Question 1

Increasing market liquidity will reduce the value of control; an increasing value of control will reduce market liquidity and contribute to increasing liquidity discounts.

Accepted Answer

Market liquidity refers to the ease and speed with which an asset can be bought or sold in the market without affecting its price. When market liquidity is high, investors can easily buy and sell without affecting the market price, which reduces the value of control. On the other hand, when the value of control is high, investors are less likely to sell their shares, reducing market liquidity and contributing to increasing liquidity discounts. Therefore, increasing market liquidity will reduce the value of control, and an increasing value of control will reduce market liquidity and contribute to increasing liquidity discounts.

Question 2

Revenue Ruling 59-60 describes the general factors that the IRS and tax courts consider relevant in valuing private businesses. Of the following valuation methods, which do the IRS and tax courts view as the most important?
A) Discounted cash flow
B) Comparable company methods
C) Tangible book value
D) Replacement cost method
E) All of the above

Accepted Answer

The IRS and tax courts often consider the Comparable company methods as the most important because it involves comparing the subject company to similar companies with known market values, providing a market-based perspective on valuation.

Question 3

Which of the following is not true of liquidity or marketability risk or discount?
A) It is measurable.
B) It is believed to have declined in recent years
C) The magnitude of the discount or risk is inversely related to the size of the investor's equity ownership in the business.
D) The magnitude of the discount or risk is directly related to the size of the investor's equity ownership in the business.
E) It is important to adjust the discount rate for liquidity risk.

Accepted Answer

The statement "The magnitude of the discount or risk is directly related to the size of the investor's equity ownership in the business" is not true. The discount or risk is actually inversely related to the size of the investor's equity ownership. This is because smaller ownership stakes are less liquid and less marketable than larger ones, leading to a higher discount or risk. The other statements are true.

Question 4

Fair market value is
A) The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business
B) The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business, assuming each had access to all necessary information
C) The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business, assuming each had access to all necessary information and that neither party is under duress.
D) The discounted value of free cash flow to the firm
E) The discounted value of free cash flow to equity investors.

Accepted Answer

Market value is the cash or cash equivalent value that a willing buyer would pay or seller would accept for a business, assuming each had access to all necessary information and that neither party is under duress. This definition takes into account the availability of information and removes the influence of any external factors that may pressure a sale or purchase.

Question 5

The discount rate may be estimated using all but the one of the following:
A) The capital asset pricing model
B) The share exchange ratio
C) The cost of capital
D) Return on total assets
E) Price-to-earnings ratio

Accepted Answer

The share exchange ratio is not a method for estimating the discount rate. It is used in mergers and acquisitions to determine the relative value of shares exchanged between companies.

Question 6

Which of the following are often true about the challenges of valuing private firms?
A) There is a lack of analyses generated by sources outside of the company.
B) Financial reporting systems are often inadequate.
C) Management depth and experience is often limited.
D) Reported earnings are often understated to minimize taxes.
E) All of the above.

Accepted Answer

All of the above statements are often true when valuing private firms. A lack of analyses from outside sources can make it more difficult to assess the company's value. Inadequate financial reporting systems can also make it challenging to obtain accurate financial information. Limited management depth and experience can impact the company's potential for growth and profitability. Finally, reported earnings may be intentionally understated to minimize taxes, which can make it difficult to accurately assess the company's financial health.

Question 7

There is widespread agreement over the magnitude of the liquidity discount.

Accepted Answer

The magnitude of the liquidity discount is a subject of debate among economists and financial analysts, as it can vary significantly depending on the asset, market conditions, and measurement methods used.

Question 8

A business owner may overstate revenue and understate actual expenses when
A) The business is about to be sold
B) They are being audited by the IRS
C) They are trying to minimize tax liabilities
D) All of the above
E) None of the above

Accepted Answer

Overstating revenue and understating actual expenses can make a business appear more profitable and valuable than it actually is, which can be a strategy used by owners looking to sell their business for a higher price.

Question 9

In valuing private businesses, the U.S. tax courts have historically supported the use of which valuation method for purposes of estate valuation?
A) Discounted cash flow
B) Comparable company method
C) Tangible book value method
D) A combination of a and c
E) All of the above

Accepted Answer

The U.S. tax courts have historically favored the Comparable Company Method for estate valuation as it provides a market-based approach by comparing the private business to similar publicly traded companies.

Question 10

All of the following represent common sources of value in appraising private or publicly owned businesses except for
A) Intellectual property
B) Customer lists
C) Licenses
D) Contingent liabilities
E) Employment contracts

Accepted Answer

Contingent liabilities represent potential costs or expenses that may or may not occur in the future, such as pending lawsuits or environmental remediation. They are not typically considered sources of value in appraising a business. The other choices, intellectual property, customer lists, licenses, and employment contracts, are all common sources of value that may contribute to a business's overall worth.

Question 11

The most important element(s) in selecting a business valuation professional include which of the following: (Select only one)
A) Overall experience
B) Demonstrated ability in the industry in which the firm to valued competes
C) Degree of specialization
D) Number of professional degrees
E) A and B only

Accepted Answer

The overall experience and demonstrated ability in the industry are the most important elements in selecting a business valuation professional as they ensure that the professional has the necessary knowledge and skills to accurately value the business. The degree of specialization and number of professional degrees may be relevant, but are not as important as overall experience and industry knowledge. Therefore, the best choice is E.

