PART I State of the Profession, the Engagement, and the Basic Theory 1

1. Business Valuation Standards and Credentials 3

Growing Consensus on Business Valuation Standards.
The Appraisal Foundation. Background and Organization.
Uniform Standards of Professional Appraisal Practice.
Standards Published by Business Valuation Professional Organizations.
Other Organizations That Have Offered.
Guidance on Business Valuation Issues. Internal Revenue Service.
Department of Labor.Association for Investment Management and Research.The ESOP Association.
Recognition of Professional Standards by Courts.
International Acceptance of U.S. Standards and Practices.
Professional Organizations Offering Accreditation in Business Valuation.
American Society of Appraisers. Institute of Business Appraisers.
National Association of Certified Valuation Analysts.
American Institute of Certified Public Accountants.
The Canadian Institute of Chartered Business Valuators.
Summary. Bibliography.

2. Defining the Assignment 29

Basic Elements of the Valuation Assignment.
Definition of Who Offered and Who Accepted the Assignment.
Description of the Legal Interest or Interests to Be Appraised.
Description of the Business Entity. Description of the Specific Business Interest.
Interests Other than Direct Fee Simple Ownership.
Description of the Specific Ownership Interest Characteristics.
Control versus Minority. Degree of Marketability. Valuation Date.
Purpose of the Appraisal. Standards of Value. Fair Market Value. Investment Value.
Intrinsic or Fundamental Value. Fair Value under State Statutes.
Fair Value for Financial Reporting. Going-Concern versus Liquidation Premise of Value.
Sources of Guidance as to Applicable Standards and Premises of Value.
Form of the Work Product. Scheduling. Fee Arrangements.
Summary.

3. Business Valuation Theory and Principles 55

Generally Accepted Theory. Reliance on Projected versus Historical Benefits.
Basic Variables Affecting Value. Impact of Risk on Value.
Accepted Business Valuation Approaches and Methods.
Background and Structure. Interrelationship of the Three Broad Approaches.
Impact of Controlling versus Noncontrolling Ownership Interest. Impact of Marketability.
Distinction between Discount for Lack of Control and Discount for Lack of Marketability.
Other Qualitative Factors Affecting Value.
Matching the Valuation Methodology with the Standard and Premises of Value.
Sum of Parts Not Necessarily Equal to Whole.
Summary of Business Valuation Principles.
Bibliography.

PART II Gathering and Analyzing Data 73

4. Gathering Company Data 75

Generalized Company Information Checklist. Financial Statements.
Relevant Time Period. Levels of Financial Statement Preparation.
Impact of Enterprise Legal Structure.
Federal Tax Returns.
Interim Statements.
Other Financial Schedules. Current Assets and Liabilities. Plant and Equipment. Officers' and Directors' Compensation Schedule. Distribution of Ownership. Dividend or Partnership Withdrawal Schedule.
Schedule of Key Person Life Insurance. Off-Balance Sheet Assets or Liabilities.
Related Party Transaction Information. Operating Information.
Company History. Brochures, Catalogs, Web Sites, and Price Lists. Key Personnel. Customer and Supplier Base. Contractual Agreements and Obligations.
Industry and Trade Association Information. List of Past Transactions in the Stock or Offers to Buy.
Budgets and Forecasts. Capital Requirements. Capital Expenditures. Deferred Maintenance.
Working Capital Requirements. Company Documents Relating to the Rights of Owners.
Corporate or Partnership Records.
Buy-Sell and Employee Stock Ownership Plan Agreements.
Employment and Noncompete Agreements.
Summary.

5. Site Visits and Interviews 91

History.
Description of the Business. Management and Management Compensation. Operations.
Materials and Supplies. Labor and Government Relations. Plant and Equipment. Inventory.
Markets and Marketing. Finance. Current Assets. Fixed Assets. Intangible Assets. Current Liabilities.
Capital Structure. Off-Balance Sheet Items. Profitability and Budgeting. Insurance. Dividends.
Prior Arm's-Length Transactions or Offers. Catch-All Question.
Interviews of Outsiders. Professionals Related to the Company. Other Possible Outside Interviews.
Summary.

