618 Making Key Strategic Decisions
as of December 31, 2000, on an as-if-freely-traded basis. Since this amount is
based on rates of return of freely traded marketable securities, Victoria will
take a valuation discount for lack of liquidity at the end of her analysis.
Because Victoria made adjustments to the 2000 pro forma income state-
ment (see the pro forma column in Exhibit 18.5) for discretionary items (offi-
cers’ compensation and rent expense) and income tax expense, the 2000 pro
forma earnings and resulting value of $31.7 million represents a value for a
control (rather than a minority) equity interest.
In summary, the discounted cash f low methodology determines ACME’s
value today, which represents an owner ’s perceived future benefits discounted
to the present value. The DCF method forecasts ACME’s cash f lows into the
future and discounts them to their present value. In addition, this method as-
sumes that the owner will sell the company at some point in the future and re-
ceive the sale price. The estimated future sale price is also discounted back to
present value. The present values of future earnings and future sale price are
added together to determine the value of ACME.
MARKET APPROACH: PUBLICLY TRADED
GUIDELINE—COMPANIES METHOD
Bob asks Victoria to explain the market approach to determining value. She
says the market approach is a general way of determining a value by comparing
the asset to similar assets that have been sold. In business valuation, this can be
done by looking for any prior arm’s-length sales of the company’s stock, sales of
other companies, or prices of shares in publicly traded companies. In the latter
two instances, careful analysis of the other companies must be done to deter-
mine if they would properly serve as guidelines under this approach. The
American Society of Appraisers describes guideline companies as those “com-
panies that provide a reasonable basis for comparison to the investment char-
acteristics of the company being valued. Ideal guideline companies are in the
same industry as the company being valued; but if there is insufficient transac-
tion evidence available in the same industry it may be necessary to select com-
panies with an underlying similar ity of relevant investment character istics
(risks) such as markets, products, growth, cyclical variability and other salient
factors.”^2
In ACME’s case, there have never been any prior sales of corporate stock.
In addition, Victoria is unable to find any sales of guideline companies in which
adequate information is available. However, she is able to identify five publicly
traded companies that could potentially serve as guidelines under the market
approach.
Having identified the list of potential public companies through database
searches, Victoria performs a qualitative and quantitative analyses on the com-
panies to determine whether they should serve as guideline companies. This
analysis results in the selection of five companies.