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Write in depth on “Standards of Value,” as in Trugman Chapter 4. SEE FULL DESCRIPTION BELOW. 

 Write a piece about the valuation standards described  in Chapter 4. That chapter is very long, so your job is to “boil it down to something manageable 

112 UNDERSTANDING BUSINESS VALUATION

Although I knew what intrinsic value meant, it was not until recently that this definition became more important to a valuation assignment than ever before. The issue was the determination of fair value of a client’s interest in a family owned business. Using the market approach, based on public companies, we estimated the value of the company to be about $75 million. Using the income approach, we estimated the value of the company at about $125 million. After spending a considerable amount of time trying to reconcile these values, we realized that the publicly traded companies were selling at very low multiples, despite having solid growth expecta- tions. The market was undervaluing these companies. In fact, the investment banking firms that followed this industry had strong buy recommendations for most of the public comparables that we used in our analysis. This means that the intrinsic value of the public companies was greater than the market value. While we were doing a critique of the opposing side’s valuation (who only used the market approach to value the business), we reread Valuing a Business.

It is truly amazing how much we learn by rereading books that we read on a regular basis. Pratt et al. discuss intrinsic value. On page 44, they explain the following about intrinsic or fundamental value. 13

Intrinsic Value. The amount that an investor considers, on the basis of an evaluation of available fact, to be the “true” or “real” worth of an item, usually an equity security. The value that will be- come the market value when other investors reach the same conclusions. The various approaches to determining intrinsic value of the finance literature are based on expectations and discounted cash flows.

As can be seen from the preceding definition, Pratt et al. indicate that “the various approaches to determining intrinsic value in the finance literature are based on expectations and discounted cash flows.” Clearly, expect- ed earnings are of critical importance, but other variables such as dividends, capital structure, management quality, and so on, are also considered in a fundamental analysis. What is striking is that Pratt et al. state, “If the market value is below what the analyst concludes is the intrinsic value, the analyst considers the stock a ‘buy.”‘ This is exactly what takes place when an investment banking firm gives a strong buy recommendation on a company’s stock. If the market price of this stock is low enough to warrant this type of recommendation, using multiples (discussed in chapter 7), without proper adjustment, may undervalue the subject company.

How the Purpose of the Valuation Influences the Standard of Value There should be little doubt that the purpose and function of a valuation will have a dramatic influence on the standards of value that may be applicable in a particular assignment. Table 4.1 highlights how the purpose and standard of value relate to each other.

TABLE 4.1 Valuation Purpose and Standard of Value Relationships

Valuation Purpose

Estate and gift taxes

Inheritance taxes

Ad valorem taxes

Employee stock ownership plans (ESOPs)

Financial acquisitions

Stockholder disputes

Corporate or partnership dissolutions

13 Pratt. et al. , Valuing A Business, 5th ed.

Applicable Standard of Value

I@” Fair market value

I@” Fair market value

I@” Fair market value

I@” Fair market value

I@” Fair market value

I@” Fair value (in most states)

I@” Fair value (in most states)

(Table continued)