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Finance / Financial Analysis and Valuation: Credit Analysis (1)

Release Time:2022-04-14 Topic:Financial Analysis and Valuation Reading:28 Navigation:Stock Liao information > educate > Finance / Financial Analysis and Valuation: Credit Analysis (1) phone-reading
For Economics and Finance Postgraduate Examination/Postgraduate Examination/Research
Reference: Jerald E. Pinto, Elaine Henry, Thomas R. Robinson & John D. Stowe. Equity Asset Valuation (3rd edition) CFA Institute Investment Series

FINance / Financial Analysis and Valuation:

Part 5 Credit Analysis (continued)
1. Private Company Valuation
2. Discount Rate Estimation
3. Li & Solvency

1. Private Company Valuation

1.1. Normalized Earnings
1.2. Income Approach
1.3. Asset-Based Approach
1.4. Market Approach

1.1. Normalized Earnings

Normalized earnings are “economic benefits adjusted for nonrecurring, non-economic, or other unusual items to eliminate anomalies and/or facilitate comparisons.”

Example for Normalized Income:

John Smith is the sole shareholder and CEO of Able Manufacturing , Inc. Smith has put Able up for sale in advance of his retirem ent. James Duvall, a manager in the corporate venturing unit of a public company, is evaluating the purchase of Able. Duvall notes the following facts affecting the most recent fiscal year's reported results:

i) Smith's compensation for the year was $1.5 million. Duvall's executive compensation consultant believes a normalized compensation expense of $500,000 for a CEO of a company like Able is appropriate. Compensation is included in selling, general, and administrative expenses (SG&A).

ii) Certain corporate assets including ranch property and a condominium are in Duvall's judgment not re for the core operations of the company. Fiscal year expenses associated with the ranch and condominium were $400,000, including $300,000 of such operating expenses as property upkeep, property taxes, and insurance reflected in SG&A expenses, and depreciation expense of $100,000. All other asset balances (including cash) are believed to be at normal levels re to support current operations.

iii) Able's debt balance of $2,000,000 (interest rate of 7.5 percent) was lower than the optimal level of debt expected for the company. As reported interest expense did not reflect an optimal charge, Duvall believes the use of an earnings figure that excludes interest expense altogether, specifical ly operating income after taxes, will facilitate the assessment of Able.

Dovall uses the reported income statement to show the derivation of reported operating income after taxes, as given below.


Based only on the information given, address the following:

Q1. Identify the adjustments that Duvall would make to reported financials to estimate normalized operating income after taxes; that is, what the operating income after taxes would have been under ownership by Duvall's unit.

SG&A expense: $5,000,000 - $1,300,000

D&A: $1,000,000 - $100,000

Q2. Based on your answer to Q1 , construct a pro forma statement of normalized operating income after taxes for Able.

For Private Company Valuation, There are three valuation approaches:

1.2. Income Approach
1.3. Asset-Based Approach
1.4. Market Approach

1.2. Income Approach< /h3>

The income approach values ​​an asset as the present discounted value of the income expected from it. The income approach has several variations depending on the assumptions the valuator makes.

The three forms of income approach include:

i) the Free Cash Flow method (often referred to as the Discounted Cash Flow method in the appraisal community),

ii) the Capitalized Cash Flow method, and

iii) Residual Income method (fre referred to as the Excess Earnings method in the valuation community).

1.3. Asset-Based Approach

The asset-based approach - Underlying principle: the value of ownership is e to the fair value of its assets less the fair value of its liabilities.

(continued)Reference: Jerald E. Pinto, Elaine Henry, Thomas R. Robinson & John D. Stowe. Equity Asset Valuation (3rd edition) CFA Institute Investment Series

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For Economic and Financial Postgraduate Examination/Postgraduate Examination/Research Certificate

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