Market Value – a brief overview.
Market Value is defined by The International Valuation Standards Council (www.ivsc.org) as “The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgably, prudently and without compulsion.”
To appreciate this standard (or definition) of value, it is important to understand that Market Value includes the following assumptions:-
- The hypothetical purchaser is not motivated by any synergistic or strategic influences.
- The business will continue as a going concern and not be liquidated unless the collection of individual assets is more valuable if put to alternative use.
- The hypothetical sale will be conducted in cash or equivalents.
- The parties are willing and able to consummate the transaction.
A business is worth the greater of:-
1. The disposable value of assets, less all liabilities and associated costs.
or
2. The risk-adjusted present value of future cash flows.
Calculating #1 is pretty straightforward, #2 is where things get interesting.
The Asset Approach is the most relevant standard of value where a company is financially distressed or is consistently loss making and rather than accept continued declines in the value of their equity rational shareholders would choose to liquidate the company and put the proceeds of sale to an alternative economic use.
The Market Approach utilises transaction data from the sale of sufficiently similar businesses in terms of size and industry sector etc (or less frequently from public company share price data) to calculate a comparable value for the subject business.
The Income Approach requires a detailed examination of forecast cash flows as well as systematic and unsystematic risks facing the business in order to determine an appropriate discount rate to be used in a Net Present Value calculation. Generally speaking, the discount rate may be defined as the yield necessary to attract investors to a particular investment, given the risks associated with that investment.
Best practice requires that the Asset, Income and Market approaches must all be considered in order to determine the most appropriate methodology for valuing a subject company.