Question 12

A business owner may overstate revenue by
A) Failing to deduct from revenue products returned by customers
B) Billing customers for products not ordered
C) Booking the entire value of a multiyear contract in the current year
D) Counting interest income as revenue
E) All of the above

Accepted Answer

All of the choices listed can result in an overstatement of revenue. Failing to deduct returned products or billing for products not ordered can increase revenue that was not actually earned. Booking the entire value of a multiyear contract in the current year can result in revenue being recognized before it is earned. Counting interest income as revenue can also lead to an overstatement of revenue.

Question 13

All of the following are true of reverse mergers except for.
A) May be used to take a private firm public
B) May represent an effective alternative to an IPO
C) Commonly use private equity placements for financing
D) Requires 2 years of audited financial statements to take a private firm public
E) A and B

Accepted Answer

Reverse mergers do not necessarily require two years of audited financial statements to take a private firm public. However, the other options are true of reverse mergers.

Question 14

All of the following are often true of privately held firms except for
A) Financial data is often inaccurate and out of date
B) Internal controls are ineffective
C) Have limited access to capital markets and product distribution channels
D) Are more easily valued than public companies
E) Have limited ability to influence customers, suppliers, unions, and regulators

Accepted Answer

Privately held firms are not required to disclose their financial information to the public, making it difficult to value them accurately. Therefore, option D is incorrect. Options A, B, C, and E are often true of privately held firms due to their lack of resources and access to capital markets.

Question 15

Leveraged employee stock ownership plans are frequently used by owners of private businesses to
A) Hide assets
B) Motivate employees
C) Sell the firm to the employees
D) B and C
E) A, B, and C

Accepted Answer

Leveraged employee stock ownership plans (ESOPs) are designed to motivate employees by providing them with an ownership stake in the firm. In some cases, they can also be used as a way for the owner to sell the firm to the employees, providing a succession plan and ensuring continuity of operations. However, using an ESOP to hide assets is not a legitimate purpose and would be considered fraudulent.

Question 16

A pure control premium is the value the acquirer believes can be created by replacing the target firm's incompetent management, by changing the strategic direction of the target, by gaining a foothold in a market not currently served, or by achieving unrelated diversification.

Accepted Answer

A pure control premium is indeed the value created by the acquirer's ability to make significant changes in the target firm's management, strategy, market, or diversification. This premium is related to the control acquired by the acquirer, and it reflects the potential benefits that can be obtained by exerting control over the target company.

Question 17

Studies of restricted stock sales since 1990 indicate a median liquidity discount of about 20 percent with several showing a decline to 13 percent after 1997 following the holding period change under Rule 144 from two years to one.

Accepted Answer

The statement accurately reflects the findings of studies on restricted stock sales.

Question 18

Corporate shells have value because they enable the buyer to
A) Avoid the cost of going public
B) Exploit intangible value such as brand name
C) A and D only
D) Provide limited liability
E) A, B, and D only

Accepted Answer

Choice A is correct because a buyer can acquire a corporate shell without going through the expensive and time-consuming process of conducting an initial public offering (IPO).

Choice B is correct because a corporate shell may have established brand recognition, customer relationships, or other intangible assets that can be leveraged to create value.

Choice D is correct because a corporate shell provides limited liability protection to its owners.

Question 19

Studies show that control premiums vary widely across countries reflecting the efficacy of shareholder rights laws and how well such laws are enforced in each country.

Accepted Answer

Control premiums, which are the additional price paid on acquiring a controlling stake in a company, are influenced by various factors including shareholder rights laws and their enforcement. Studies have shown that the effectiveness of these laws vary across countries, resulting in varying levels of control premiums. Therefore, the statement is true.

Question 20

A minority discount is the reduction in the value of a minority investor's investment because minority owners have little influence in how the firm is managed.

Accepted Answer

A minority discount is the reduction in the value of a minority investor's investment because minority owners have little influence in how the firm is managed. Therefore, the value of their investment is lower due to their lack of control and influence.

Quiz 10: Analysis and Valuation

Increasing market liquidity will reduce the value of control; an increasing value of control will reduce market liquidity and contribute to increasing liquidity discounts.

Revenue Ruling 59-60 describes the general factors that the IRS and tax courts consider relevant in valuing private businesses. Of the following valuation methods, which do the IRS and tax courts view as the most important?

Which of the following is not true of liquidity or marketability risk or discount?

Fair market value is

The discount rate may be estimated using all but the one of the following:

Which of the following are often true about the challenges of valuing private firms?

There is widespread agreement over the magnitude of the liquidity discount.

A business owner may overstate revenue and understate actual expenses when

In valuing private businesses, the U.S. tax courts have historically supported the use of which valuation method for purposes of estate valuation?

All of the following represent common sources of value in appraising private or publicly owned businesses except for

The most important element(s) in selecting a business valuation professional include which of the following: (Select only one)

A business owner may overstate revenue by

All of the following are true of reverse mergers except for.

All of the following are often true of privately held firms except for

Leveraged employee stock ownership plans are frequently used by owners of private businesses to

A pure control premium is the value the acquirer believes can be created by replacing the target firm's incompetent management, by changing the strategic direction of the target, by gaining a foothold in a market not currently served, or by achieving unrelated diversification.

Studies of restricted stock sales since 1990 indicate a median liquidity discount of about 20 percent with several showing a decline to 13 percent after 1997 following the holding period change under Rule 144 from two years to one.

Corporate shells have value because they enable the buyer to

Studies show that control premiums vary widely across countries reflecting the efficacy of shareholder rights laws and how well such laws are enforced in each country.

A minority discount is the reduction in the value of a minority investor's investment because minority owners have little influence in how the firm is managed.