Business Valuation
The Business Valuation domain tests whether you can choose among the income, market, and asset approaches, apply the correct standard of value on a stated valuation date, and bridge the result from enterprise value to equity value. Expect questions on normalization, discount and capitalization rates, and the level of value.
Standards of value and premise
- Fair market value assumes a willing buyer and seller, neither compelled, both reasonably informed; it is the default in tax and many litigation settings.
- Fair value is a statutory term (for example, dissenters' rights) and often excludes minority and marketability discounts.
- Investment value is buyer-specific. State the premise (going concern or liquidation) and the level of value (control or minority, marketable or not) before selecting a method.
Income approach
- Capitalization: Value = normalized benefit stream ÷ (discount rate − expected growth). The growth rate must be sustainable and consistent with the benefit stream.
- DCF: forecast cash flows, discount at WACC for enterprise cash flows or cost of equity for equity cash flows, add terminal value, and use the mid-year convention when cash arrives throughout the year. Then subtract interest-bearing debt, add excess cash, and subtract preferred stock to reach equity value.
Market and asset approaches
- Apply guideline public company or transaction multiples (EV/EBITDA, EV/revenue, P/E) to the matching metric and adjust for size, growth, and control.
- Adjusted book value restates assets and liabilities to fair market value; it is a cross-check and often a floor for asset-intensive companies.
Worked example
Normalized EBITDA is $1,500,000 after adding back $200,000 of above-market owner compensation and $100,000 of nonrecurring legal costs. The required return is 22% and sustainable growth is 3%, so the capitalization rate is 19%. Indicated enterprise value = $1,500,000 ÷ 0.19 = $7,894,737. The company has $2,000,000 of interest-bearing debt and $300,000 of excess cash. Equity value = $7,894,737 − $2,000,000 + $300,000 = $6,194,737.
Traps
- Matching a pre-tax benefit stream to an after-tax discount rate, or nominal cash flows to a real rate.
- Double-counting normalization adjustments already reflected in the projections.
- Applying a control multiple to a minority interest without a discount or adjustment.
- Omitting the enterprise-to-equity bridge or forgetting debt-like items such as unfunded pensions.