ASA Business Valuation Methods 2 — Questions and Answers
Question 1: In ASA business valuation, normalizing adjustments to financial statements are made to:
- Remove non-recurring items and owner-related anomalies (Correct answer)
- Add intangible assets not on the balance sheet
- Convert financial statements to IFRS standards
- Eliminate all depreciation charges
Correct answer: Remove non-recurring items and owner-related anomalies
Normalizing adjustments restate earnings to reflect what a hypothetical buyer would expect from the ongoing business operations.
Question 2: The discount for lack of marketability (DLOM) reflects the reduced value of:
- An interest in a privately held company that cannot be quickly sold (Correct answer)
- A minority interest's lack of voting power
- A company with declining revenues
- An asset with high obsolescence
Correct answer: An interest in a privately held company that cannot be quickly sold
DLOM compensates for the illiquidity of a private equity interest, as selling it takes more time and cost than selling publicly traded shares.
Question 3: Which method under the asset approach adjusts all balance sheet assets and liabilities to their fair market values?
- Adjusted net asset method (Correct answer)
- Liquidation value method
- Excess earnings method
- Capitalization of cash flow method
Correct answer: Adjusted net asset method
The adjusted net asset method restates each asset and liability on the balance sheet to fair market value, and the difference is the entity's equity value.
Question 4: Weighted average cost of capital (WACC) is used in business valuation as the discount rate for:
- Invested capital (debt-free) cash flows (Correct answer)
- Equity cash flows only
- Dividend discount models
- Liquidation value calculations
Correct answer: Invested capital (debt-free) cash flows
WACC blends the cost of debt and equity in proportion to the capital structure and is applied to discount cash flows available to all capital providers.
Question 5: In the excess earnings method of business valuation, intangible value is estimated by capitalizing:
- Earnings in excess of a fair return on tangible assets (Correct answer)
- Total EBITDA minus taxes
- Revenue minus cost of goods sold
- Net income divided by the risk-free rate
Correct answer: Earnings in excess of a fair return on tangible assets
Excess earnings are what remains after subtracting a fair return on the identified tangible assets, and capitalizing these estimates the value of intangibles.
Question 6: Under IRS Revenue Ruling 59-60, which of the following is NOT listed as a factor to consider in valuing closely held stock?
- The current price of the company's preferred stock on a stock exchange (Correct answer)
- The book value of the stock and financial condition of the business
- The earning capacity of the company
- The dividend-paying capacity of the company
Correct answer: The current price of the company's preferred stock on a stock exchange
Revenue Ruling 59-60 applies to closely held companies that by definition do not have exchange-listed stock, so exchange prices are not one of its eight enumerated factors.
ASA Business Valuation Methods 2
In ASA business valuation, normalizing adjustments to financial statements are made to: