CDA Business Valuation in Divorce 2 — Questions and Answers
Question 1: Which valuation approach estimates a business's value based on the present value of expected future earnings?
- Asset-based approach
- Income approach (Correct answer)
- Market approach
- Replacement cost approach
Correct answer: Income approach
The income approach values a business by discounting projected future cash flows or earnings to their present value.
Question 2: When valuing a closely held business in divorce, what is 'excess earnings' typically used to estimate?
- Depreciation of physical assets
- Business goodwill (Correct answer)
- Inventory turnover rate
- Accounts receivable aging
Correct answer: Business goodwill
The excess earnings method estimates goodwill by identifying earnings above a fair return on tangible assets.
Question 3: A spouse owns a dental practice. The state uses a standard of value that reflects what a hypothetical willing buyer would pay a hypothetical willing seller. This is known as:
- Investment value
- Intrinsic value
- Fair market value (Correct answer)
- Liquidation value
Correct answer: Fair market value
Fair market value is the standard price between a hypothetical willing buyer and seller, both having reasonable knowledge of facts.
Question 4: Which factor most directly causes a marketability discount in the valuation of a privately held business?
- High accounts payable balances
- Lack of a ready market to sell ownership interests (Correct answer)
- Excess inventory levels
- Owner's draw above market compensation
Correct answer: Lack of a ready market to sell ownership interests
A marketability discount reflects the reduced value of an interest that cannot be easily converted to cash due to absence of a ready market.
Question 5: In the context of business valuation for divorce, 'normalization adjustments' are made to:
- Increase the business's tax liability
- Remove non-recurring or owner-related anomalies from financial statements (Correct answer)
- Add goodwill to the balance sheet
- Convert cash-basis accounting to accrual-basis only
Correct answer: Remove non-recurring or owner-related anomalies from financial statements
Normalization adjustments restate financials to reflect true economic earnings by removing personal expenses, one-time events, or above/below-market owner compensation.
Question 6: A business valuation expert applies a capitalization rate of 20% to normalized earnings of $200,000. What is the indicated business value?
- $40,000
- $400,000
- $1,000,000 (Correct answer)
- $4,000,000
Correct answer: $1,000,000
Value = Earnings ÷ Capitalization Rate = $200,000 ÷ 0.20 = $1,000,000.
Question 7: Which of the following best describes 'enterprise goodwill' in the context of divorce?
- Goodwill tied to the personal reputation of the owner
- Goodwill inherent in the business itself that would survive a change in ownership (Correct answer)
- The value of the owner's professional license
- Intangible assets listed on the balance sheet
Correct answer: Goodwill inherent in the business itself that would survive a change in ownership
Enterprise goodwill is the value attributable to the business entity—its systems, brand, and customer base—that transfers with a sale.
CDA Business Valuation in Divorce 2
Which valuation approach estimates a business's value based on the present value of expected future earnings?