6. Researching Economic and Industry Information 103

National Economic Information.
The Federal Statistical System. Banks. Business Periodicals and Statistical Services.
Regional Economic
Information. Industry Information. General Industry Information.
Composite Company Data. Information on Management Compensation.
Online Information. Indexes to Economic and Industry Information.
Summary. Bibliography.

7. Analyzing Financial Statements 129

Normalizing versus Controlling Adjustments. Adequacy of Allowance and Reserve Accounts.
Allowance for Doubtful Accounts-Accounts Receivable. Allowance for Doubtful Accounts-Notes Receivable.
Inventory Accounting Methods. FIFO, LIFO, and Other Methods. Write-Down and Write-Off
Policies. Depreciation Methods and Schedules. Declining-Balance Method.
Sum-of-the-Years'-Digits Method. ACRS and MACRS. Analytical
Implications. Depletion. Treatment of Intangibles. Leasehold Interests.
Other Intangible Assets. Capitalization versus Expensing of Various Costs.
Timing of Recognition of Revenues and Expenses. Contract Work.
Installment Sales. Sales Involving Actual or Contingent Liabilities.
Prior-Period Adjustments. Accounting for Leases.
Net Operating Loss Carryforwards.
Treatment of Interests in Affiliates. Extraordinary or Nonrecurring Items.
Ordinary versus Extraordinary Items. Other Nonrecurring Items. Discontinued Operations.
Operating versus Nonoperating Items. Management Compensation and Perquisites.
Transactions Involving Company Insiders. Contingent Assets and Liabilities.
Adjustments to Asset Valuations. Marketable Securities. Other Assets.
Computation of Earnings per Share. Weighted Average Basis. Basic versus Diluted Earnings.
Computation of Book Value per Share. An Example of the Effect of Alternative Accounting Methods.
Adjusting the Balance Sheet to Current Values.
Summary. Bibliography.

8. Financial Statement Ratio Analysis 153

Use and Interpretation of Ratio Analysis. Common-Size Statements.
Short-Term Liquidity Measures. Current Ratio. Quick (Acid-Test) Ratio.
Activity Ratios. Accounts Receivable Turnover. Inventory Turnover.
Sales to Net Working Capital. Sales to Fixed Assets and Total Assets.
Risk Analysis. Business Risk. Financial Risk.
Balance Sheet Leverage Ratios. Total Debt to Total Assets. Equity to Total Assets.
Long-Term Debt to Total Capital.
Equity to Total Capital. Fixed Assets to Equity. Debt to Equity.
Income Statement Coverage Ratios. Times Interest Earned. Coverage of Fixed Charges.
Income Statement Profitability Ratios. Return on Investment Ratios.
Return on Equity. Return on Investment. Return on Total Assets.
Asset Utilization Ratios.
Summary.

PART III Business Valuation Approaches and Methods 171

9. Income Approach: Discounted Future Economic Income Method 173

Introduction: Theoretical and Practical Soundness of the Approach.
The Basic Discounted Economic Income Framework.
The Numerator: Expected Prospective Economic Income.
The Denominator: The Discount Rate. Estimating the Discount Rate.
Return and Rate of Return Defined. Components of the Discount Rate.
The Risk-Free Rate. The Equity Risk Premium. The Capital Asset Pricing Model.
Systematic and Unsystematic Risk. Beta: The Measure of Systematic Risk.
Using Beta to Estimate Expected Rate of Return. Levered and Unlevered Betas.
Assumptions Underlying the Capital Asset Pricing Model. The Size Premium.
The Build-Up Model. Formula for the Build-Up Model.
Company-Specific Risk Premium. Industry Risk Premia.
The Discounted Cash Flow or the Implied Method of Estimating the Cost of Capital.
Arbitrage Pricing Theory. Sources of Data to Estimate the Cost of Equity Capital.
Risk-Free Rate. Equity Risk Premium. Beta. Size Premium. Industry Risk Premia.
Investment-Specific Risk. Arbitrage Pricing Theory Factors.
Rate of Return Allowed to Regulated Companies. Cost of Capital Yearbook.
Discounting Economic Income Available to Overall Capital.
Defining the Capital Structure. Weighted-Average Cost of Capital Formula.
Should an Actual or a Hypothetical Capital Structure Be Used?
Specific Projection Period plus a Terminal Value. The "Midyear Discounting Convention".
Example of Application of Discounted Economic Income Methods. Estimating an Equity Discount Rate.
Discounting Net Cash Flow to Equity. Estimating a Weighted-Average Cost of Capital.
Discounting Net Cash Flow to Invested Capital.
Caveats in Using Discounted Economic Income Methods.
Converting a Discount Rate Applicable to Net Cash Flow to a Discount Rate Applicable to Net Income.
Does the Discounted Economic Income Model Produce a Control or a Minority Value? What Standard of Value Does a Discounted Economic Income Model Produce? Common Errors.
Mismatching the Discount Rate with the Economic Income Measure.
Confusing Discount Rates with Capitalization Rates.
Projecting Growth Beyond What the Capital Being Valued Will Support.
Projecting That Extrapolation of the Recent Past Represents the Best Estimate of Future Results.
Discounting a Terminal Value for an Incorrect Number of Periods.
Internally Inconsistent Capital Structure Projection.
Assumptions That Produce a Standard or Premise of Value Other Than That Called for in the Valuation Engagement.
Summary. Bibliography.

