CHAPTER 1
Valuation Case Study Exercises

1.1 INTRODUCTION

The purpose of this chapter is to highlight and discuss important concepts in valuation through a series of Exercises. These Exercises have been intermittently placed in excerpts of a valuation report. You should attempt to complete these Exercises as you read the report with reasoning and emphasis on an explanation of your conclusion. The authors' solutions to these Exercises can be found in Chapter 2.

The following case presents selected excerpts from a business valuation report that, in its entirety, was in full compliance with the AICPA's Statements on Standards for Valuation Services VS Section 100 and the Uniform Standards of Professional Appraisal Practice. For more information on reports and standards compliance, see Chapters 11 and  12 of Financial Valuation Applications and Models, 5th edition. This report format is one of many that analysts can use in presenting business valuations. The schedules have been included and are referenced throughout. Some of the terms, numbers, sources, and other data have been changed for ease of presentation.

1.2 THE VALUATION REPORT

February 15, 2023

Sherman E. Hitchner, Esq.
Hitchner & Wessinger
4747 Washington Street, Suite 1740
St. Louis, Missouri 12345

Re: Fair Market Value of a 100 Percent Equity Interest in Nova Fastener & Tool, Inc. as of December 1, 2022

Dear Mr. Hitchner:

At your request XYZ Appraisal Associates LLC (XYZ) was retained to prepare a valuation analysis and appraisal (valuation engagement and conclusion of value) and detailed/comprehensive appraisal report (the report) to assist you and your client, Ms. Louise Atkins, in the determination of the fair market value of a 100 percent equity interest in Nova Fastener & Tool, Inc. (Nova or the Company).

This interest is a controlling interest and is therefore marketable. The value conclusion is considered as a cash or cash-equivalent value. The valuation date is December 1, 2022 (the valuation date). This valuation and report are to be used only as of this date and are not valid as of any other date.

EXERCISE 1 Which of the following is the as of date for valuation?

1. Any time within one year
2. As of a single point in time
3. As of a single point in time or six months later
4. Date that the report is signed

We have prepared a valuation engagement and present our detailed report in conformity with the Statements on Standards for Valuation Services VS Section 100 (SSVS) of the American Institute of Certified Public Accountants (AICPA). SSVS defines a valuation engagement as

an engagement to estimate value in which a valuation analyst determines an estimate of the value of a subject interest by performing appropriate procedures, as outlined in the AICPA Statements on Standards for Valuation Services, and is free to apply the valuation approaches and methods he or she deems appropriate in the circumstances. The valuation analyst expresses the results of the valuation engagement as a conclusion of value, which may be either a single amount or a range.1

SSVS addresses a detailed report as follows:

The detailed report is structured to provide sufficient information to permit intended users to understand the data, reasoning, and analyses underlying the valuation analyst's conclusion of value.2

EXERCISE 2 This is a detailed report per SSVS. What other types of reports are allowed under SSVS?

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This valuation was prepared to assist in the determination of the value solely for purposes of internal operational and tax planning, and the resulting estimate of value should not be used for any other purpose, or by any other party for any purpose, without our express written consent.

EXERCISE 3 The purpose of the valuation of Nova is to assist management in internal operational and tax planning. What other purposes are there?

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Our analysis and report are in conformance with the 2020-2021 (extended to 2022 and 2023) Uniform Standards of Professional Appraisal Practice (USPAP) promulgated by the Appraisal Standards Board of the Appraisal Foundation,3 the ethics and standards of the American Society of Appraisers (ASA), IRS business valuation development and reporting guidelines, and the National Association of Certified Valuators and Analysts (NACVA).

EXERCISE 4 If the analyst belongs to more than one valuation organization with standards, that analyst must comply with the standards of each organization they belong to.

1. True
2. False

Our analysis is also in conformance with Revenue Ruling 59-60, which outlines the approaches, methods, and factors to be considered in valuing shares of capital stock in closely held corporations for federal tax purposes. Revenue Ruling 59-60 is often also considered as useful guidance in valuations performed for nontax purposes.

EXERCISE 5 Revenue Ruling 59-60 is only applicable to estate, gift, and income tax valuations.

1. True
2. False

The standard of value is fair market value, defined in Revenue Ruling 59-60 as

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.4

Revenue Ruling 59-60 also defines the willing buyer and seller as hypothetical as follows:

Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property.5

Furthermore, fair market value assumes that the price is transacted in cash or cash equivalents. Revenue Ruling 59-60, although used in tax valuations, is also used in many nontax valuations.

Fair market value is also defined in a similar way in the SSVS6 as

the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm's length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

EXERCISE 6 Which of these are standards of value?

1. Fair market value, fair value financial reporting, investment value
2. Fair value investment reporting, fair value state actions, intrinsic value
3. Investment value, intrinsic value, equal value
4. Fair market value, equal value, investment value

The premise of value is going concern. The 2001 International Glossary of Business Valuation Terms defines going concern as "an ongoing operating business enterprise," and going concern value as

the value of a business enterprise that is expected to continue to operate into the future. The intangible elements of going concern value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.7

The 2022 International Valuation Glossary-Business Valuation defines going concern the same way and defines going concern value as

a Premise of Value that assumes the business is an ongoing commercial enterprise with a reasonable expectation of future earning power.8

The liquidation premise of value was considered and rejected as not applicable, as the going-concern value results in a higher value for the interest than the liquidation value, whether orderly or forced.

In our conclusion of value, we considered the following relevant factors, which are specified in Revenue Ruling 59-60:9

• The history and nature of the business
• The economic outlook of the United States and that of the specific industry in particular
• The book value of the subject company's stock and the financial condition of the business
• The earning capacity of the company
• The dividend-paying capacity of the company
• Whether or not the firm has goodwill or other intangible value
• Sales of the stock and size of the block of stock to be valued
• The market price of publicly traded stocks or corporations engaged in similar industries or lines of business

Our analysis included, but was not limited to, the previously mentioned factors.

EXERCISE 7 These are the only eight tenets of value in Revenue Ruling 59-60 that need to be considered.

1. True
2. False

EXERCISE 8 Valuation...