CDA Business Valuation in Divorce 3 — Questions and Answers
Question 1: When a spouse owns a minority interest in a private company during divorce, which discount is most likely applied?
- Key person discount
- Minority interest discount (Correct answer)
- Portfolio discount
- Blockage discount
Correct answer: Minority interest discount
A minority interest discount reflects the lack of control a minority owner has over business decisions, reducing the proportional value of their share.
Question 2: Which business valuation method compares a subject company to similar businesses that have recently been sold?
- Discounted cash flow method
- Capitalization of earnings method
- Guideline transaction method (Correct answer)
- Book value method
Correct answer: Guideline transaction method
The guideline transaction method uses sale prices of comparable companies as a benchmark to estimate the subject company's value.
Question 3: In divorce valuations, 'double-dipping' refers to the controversy of:
- Counting business income twice in the same fiscal year
- Using business income both to value the business and to calculate support obligations (Correct answer)
- Deducting business expenses from both income and assets
- Claiming depreciation on the same asset in two tax years
Correct answer: Using business income both to value the business and to calculate support obligations
Double-dipping occurs when the same income stream is used both to capitalize the business value (marital asset) and to compute ongoing support payments.
Question 4: What is the primary purpose of a 'weighted average cost of capital' (WACC) in business valuation?
- To calculate operating expenses as a percentage of revenue
- To determine the discount rate reflecting the cost of all capital sources (Correct answer)
- To estimate the liquidation value of assets
- To measure inventory efficiency
Correct answer: To determine the discount rate reflecting the cost of all capital sources
WACC blends the cost of debt and equity capital, weighted by their proportions, and is commonly used as the discount rate in DCF analysis.
Question 5: A professional practice owned entirely by one spouse generates revenue solely because of that spouse's reputation and referral network. This value is most likely classified as:
- Enterprise goodwill
- Personal goodwill (Correct answer)
- Going concern value
- Replacement cost value
Correct answer: Personal goodwill
Personal goodwill is tied to the individual owner's skills, reputation, and relationships and is generally non-transferable.
Question 6: Which financial statement is most critical when using the asset-based approach to value a business in divorce?
- Income statement
- Cash flow statement
- Balance sheet (Correct answer)
- Statement of retained earnings
Correct answer: Balance sheet
The asset-based approach starts with the balance sheet, adjusting assets and liabilities to fair market value to determine net asset value.
Question 7: In divorce proceedings, a business owner spouse increases their own salary significantly in the year before filing. A valuator would most likely:
- Accept the new salary as the market rate without adjustment
- Increase the business value to reflect higher expenses
- Normalize compensation to a market-rate salary to avoid artificially deflating earnings (Correct answer)
- Exclude salary from the income-based valuation entirely
Correct answer: Normalize compensation to a market-rate salary to avoid artificially deflating earnings
Valuators normalize owner compensation to market rate to prevent manipulation of earnings that would artificially lower the business's value.
CDA Business Valuation in Divorce 3
When a spouse owns a minority interest in a private company during divorce, which discount is most likely applied?