10. Income Approach: Capitalized Economic Income Method 237

Essential Difference between the Discounting Model and the Capitalization Model.
The Perpetual Economic Income Stream Model.
Converting a Discount Rate to a Capitalization Rate-The Constant Growth Model.
The Gordon Growth Model, Sensitivity to Growth Rate Assumptions.
When to Use the Discounting versus the Capitalization Method.
Equivalence of the Discounting and Capitalization Methods.
Implementing the Capitalized Economic Income Method.
Projecting the Basic Economic Income Level and the Growth Rate.
Start with Sustainable Expected Economic Income.
The Projected Long-Term Growth Rate. Defining the Components in the Capitalization Method.
Valuing Equity versus Invested Capital. Selecting the Appropriate Measure of Economic Income.
Modification of the Capitalized Economic Income Method to Reflect the Midyear Discounting Convention.
Using the Capitalized Economic Income Method to Develop a Terminal Value for the Discounted Economic Income Method.
Why the Capitalized Economic Income Method Is Preferable.
Implementation of the Capitalized Economic Income Method to Estimate the Terminal Value.
Does the Capitalized Economic Income Method Produce a Control Value or a Minority Value?
What Standard of Value Does the Capitalized Economic Income Model Produce?
Relationship between the Capitalized Economic Income Method and the Market Approach.
Derivation of Income Approach Capitalization Rates versus Market Approach Multiples.
Economic Income Variables Used in the Income Approach versus the Market Approach.
Summary. Bibliography.

11. Market Approach: Guideline Publicly Traded Company Method 261

Overview of the Guideline Publicly Traded Company Method.
When Is the Guideline Publicly Traded Company Method Most Useful? Standard of Value.
Ownership Characteristics. Going-Concern versus Liquidation Value.
Quantity and Quality of Available Data. Criteria for Guideline Company Selection.
How Many Guideline Companies? Time Period to Consider.
Deciding Which Valuation Multiples to Use. Influence of the Ownership Characteristics.
Going-Concern versus Liquidation Value. Type of Company. Availability of Data.
Compiling Guideline Company Tables. Developing a List of Guideline Companies.
Financial Statement Adjustments to Guideline Companies. Adjusting for Operating Leases.
Comparative Ratio Analysis. Obtaining the Guideline Companies' Market Value Data.
Presenting Guideline Company Tables.
Selecting and Weighting Multiples for the Subject Company Based on Guideline Companies.
Impact of Guideline Company Data Evaluation. Measures of Central Tendency and Dispersion.
Multiples of Economic Income Variables. Capitalization of Dividends or Dividend-Paying Capacity.
Multiples of Revenue. Multiple of Stock Value to Asset Value.
Treating Nonoperating Assets, Excess Assets, and Asset Deficiencies. Nonoperating Assets.
Marginal Operating Real Estate. Excess Assets or Asset Deficiencies.
Beware of Recent Acquisitions. Multiline Companies. Procedures for Valuation. "Portfolio Effect".
Typical Adjustments to Reach a Value Conclusion. Valuation Multiples Using Market Value of Invested Capital.
Common Errors. Failure to Conduct an Adequate Search for Guideline Company Data.
Failure to Make Appropriate Financial Statement Adjustments to Guideline Companies.
Multiples that Mismatch Numerator and Denominator.
Simple Reliance on Average of Guideline Company Multiples without Comparative Analysis.
Summary. Bibliography.

