In Vol. 1 we discussed from a 50,000 foot view the methodologies used in valuing a going concern business. Before discussing the issues of discount rates and cash flows we turn our attention to understanding the differences and similarities between the different definitions of value.
There are several commonly used terms each of which refer to value and it is important that any two people discussing value are in fact comparing or speaking about “apples” and not “apples and oranges”. We will briefly look at some of the commonly used terms:
• Book value
• Adjusted book value
• Replacement value
• Reproduction value
• Value to Owner
• Liquidation value
• Net realisable value
• Market value
• Fair market value (Intrinsic value)
• Fair value
The terms Book value and Adjusted book value are used interchangeably to describe the amount at which assets and liabilities are recorded in financial statements. Under IFRS this is also referred to carrying value.
Replacement value represents the cost of substituting the asset with another asset having equivalent functional utility and remaining economic life as the asset in question.
Whereas Reproduction value represents the cost to construct at current prices an exact duplicate or replica of the asset in question using the same materials, construction standards, design, layout and quality of workmanship, and embodying all of the subject’s deficiencies, super-adequacies and obsolescence.
Value to Owner is used to describe owner-perceived economic advantage, non-economic advantage or a combination of both and may be equal to or greater than fair market value. It is the amount an owner would rationally pay for his/her property rather than be deprived of the use and enjoyment of it.
The practical application of Value to Owner is somewhat limited. It is used in expropriation cases and, in limited cases, in family law (e.g., in the valuation of a trust interest). Value to Owner can be difficult to quantify, is compensatory in nature and often includes an amount that would otherwise be considered personal goodwill. Generally, in determining Fair market value, the notion of personal goodwill is excluded.
Liquidation value is the net amount of money available to equity owners following a voluntary liquidation, a reorganization of a business pursuant either to a proposal to creditors, or a liquidation of a business pursuant to a receivership or other bankruptcy proceeding.
A notional Liquidation value assumes the sale of assets on a piecemeal basis and takes into account disposition costs including taxes incurred upon liquidation.
Net realisable value is defined as the net proceeds obtainable upon the sale of an asset, after providing for all costs of disposition, including income taxes. IFRS has similar concept known as fair value less cost to sell.
Market value is the highest price for which the owner can sell the property under prevailing conditions in the open market. Since it is based on prevailing market conditions, it does not adjust for abnormalities in the market. For instance, in times of depression Market value may be abnormally low but would be considered just as valid as the value that would be determined under normal market conditions.
It has been suggested that the difference between Market value and Fair market value comes from the word “fair”. It has been articulated in the courts that the word “fair” suggests that:
“…the market price must have some consistency and not be the effect of a transient boom or sudden panic on the market…”.
This suggests that in determining a Fair market value, one must look beyond prevailing market conditions.
Fair market value is currently defined by the Canadian Institute of Chartered Business Valuators as “The highest price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”
The Fair market value (Intrinsic value) represents a notional market value, based upon rates of return required by investors, given economic and business conditions existing at the valuation date, usually without consideration of possible synergistic (or economies of scale) benefits that might accrue to purchasers.
The differing roles of appraisers and brokers assist in illustrating the difference between Fair market value and Market value. Appraisers provide an opinion as to the price of an asset based on its investment merits (Fair market value) whereas a broker is concerned with selling the asset at the highest price available under existing market conditions (Market value).
IFRS 13 defines Fair value as “The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
We note that the concept of Fair value, as defined under the IFRS and the concept of Fair market value under CICBV standards of the CICBV contain significant differences which will be discussed in other volumes of the series.
The key is for client and valuator to agree the purpose and use of the valuation as the definition of value used is influenced by the purpose for which the valuation is being conducted.
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