CHAPTER 3: LIQUIDATION BASED VALUE
LIQUIDATION VALUE
- According to the CFA Institute, it is the value
of a company if it were dissolved and its
assets were sold individually.
- Represents the net amount that can be
gathered if the business is shut down and its
assets are sold piecemeal.
- Also know as net asset value.
 NOTE: Circumstances clearly
dictates whether it will be appropriate
to use liquidation value or going
concern value in a valuation exercise.
 If a business is profitable or has
sustainable growth prospects,
these will normally show future cash
flows which will result in the firm value
that is higher than if the assets are
just separately like in a liquidation.
-
-
LIQUIDATION
VALUE
>
GOING
CONCERN VALUE = a significant business
event transpired which makes the liquidation
value more appropriate in valuation exercise.
Liquidation Value – is the base or the floor
price for any firm valuation exercise.
o Should not be used to value profitable
or growing companies as this
approach does not consider growth
prospects of the business.
o Instead, liquidation value should be
used for dying or losing companies
where liquidation is imminent to
check whether profits can still be
realized upon sale of the assets
owned.
-
Liquidation Prices - can be difficult as these
are not readily available.
SITUATIONS
VALUE
TO
CONSIDER
LIQUIDATION
1.) Business Failures
- The most common reason why businesses
close or liquidate.
- Early Symptoms – low or negative returns,
or when the firm earns return at a rate lower
than its cost of capital.
When left unresolved, this may lead to
insolvency or even bankruptcy.
INSOLVENCY
BANKRUPTCY
- Inability to pay Happens
when
liabilities when they fall liabilities become greater
due.
than asset balance.
ASSETS > LIABILITIES
- Asset balance is still
greater than its liabilities
but is having liquidity
problems as a result of
depleted cash.
ASSETS < LIABILITIES
- Inability to pay liabilities
unless the assets can be
sold at a higher price
than its book value.
-
Internal Factors:
o Mismanagement
o Poor Financial Evaluation and
Decisions
o Failure to execute strategic plans
o Inadequate Cash Flow Planning
o Failure to Manage Working Capital
-
External Factors:
o Severe Economic Downturn
o Dynamic Consumer Preferences
o Material Adverse Governmental
Action or Regulation
o Occurrence of Natural Disasters or
Calamities
o Occurrence of Pandemic or General
Health Hazard

NOTE: Liquidation value can be used
for businesses which are:
 Closing
 Are closed
 Are in bankruptcy
 Are in industries that are in
irreversible trouble
 Or going concern firms that
isn’t putting its assets to good
use and may be better off
closing down and selling the
assets.
2.) Corporate or Project End of Life
- Corporations with a finite number of years to
operate as stated in their Articles of
Incorporation.
- Once the date arrives, and life is not
extended, the corporation ends and the
liquidation process starts.
-
Is corporate end of life is already certain, it is
more appropriate to compute terminal value
using liquidation value.
3.) Depletion of Scarce Resources
- Used in some industries like mining and oil
where the availability of scarce resources
significantly influences firm value.
- These are industries that are highly regulated
by the government.
- Once the contract with the government
expires, or the scarce resource becomes
fully depleted, this might signal potential
liquidation.
GENERAL PRINCIPLES OF LIQUIDATION
VALUE
- Liquidation value – is the most
conservative valuation approach among all
o It considers the realizable value of the
asset if it is sold now based on
current conditions.
o This captures any markdowns (or
markups) that potential buyers
negotiate to buy the assets.
- General concepts considered in liquidation
value are as follows:
 If the liquidation value is above income
approach valuation (based on goingconcern principle) and liquidation comes
into consideration, liquidation value
should be used.

If the nature of the business implies
limited lifetime (e.g., a quarry, gravel,
fixed-term company etc.), the terminal
value must be based on liquidation.


All costs necessary to close the
operations (e.g., plant closure
costs,
disposal
costs,
rehabilitation costs) should also
be factored in and deducted to
arrive at the liquidation value.
Non-operating assets should be valued
by liquidation method as the market
value is reduced by costs of sale and
taxes.

Since they are not part of the
firm's operating activities, it might
be inappropriate to use the same
going
concern
valuation
technique used for business
operations. If such result is higher
than net present value of cash

-
flows from operating the asset,
the liquidation value should be
used.
Liquidation valuation must be used if the
business continuity is dependent on
current management that will not stay.
Liquidation value method can also be used
as benchmark in making investment
decisions
o When a company is profitable with
good industry outlook, the liquidation
will typically be lower than the
prevailing market price of the share.
PROFITABLE: LIQUIDATION < PREVAILING
MARKET PRICE
o For the firms that are experiencing
decline or industry is consistently
declining, prevailing share prices
might be lower than liquidation value.
o If this happens, the rational
decision for the business is to
permanently
close
the
business and liquidate its
assets.
NOT PROFITABLE: LIQUIDATION > PREVAILING
MARKET PRICE

NOTE: if the company can be readily
liquidated any time, market price per
share should never be below book
value per share if all reported assets
in the balance sheet is accurate.
TYPES OF LIQUIDATION:
1.) Orderly Liquidation
- Assets are sold strategically over an orderly
period to attract and generate the most
money for the assets.
- This process will expose assets for sale on
the open market, with a reasonable time
allowed to find a purchaser, both buyer and
seller having knowledge of the uses and
purposes to which the asset is adapted and
for which it is capable of being used, the
seller being compelled to sell and the buyer
willing, but not compelled, to buy.
2.) Forced Liquidation
- Liquidation process, at which the asset or
assets are sold as quickly as possible,
such as at an action.
CALCULATING LIQUIDATION VALUE
- Liquidation value - considers the present
value of the sums that can be obtained
through the disposal of the assets of the firm
in the most appropriate way, net of the sums
set aside for the closure costs, repayment of
the debts and settlement of all liabilities and
net of the tax charges related to the
transaction and the costs of the process of
liquidation itself.
- Liquidation value can be further computed
on a per share basis by dividing total
liquidation value by outstanding ordinary
shares.
 NOTE: Calculation for liquidation
value at closure date is somewhat
like the book value calculation,
except the value assumes a forced or
orderly liquidation value.
-
-
Book value should not be used as liquidation
value.
o Liquidation value can be obtained
based on the potential sales price of
the assets being sold instead of
relying on the costs recorded in the
books.
Liquidation value
o Is far more realistic as compared to
the book value method.
o Can be used as a basis for terminal
cash flow (instead of going concern
terminal cash flow) in a DCF
calculation in order to compute firm
value in case there are years that the
firm will still be operational prior to
liquidation.
o Estimation of liquidation values will
be complex if assets cannot be easily
identified or separated; hence,
individual
valuation
may
be
impractical.