 73, 360–362 Statement of Financial Accounting Concepts No 7, 966 Statement on Standards for Attestation Engagements (SSAE), 560–561 Statement on Standards for Valuation Services No (SSVS), 463, 465, 467, 519, 842, 843 Statements of Financial Accounting Standards (SFAS), 5, 31, 555 State rights (fair value), Stat-usa.gov, 64 Stockdale, John J., 417 Stock options/share-based compensation basics of, 1061–1062 components of value, 1063–1064 definitions, 1060–1061, 1063 dividend effect, 1065 introduction to, 1058, 1059–1060 marketability and, 1079–1080 option contract, 1062 options trading, 1063 privately held stock options, 1073–1076 reasons for valuing, 1077–1078 valuation considerations, 1076–1077 valuation tools, 1065–1073 vesting, 1080 volatility and, 1078–1079 warrants, 1063 Strengths/weaknesses/ opportunities/threats (SWOT) analyses, 59, 112 Stryker, Charles, 395–396 Subchapter C corporations See C corporations Subchapter S corporations See S corporations Subject company adjustments to, 286–288 basic financial indicators, 280 financial statement measures, 295 Subsequent events, 41, 559 Summary Appraisal Report, 341, 452 Supermajority, 375 Supermajority states, 372, 373 Supply-side ERP, 197–201 Supreme Court, 800–802, 804 SWOT analyses, 59, 112 Synergies, 923 Synergistic adjustments/value, 130 Systematic risk, 190–191, 222 See also Beta(s) TAMs See Technical advice memorandums (TAMs) Tangible assets, valuation of accounts receivable, 930 inventory, 930 land/building, 931 machinery/equipment, 931 marketable securities, 929–930 organization cost/existing goodwill, 931 prepaid expenses, 930–931 Tarbell, Jeffery S., 203 TARP See Troubled Asset Relief Program (TARP) Tax-affecting S corporations, 1220 Tax amortization See Amortization benefit Tax court case issues See also specific court case asset approach, 778 blockage discounts, 774–775 built-in gains tax, 760–765 buy-sell agreements, 765–767 CAPM/discount rate/WACC, 769–773 concluding observations on, 785 Daubert challenges, 785 discounts for lack of control/marketability, 745–760 fractional interest discounts, 775–777 gift of future interest, 783 IRS code section 2036 and, 777 key employee discount, 783–784 market approach, 778 noncompete agreements, 779 overview, 743–744 preferred stock, 784–785 S corporation earnings, tax affecting, 773–774 subsequent events, 780–782 tax cases, 785–787 valuation date, 784 valuations, support for, 744–745 voting vs nonvoting stock, 767–769 weighting of methods, 779 Tax Court cases, 29 Taxes adjustments for, income approach, 129–130 after-tax discount rate/aftertax earnings, 1003 business damages and, 1000–1003 calculation of, methods, 1243–1244 deferred, 878 ESOPs and, 810 FLPs and, 700 income taxes, 288, 1177, 1179 for intangible assets, 904 pass-through entities and, 578–580 tax rates, PTEs and, 591–593 Tax Reform Act of 1986, 326, 332, 678 TBM See Total beta model (TBM) Technical advice memorandums (TAMs), 68, 314, 427 Technology, existing, 950–951, 952 10-Ks, 59, 858 10-Qs, 272, 858 Terminal value calculation of, 151–152 definition/overview, 149, 151 other (non-DCF) models, 152–155 Terminology See also International Glossary of Business Valuation Terms healthcare industry, 1097–1100 stock options/share-based compensation, 1060–1061 Thin management discount, 427–428 Third party specialist, 558 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1284 Aptara 1284 Thompson v Commissioner, 840 Thompson v Thompson, 50, 871 Thomsonreuters.com, 62, 66–67 Three Ms, 975, 987 Three-tier system, 113 Time series analysis, 103 Time value of money, 183 Tofte v Tofte, 50 Total asset turnover, 116 Total beta model (TBM), 214–215 Total debt to equity ratio, 118, 1236 Total debt to total assets ratio, 118 Total equity to total assets ratio, 118 Trade associations, 58–59 Trade names/trademarks, 939–941, 942–943 Trade publications, 59 Training, 939, 980 Transaction databases, 67–68, 267–269, 1255 Transfer pricing analyses, 1011 Transportation infrastructure, 487 Trapped capital gains discount, 427 Trapped-in capital gains tax, 678–681 Treasury bills/notes, 195–196 Treasury bonds, 1246, 1247 Treasury Department Circular 230, 681–682 Treasury Regulations corporate stock valuation, 641–642 fair market value and, 31, 722 fair value and, 33 FLPs and, 714–715 gifts, disclosure of, 643–644 standard of value and, 29, 641 unincorporated interests in business, 642–643 Treharne, Chris D., 573, 593, 804 Treharne model cash to investor, 597 compared to other models, 615, 625–626 “Double Taxation Adjustment,” 634–635 overview of, 594–595 retained cash flow, 596 shareholder basis, 595, 598 summary of, 598 INDEX Trend analysis, 103 Trending