Question #37
Reading: Reading 24 Private Company Valuation
PDF File: Reading 24 Private Company Valuation.pdf
Page: 19
Status: Incorrect
Correct Answer: B
Your Answer: C
Question
An analyst is valuing a firm's equity using the price-to-book-value ratio of similar firms. Which of the following is the most likely valuation approach the analyst will use?
Answer Choices:
A. The income approach
B. The market approach
C. The asset-based approach. Stan Bowles works for Marsh Inc. and has been tasked with the valuation of Park Limited, a small private footwear producer. Bowles prepares a valuation report on Park Limited and his report contains the following: Comment 1: Company-specific characteristics such as the quality and depth of management, tax considerations, and shareholders agreements that restrict liquidity mark the main differences between a private and public company
Explanation
The market approach values a firm using the price-multiples such as the price-to-book-
value ratio and price-earnings ratio of comparable assets. The income approach values a
firm as the present value of its future income. The asset-based approach values a firm as
its assets minus liabilities.
(Module 24.3, LOS 24.g)
Stan Bowles works for Marsh Inc. and has been tasked with the valuation of Park Limited, a
small private footwear producer. Bowles prepares a valuation report on Park Limited and his
report contains the following:
Comment 1:
Company-specific characteristics such as the quality and depth of
management, tax considerations, and shareholders agreements that restrict
liquidity mark the main differences between a private and public company.
Comment 2:
The value of a private company depends on the investor's expectations and
investment requirements and could differ from one buyer to the next due to
different perception of risk and future potential.
Comment 3:
To obtain an appropriate discount rate for Park, we have assumed the
following:
Estimated beta of Park: 0.75
Company specific risk premium: 1.2%
Small stock premium: 2.8%
Risk free rate: 3%
Equity risk premium: 4.5%
Comment 4:
If we are valuing Park for non-controlling equity interest, a discount for lack
of control might be required.