12. Market Approach: Guideline Merged and Acquired Company Method 309

Overview of the Merged and Acquired Company Method.
When Is the Guideline Merged and Acquired Company Method Most Useful? Standard of Value.
Going-Concern versus Liquidation Value. Quantity and Quality of Data Available.
Control Transaction (Acquisition) Valuation Multiples.
Announcement versus Closing Date Value.
Caveat: Check the Deal Structure.
Deal Terms. Exactly What Was Transacted? Noncompete and Employment or Consulting Agreements.
Sources of Merger and Acquisition Data. Sources for Large Company Transactions.
Sources for Middle-Market and Smaller Company Transactions.
Past Subject Company Transactions. Past Subject Company Changes of Control.
Bona Fide Offers. Past Acquisitions by the Subject Company.
Formulas or Rules of Thumb. Nonoperating Assets, Excess Assets, and Asset Deficiencies.
Selecting and Weighting Multiples for the Subject Company Based on Guideline Transactions.
Impact of Guideline Transactional Data Evaluation. Multiple of Stock Value to Asset Value.
Reaching the Value Conclusion. Summary. Bibliography.

13. The Capitalized Excess Earnings Method 331

The History of the Capitalized Excess Earnings Method.
The Capitalized Excess Earnings Valuation Method. Practical Application of This Method.
The Seeming Simplicity of This Method. An Illustration. Analysis of the Capitalized Excess Earnings Method.
Estimation of the "Net Tangible Asset Value". Estimation of the "Normalized Level of Earnings".
Appropriate Rate of Return on Tangible Assets. Appropriate Direct Capitalization Rate for Excess Earnings.
Comprehensive Example. The Treatment of Negative Goodwill.
Common Errors in Applying the Capitalized Excess Earnings Method.
Failure to Allow for Shareholder/Employee Salary. Failure to Use Realistic Estimate of Future Normalized Earnings.
Errors in Developing the Appropriate Direct Capitalization Rates.
Summary. Bibliography

14. Asset-Based Approach: Asset Accumulation Method 349

Fundamentals of the Asset Accumulation Method. Asset-Based Approach versus Book Value.
Asset Accumulation Method and Capitalized Excess Earnings Method. Asset Accumulation Method-Individual Revaluation.
Combining Elements of Asset Accumulation Method and Capitalized Excess Earnings Method.
Asset Accumulation Method Procedures. Obtain or Develop a Cost-Basis Balance Sheet.
Identify Assets and Liabilities to Be Revalued. Identify Off-Balance Sheet Assets.
Identify Off-Balance Sheet and Contingent Liabilities. Value the Accounts Identified Above.
Construct a Value-Basis Balance Sheet. Individual Asset Valuation Procedures.
Financial Assets. Real Estate. Tangible Personal Property. Intangible Real Property.
Intangible Personal Property. Categorization of Intangible Assets.
Valuation of Intangible Assets. Remaining Useful Life Analysis of Intangible Assets.
Example. Advantages of the Asset Accumulation Method.
Disadvantages of the Asset Accumulation Method.
Summary. Bibliography.

PART IV Discounts, Premiums, and the Value Conclusion 381

15. Control and Acquisition Premiums 383

Levels of Value. Elements of Control. Control or Lack of Control Covers a Spectrum.
How the Standard of Value Affects the Control Premium. Fair Market Value. Fair Value.
Fair Value for Financial Reporting. Investment Value.
Market Evidence Regarding Control and Acquisition Premiums.
The Mergerstat Review. The Mergerstat/Shannon Pratt's Control Premium Study.
Negative Control Premiums. Means, Medians, and Effect of Negative Premiums.
Robinson, Rumsey, and White Study.
Summary. Bibliography.