method, 354 Trend line-static method, 136–138 TRICARE, 1104, 1112 Tri-continental Corp v Battye, 42, 796 Troubled Asset Relief Program (TARP), 408 Trout, Robert R., 398–399 Trugman Valuation Advisors, Inc (TVA), 408–409 TVA See Trugman Valuation Advisors, Inc (TVA) Two-ratio approach, 111 Types of businesses/interest in businesses, UILC See Uniform Issue List Code (UILC) Uncollectible receivables, 977 Undervaluation, appraisal penalties for Pension Protection Act of 2006 (PPA), 682–683 Treasury Department Circular 230, 681–682 Undiversifiable risk, 190 Uniform Business Corporation Act, Uniform Issue List Code (UILC), 812–813 Uniform Limited Partnership Act, 699 Uniform Standards of Professional Appraisal Practice (USPAP), 4, 28, 340–341, 349, 451–452, 465, 545, 842–843 United States Green Building Council (USGBC), 348 Unless exclusion would be inequitable, 44 Unsystematic risk definition of, 191, 222 methods to articulate, 209–219 specific company risk/total beta model, 214–215 types of, 192–193 unique, 190 Unusual items, 89, 90 Upton, David E., 584–585, 586–587, 588 U.S Census Bureau, 64 Useful life, analysis of, 922 U.S financial reporting requirements, 555 USGBC See United States Green Building Council (USGBC) USPAP See Uniform Standards of Professional Appraisal Practice (USPAP) USPAP business valuation standards (2010/2011) competency rule, 547 ethics rule, 546–547 jurisdictional exception rule, 547 preamble, 546 scope of work, 547 standard 3, 548 standard 9, 548–549 standard 10, 549–551 summary of, 551–552 U.S Treasury bonds, 195–196 Validation Advisors’ lack of marketability discount study, 414–416 Valuation Advisors studies, 408–409, 514 Valuation analyst, 561–562 Valuation basics, 1, 2–3, Valuation checklist/ready reference book value/financial condition, 12–13 dates of valuation, 10–11 dividend-paying capacity, 14 earning capacity, 13–14 economic outlook, 12 fair market value, 11 goodwill/intangible capacity, 14–15 market price of stocks, 15–17 nature/history of business, 11–12 Revenue Ruling 59-60, 10 sales of stock/block of stock, 15 Valuation discounts/premiums analysis of premiums, 432 classifying discounts, 369–371 detailed studies, 411–416 discounts, other, 425–431 discounts for lack of control/control premiums, 371–380 discounts for lack of marketability, 380–382 discounts/premiums summary, 432–450 empirical evidence, marketability discounts, 382–411 levels of value, 366–369 overview, 365 quantitative tools, 416–425 summary of, 432 voting premiums, study of, 432, 433–450 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1285 Aptara 1285 Index Valuation Edition Yearbook, 241 Valuation engagement, 558, 560 Valuation example, individual assets/liabilities balance sheet, 316–317 fixed assets, 320 intangible assets, 321 inventory, 318–319 prepaid expenses, 319, 320 Valuation for Financial Reporting (Mard, Hitchner, and Hyden), 895 Valuation information request (VIR) corporate documents/records, 74–75 facilities, 73 financial information, 70–71 operations, 72–73 personnel, 73–74 products/markets, 71–72 Valuation methodology, 471–472 Valuation multiples, 296, 297, 299–300, 1257–1258 Valuation of intangible assets See also Fair value, intangible assets acquired software, 933–935 amortization benefit, 935, 936 assembled/trained workforce, 937–939 cash flows, projected, 946, 948–949 customer relationships, 955, 956, 957 discount rate for amortization benefit, 936–937 goodwill, valuation of, 958 intellectual property, 971–974 IPR&D, 952, 953 MPEEM and, 906–907, 921–922, 947, 950, 951, 954–955 noncompete agreement, 941, 944–945, 946, 948–949 rates of return, 932–933 technology, existing, 950–951, 952 technology/customer relationships, 945, 947–950 trade name, 939–941, 942–943 Valuation of Property (Bonbright), 27 Valuationproducts.com, 69 Valuation report, 559 Valuation report sample assignment description, 470–471 assumptions/limiting conditions, 523–526 background (see Background, valuation report sample) client/scope of work, understanding with, 465–467 conclusion of value, 519–520 construction industry overview, 485–488 correspondence, sample, 463–465 discount studies/application (see Discount studies/ application) economic overview, U.S., 488–491 exhibits, historical financial statements, 528–541 financial (see Financial statement analysis, valuation report sample) income approach (see Income approach, valuation report sample) industry analysis, 482–485 information sources, 472–473, 528 market approach, 506–510 nonoperating/excess assets, 517–519 premise of value, 471 qualifications of analyst/appraiser, 527 reconciliation of valuation methods, 519 standard of value, 471 