CHAPTER 12
BUSINESS VALUATION
SOLUTIONS TO SELF-TEST EXERCISES
SELF-TEST EXERCISE 12.1:
BOOK VALUE
Use CompuTech Inc.’s 2015 statement of financial position in Appendix A to calculate
the company’s book value.
CompuTech Inc.’s 2015 book value is $305,000. It is calculated as follows:
Total assets
Total liabilities
Equity (book value)
$637,000
332,000
$305,000
SELF-TEST EXERCISE 12.2:
LIQUIDATION VALUE
Use CompuTech Inc.’s 2015 statement of financial position (see Appendix A at the end
of this book) and the following assumptions to calculate the company’s liquidation value.
By liquidating the assets, the Millers would probably obtain the following:
• 30% for the non-current assets
• 50% for inventories
• 70% of trade receivables
Would the Millers have enough money to pay all their creditors? If the Millers’ business
cannot cover all its liabilities, what will they have to do?
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12-2
Chapter 12 Business Valuation
Statement of Financial Position
(in 000s of $)
2015
Book Value
Assets
Non-current assets
Property, plant and equipment
Goodwill
Other intangible assets
Accumulated depreciation
Total non-current assets
Liquidation
Value
560
―
―
(158)
402
―
―
―
―
121
Current assets
Inventories
Trade receivables
Prepaid expenses
Cash and cash equivalents
Total current assets
110
90
10
25
35
55
63
10
25
153
Total assets
637
274
Equity and liabilities
Equity
Share capital
Retained earnings
Contributed surplus
Total equity
170
135
―
305
(58)
―
―
(58)
Non-current liabilities
Long-term borrowings
200
200
Current liabilities
Trade and other payables
Short-term borrowings
Current portion of long-term borrowings
Total current liabilities
47
75
10
132
47
75
10
132
Total liabilities
332
332
Total equity and liabilities
637
274
© 2014 by Nelson Education Ltd.
30%
50%
70%
Chapter 12 Business Valuation
12-3
CompuTech’s liquidation value is negative by $58,000. Hence the Millers cannot pay all
their creditors. Limited liability for a corporation means that in this case the Millers can
walk away from their business. They are not personally liable for the unpaid debts of the
company.
SELF-TEST EXERCISE 12.3:
COMMON SHARE VALUATION
1. What is the book value of the shares?
Book value
$ 305,000
$15.25 ($305,000 ÷ 20,000)
2. What is the market value of the shares?
Market value
$ 710,000
$35.50 × 20,000
3. What is the ratio of the market value to the book value?
Ratio
2.33
2.33
SELF-TEST EXERCISE 12. 4:
CUMULATIVE CASH FLOWS AND NET PRESENT VALUES
By using 11% as the weighted average cost of capital, the (1) yearly present values and
(2) the cumulative net present value of the company's cash flows for the five-year period
are as follows.
(in 000s of $)
Year 1 Year 2
Year 3
Year 4 Year 5
Projected profit for the year
Projected capital cost allowance
80
6
90
8
100
9
110
10
120
11
After-tax cash flows
Projected incremental investments
in working capital
86
98
109
120
131
(2)
(3)
Net cash flows
84
95
107
119
130
Present value factors (11%)
0.901
0.812
0.731
0.659
0.593
Present values (1)
75.7
77.1
78.2
78.4
77.1
Cumulative present values (2)
75.7
152.8
231.0
309.4
386.5
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(2)
(1)
(1)
12-4
Chapter 12 Business Valuation
SELF-TEST EXERCISE 12.5:
CAPITALIZATION RATE
Statement of Income
Revenue
Cost of sales
Gross profit
$ 800,000
(406,000)
394,000
Operating expenses
Distribution costs
Administrative expenses
Finance costs
Total expenses
Profit before taxes
Income tax expense
Profit for the year
Add back depreciation
(135,000)
(110,000)
(30,000)
(275,000)
119,000
(42,000)
77,000
80,000
After-tax cash flow from operations
$ 157,000
1. Calculate the value of the business as a going concern by using the following
capitalization rates: 15% and 25%.
After-tax cash
flows
$157,000
$157,000
Capitalization
Rates
15%
25%
Going
Concern
Value
$1,046,667
$628,000
2. Use a 30% discount rate to calculate the present value of the business if it had a 15year lifespan.
Cash Flow
$157,000
Number of
Years
15
Discount
Rate
30%
Discount
Factor
3.2682
Present
Value
$ 513,107
3. If an investor were to invest $300,000 in the business, how much cash should the
business generate each year during a five-year period if the investor wants to earn
25%?
Discount
Annual
Investment
Rate
Cash Flow
$300,000
÷
2.6893
=
$111,553
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Chapter 12 Business Valuation
12-5
SELF-TEST EXERCISE 12.6:
BUSINESS VALUATION USING THE DISCOUNTED CASH FLOW METHOD
1. What is CompuTech’s net present value?
Cash
Year
Flows
0
--1
$200,000
2
300,000
3
500,000
4
600,000
5
900,000
Net present value
Investments
$(200,000)
(200,000)
(300,000)
(300,000)
(50,000)
(50,000)
Working
Capital
--(100,000)
(100,000)
(50,000)
(25,000)
(25,000)
NCF
$(200,000)
(100,000)
(100,000)
150,000
520,000
825,000
Factors
15%
1.00000
0.86957
0.75614
0.65752
0.57175
0.49718
Discounted
Value
$(200,000)
(86,957)
(75,614)
98,628
300,169
410,174
$446,400
2. What is CompuTech’s internal rate of return using only the five-year projections?
Internal rate of return is 42.52%.
3. What is CompuTech’s present value of the residual value?
Using the company’s 5th year cash flow of $825,000 and the 15% capitalization rate, the
present value of the residual value is $5,500,000 and amounts to $2,734,490 when
discounted at 15% for a five-year period.
$825,000 ÷ 15%
Discounted @ 15%
Present value
$5,500,000
.49718
$2,734,490
4. What is CompuTech’s fair market value?
Present value of the five year forecast
Present value of the residual value
Fair market value
$
446,400
2,734,490
$ 3,180,890
5. What is Oscar Eden’s internal rate of return on his investment?
5th year projections
Multiple factor
Value
20% share
$ 825,000
5
4,125,000
$ 825,000
Using a 32.77% discount factor, the present value of $825,000 amounts to $200,000,
which equals the initial $200,000 investment by Oscar Eden.
© 2014 by Nelson Education Ltd.