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The worth of a thing is the price it will bring… Over the past 25 years of valuing businesses and their assets we have consulted a considerable number of valuation texts authored by academicians, practitioners and those that purport to be both. These texts provide methodologies for valuing any asset, covering such topics as cost of capital, cash flow projections, and valuation multiples, etc. in great detail. Yet many of these texts, eager to equip the student with the tools of valuation, fail to address what from an appraiser’s viewpoint may be the most critical issue: that "value" can and does mean different things depending on the purpose of the appraisal. While some may take comfort from the analytical precision used to arrive at a value, the exercise may be futile if its not the value needed. Below are a few examples of different value standards, which if applied in the appraisal of the same property could result in different numerical values: Fair Market Value One of the most widely used definitions of fair market value is the one adopted by the IRS in 1959 (Revenue Ruling 59-60): The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Under this hypothetical buyer-seller standard, fair market value reflects the consensus opinion among all the buyers and sellers constituting the market for a property as to its worth rather than the opinion of any individual investor. Fair market value is the most widely used standard of value in business valuation. It applies in almost all appraisals for federal and state tax purposes, including income, estate, gift and property taxes. While alternative definitions of fair market value generally conform to the above, there are sometimes subtle but critical differences which an appraiser must take into account depending on the jurisdiction or other requirement. For example, the definition adopted by the American Society of Appraisers stipulates that value is the "most probable price" while the definition adopted by Revenue Canada specifies the "highest price". Investment Value While fair market value reflects the consensus opinion of all investors, investment value is based on the opinion of a specific investor. It thus reflects the individual investor’s expectation of the benefits to be derived from ownership, perception of and tolerance for risk, mix of debt and equity to be used in making the investment, as well as such factors as the investor’s tax status and overall investment portfolio. The investment value of a property may be higher than its fair market value, providing the investor with an incentive to buy, or it could be lower, prompting the investor to sell. It is the composite of investment values, as reflected in the prices paid for comparable properties, that determines the fair market value of a property. Fair Value The term fair value is both a legal and an accounting
concept. Fair value is a legal term that jurisdictions have chosen as the
standard of value to apply in specific transactions, most often in the case
of dissenting minority shareholder rights. The problem is that most
jurisdictions have left it to the courts to interpret "value" in
this context forcing appraisers to seek guidance from attorneys and others. Fair value is also the
standard of value that the Financial Accounting Standards Board has adopted for
valuation in its Statement of Financial Accounting Standards No. 141 and 142.
Unlike the legal concept, fair value for accounting purposes is a defined
term: The fair value of an
asset (or Liability) is the amount at which that asset (or liability) could
be bought (or incurred) or sold (or settled) in a current transaction between
willing parties, that is, other than in a forced or liquidation sale. Intrinsic Value The term intrinsic value is most often used in the context of common stock valuation, but can be applied to any asset. It is the theoretical value of an asset as justified by the facts. Since value is a function of expected future earnings, an asset’s intrinsic value can be discerned from an objective analysis of those fundamental factors that give rise to the property’s earnings, which in the case of a business include products, market share, quality of management, expected growth, etc. The term value is also used in a myriad of other contexts as well, e.g., insurance value, collateral value, liquidation value, transaction value. The point is that an appraiser must first understand what standard of value is appropriate before applying the tools of his trade, lest he find himself with a value which is of no value to his client. Thus the appraiser’s second question, after determining what is to be appraised, ought to be: what is the purpose of the appraisal? [ Return to top ] Copyright 1999, J.C. Ostrom
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