table of contents, 468–469 valuation approaches/ methods, 498–499 valuation methodology, 471–472 valuation representation/ certification, 521–526 valuation summary, 470 Valuation report sections analysis of company/entity, 455–456 analysis of economic conditions, 456–457 analysis of industry conditions, 457 appendixes, 460 applicable discounts/premiums, 459 assumptions/limiting conditions, 461–462 conclusion/reconciliation, 460 financial statement analysis, 457–458 introduction, 454–455 nonoperating/excess assets, 460 other business valuation reports, 462 overview, 453 sources of information, 455 valuation approaches/methods, 458–459 valuation representation/analyst’s certification and signature, 460–461 valuation summary, 454 Valuationresources.com, 69 Valuation services group engagement acceptance process, 981–982 engagement control, 984–985 engagement principles, 980–981 fees/retainers/billing/collection, 982–984 “good economics” and, 976–980 litigation services’ engagements, 985–987 overview, 975 Valuation standards, history of, 543 Valuation Strategies, 405 Valuation Views (VV) assignment description, 1219 balance sheets, 1231–1232 company history/summary description, 1220–1221 conclusion: marketable control basis, 1261 correlation of values, 1260–1261 fair market value, appraisal of, 1237–1259 financial ratio analysis, 1232–1237 historical overview/analysis, 1229–1230 income statements, 1230–1231 industry outlook, 1228–1229 information sources, 1223–1224 lack of marketability discount, 1259–1260 local economy, 1227–1228 national economic outlook, 1224–1226 ownership/capital structure and, 1221–1222 regional economic data, 1226–1227 report on, 1217–1219 standard of value, 1222–1223 water/sewer systems, 1228–1229 JWBT309_Ind_p1263-1286.qxd 02/04/2011 6:42 PM Page 1286 Aptara 1286 Valuation Yearbook, 206, 246, 247–248, 250 Value adjustments on, 290–291 approaches to, 344–346 creation of, 1093, 1094 in divorce setting, 829 levels of, 366–369 market approach and, 300–301 Value driver(s), 1092–1093 Value driver model, 152–154 Value in exchange, 30 Value to the holder, 30 Valuing a Business (Pratt), 543 Valuing Enterprise and Shareholder Cash Flows (Mercer), 379, 419 Valuing Intangible Assets (Reilly and Schwiehs), 922, 934 Valuing Machinery and Equipment, 354 Vander Linden, Eric, 221 Van Vleet, Daniel, 593, 624 Van Vleet model assumptions in, 603–604 business valuation approaches, 599–600 compared to other models, 624–627 example of, 604, 605 overview of, 598–599 S corporation economic adjustment (SEA), 601–602 INDEX S corporation equity adjustment multiple (SEAM), 601–606 summary of, 604, 606 underpinnings of, 600 Vendor-specific objective evidence (VSOE), 1009 Vinso, Joseph D., 586, 587, 588 VIR See Valuation information request (VIR) Virginia Court of Appeals, 834 Vogt, Paul J., 251–258 Voting premiums, study of, 432, 433–450 VSOE See Vendor-specific objective evidence (VSOE) VV See Valuation Views (VV) WACC See Weighted average cost of capital (WACC) Wall Street Journal, 195, 233 Wall v Commissioner, 769, 774 Walter v Duffy, 39, 40 Wang, Shiing-wu, 583–584, 585, 586, 590, 614 WARA See Weighted average return on assets (WARA) Water/sewer systems, 1228–1229 Weighted average cost of capital (WACC) calculation of, 228–229, 1244, 1245, 1250–1252 cost of debt and, 228–229 definition of, 228 functional obsolescence and, 356 intangible assets and, 928–929 invested capital capitalization rate and, 306 minority vs control considerations, 230 in sample valuation report, 504–505 tax court cases and, 769–773 value driver model and, 152 weights in, 1251 Weighted average method, 135–136 Weighted average return on assets (WARA), 959–960 Weighting of methods, 779 Weinberger v UOP, Inc., 45, 798 Weinstock v Weinstock, 871 Willamette.com, 69 Willamette Management Associates, 386–387, 390, 401, 514, 543 Willing buyer/seller, 39–40 Workforce, assembled/trained, 937–939 Working capital, 289–290 Work plans/budgets, 983, 986 Yoon v Yoon, 834–835 Z-score, 206, 1052, 1248 Zwieg White Merger & Acquisitions Survey, 867 ... construed as the rendering of valuation advice, the rendering of a valuation opinion, the rendering of an opinion of a particular valuation position, or the rendering of any other professional opinion... a Fellow of the American Society of Appraisers, a Fellow of the Royal Institution of Chartered Surveyors, a former chairman of the Business Valuation Committee of the American Society of Appraisers,... chairman of the Business Valuation Committee of the Georgia Society of CPAs, past member of the AICPA Business Valuation Subcommittee, past member of the AICPA ABV exam committee, and past chairman of