VI common mistakes
VI · Understand the traps and how to avoid them.
Choosing the valuation approach first and then searching for the data to support it, rather than letting the purpose, standard of value, and available data drive the approach selection.
Candidates memorize the three approaches and reach for the one they know best (usually income), treating approach selection as a preference rather than a reasoned judgment tied to the assignment's purpose and premise of value.
What to do instead
Before computing anything, write one sentence each on: purpose and intended use, standard of value, premise of value, and the quantity/quality of data available for each approach. Then justify inclusion or exclusion of each approach in writing, as the report would require.
Applying a control premium or marketability discount to a per-share value without first establishing the correct base (proportional vs. controlling interest) and the level of value at which the discount is applied.
Candidates memorize discount and premium magnitudes and apply them mechanically, forgetting that the discount must be consistent with the base value and applied at the right stage of the analysis.
What to do instead
Always state the level of value of the starting figure (minority/marketable, minority/nonmarketable, control/marketable, etc.), then apply only the adjustments that move from that level to the required level. Never apply both a control premium and a minority discount to the same base.
Mixing nominal (nominal-dollar) cash flows with real discount rates, or pre-tax cash flows with after-tax discount rates, in a DCF.
Candidates pull a discount rate from a source (e.g., a published WACC) without checking whether it is consistent with the cash flow definition they built.
What to do instead
Before discounting, label each input as nominal or real and pre-tax or after-tax. Match the discount rate to the cash flow definition exactly; if the cash flow is nominal after-tax, the rate must be nominal after-tax. Reconcile any mismatch explicitly.
Building a WACC with a cost of debt that is not tax-effected, or using book-value weights instead of market-value (target) weights.
Candidates copy the debt cost from the interest rate on the balance sheet and use the debt and equity balances as weights, overlooking the interest tax shield and the market-value requirement.
What to do instead
Compute after-tax cost of debt as pre-tax rate times (1 minus tax rate), and weight using market values of debt and equity (or a defensible target capital structure). State the weighting basis in the answer.
Treating a guideline company or transaction multiple as directly comparable without adjusting for differences in growth, margin, size, or accounting policies.
Candidates assume that because companies are in the same industry, their multiples are interchangeable, and skip the qualitative adjustment step under time pressure.
What to do instead
For each multiple selected, document the comparability factors (growth, profitability, size, leverage, accounting basis) and either adjust the multiple or explain why no adjustment is needed. Prefer multiples whose denominator matches the subject's economics.
Confusing impairment testing under accounting standards with a fair-value engagement, and applying the wrong standard of value or premise.
Candidates conflate the valuation concepts learned for fair value measurement with those for fair value in a transaction context, and the exam rewards precise standard-of-value identification.
What to do instead
Anchor every financial-reporting question to the specific standard of value and definition required (e.g., fair value as defined for financial reporting, with its exit-price and market-participant assumptions). State the definition before computing.
Ignoring deferred taxes, uncertain tax positions, or the difference between the book and tax basis of assets when valuing a business or its net assets.
Candidates focus on operating cash flows and treat tax as a single line, missing that deferred tax liabilities and asset basis differences affect value, especially in asset-based and liquidation analyses.
What to do instead
When using an asset-based approach or adjusting net assets, reconcile book to tax basis and reflect deferred tax consequences. In income approaches, verify the tax rate used reflects the entity's actual tax position.
Failing to distinguish identifiable intangible assets from goodwill, or valuing an intangible without selecting and justifying the appropriate method (relief-from-royalty, excess earnings, cost, etc.).
Candidates treat all intangibles as a single category and default to one method regardless of whether the asset has a measurable income stream, a market, or a replacement cost basis.
What to do instead
Classify the intangible (customer-related, technology, marketing, contract-based) and choose the method whose economic logic matches the asset's characteristics. Justify why the chosen method captures the asset's value and why alternatives were rejected.
Applying a discount for lack of marketability or a blockage discount to a publicly traded security, or otherwise misapplying liquidity adjustments to financial assets.
Candidates over-generalize the private-company discount toolkit to marketable securities, where the asset's own trading characteristics already reflect liquidity.
What to do instead
For financial assets, first establish whether the asset is publicly traded and actively traded. Apply liquidity or blockage adjustments only when the holding or the asset's characteristics justify them, and document the basis.
Presenting a single point estimate without a sensitivity analysis, reconciliation of approaches, or explanation of how the concluded value was selected.
Candidates treat the valuation as an arithmetic exercise and stop at the number, missing that professional standards require a reasoned conclusion and reconciliation among approaches.
What to do instead
Always include a sensitivity table (e.g., discount rate vs. growth, or multiple range vs. earnings), reconcile the approaches, and write a short conclusion explaining weighting and why the selected value is reasonable.