Business Valuation
Business Valuation tests whether you can choose a defensible standard and premise of value, apply the income, market, and asset approaches, normalize financial statements, and support discounts. It is applied economics, but the exam rewards consistency and documentation more than exotic models.
Core rules and concepts
- Define the standard of value first: fair market value assumes a hypothetical willing buyer and seller, both informed and not compelled; fair value and investment value depend on the legal or client context.
- Match the premise (going concern vs liquidation) to the purpose.
- Income approach: discount projected cash flows at a rate matching the cash-flow definition (FCFF with WACC; FCFE with cost of equity), or capitalize normalized earnings. Terminal value must use a defensible growth rate or exit multiple.
- Market approach: apply guideline public company, guideline transaction, or prior-transaction multiples to the correct metric, then adjust for size, growth, profitability, and risk.
- Asset approach: adjusted net asset value or liquidation value; useful for holding companies and asset-heavy firms.
- Revenue Ruling 59-60 factors remain a common checklist: history, economic outlook, book value and financial condition, earning capacity, dividend capacity, goodwill, prior sales, and comparable market prices.
- Quantify control and marketability adjustments explicitly and avoid double counting.
Worked example
Reported EBITDA is $1.8 million. Add back $200,000 of above-market owner compensation and remove $50,000 of nonrecurring gain, giving normalized EBITDA of $1.95 million. A 6.0x transaction multiple gives enterprise value of $11.7 million. Subtract $2.0 million debt and add $0.5 million cash for equity value of $10.2 million. A 20% discount for lack of marketability on a minority interest gives $8.16 million.
Traps
Using reported rather than normalized earnings; mixing equity and enterprise bases; applying a pre-tax multiple to after-tax cash flow; double-counting risk in both discount rate and multiple; applying DLOM and DLOC without support; and assuming marketability discounts apply equally to controlling interests.