16. Discount for Lack of Control 397

Lack of Control Covers a Spectrum. Factors That Influence the Lack of Control Discount.
Effect of State Statutes. Articles of Incorporation and Bylaws. Potential Dilution.
Preemptive Rights. Cumulative versus Noncumulative Voting. Contractual Restrictions.
Financial Condition of Business. Highly Regulated Industries.
Buy-Sell and Other Shareholder Agreements. Fiduciary Duties.
Private Company with Public Securities. Private Company That Operates Like a Public Company.
Control Has Already Been Dissipated. Nonoperating Assets.
Empirical Evidence to Quantify Lack of Control Discounts. Discounts from Net Asset Value.
Holding Companies. Limited Partnerships. Built-In Gains Discount.
Trust and Estate Sales Study. Discounts for Direct Undivided Ownership Interests in Real Estate.
Procedures for the Valuation of Noncontrolling Ownership Interests. The Discount Approach.
The Direct Comparison Approach. The Bottom-Up Approach (Income Approach).
Adjustments to Income Statement. Summary. Bibliography.

17. Discounts for Illiquidity and Lack of Marketability 415

Concept and Importance of Marketability.
Adjustment for Lack of Marketability for Noncontrolling Ownership Interests.
Evidence for the Quantification of Discount for Lack of Marketability.
Marketability Discounts Extracted from Prices of Restricted Stocks.
SEC Institutional Investor Study. Gelman Study. Trout Study. Moroney Study.
Maher Study. Standard Research Consultants Study. Willamette Management Associates Study.
Silber Study. FMV Opinions, Inc., Study. Management Planning, Inc., Study. Johnson Study.
Columbia Financial Advisor Study. LiquiStat Database.
Summary of Empirical Studies on Restricted Stock Transactions.
Studies of Private Transactions before Initial Public Offerings.
Robert W. Baird & Company Studies. Willamette Management Associates Studies.
Criticisms of Willamette Management Associates Studies. Valuation Advisor Studies.
Summary of Conclusions from Private Transaction Studies.
Other Analysis of Discounts for Lack of Marketability for Minority Ownership Interests.
Discounts for Lack of Marketability for Controlling Ownership Interests.
Illiquidity Factors Affecting Controlling Ownership Interests.
Benchmark for the Illiquidity Discount for Controlling Ownership Interests.
Differences between Private and Public Company Acquisition Price/Earnings Multiples.
Factors That Affect the Discounts for Illiquidity and Lack of Marketability. "Put" Rights.
Dividend Payments. Potential Buyers. Size of Interest.
Prospect of Public Offering or Sale of the Business. Information Access and Reliability.
Restrictive Transfer Provisions. Company Characteristics: Size, Performance, and Risk.
Court Decisions on Discounts for Illiquidity and Lack of Marketability.
Mandelbaum v. Commissioner Reviews Lack of Marketability Factors.
Estate of Barge v. Commissioner Considers Lack of Marketability Factors.
Okerlund v. United States Approves Pre-IPO Studies. McCord v. Commissioner Lacks Rebuttal.
Howard v. Shay Upholds 50 Percent DLOM.
Summary. Bibliography.

18. Other Valuation Discounts 459

Entity Level Discounts. Key Person Discounts. Discounts for Trapped-In Capital Gains Taxes.
"Portfolio" (Nonhomogeneous Assets) Discount. Discount for Contingent Liabilities.
Other Shareholder Level Discounts. Nonvoting versus Voting Stock. Blockage.
Summary. Bibliography.

19. Valuation Synthesis and Conclusion 471

The Reconciliation Process. Criteria for the Selection of Valuation Approaches and Methods.
Quantity and Quality of Available Data.
Type of Business, Nature of Business Assets, and Type of Industry Subject to Valuation.
Nature of the Business Interest Subject to Valuation.
Statutory, Judicial, and Administrative Considerations. Informational Needs of the Valuation Audience.
Purpose and Objective of the Analysis. Professional Judgment and Expertise of the Analyst.
Reconciling Divergent Indications among Valuation Methods. Weighting of Valuation Method Results.
At What Point Are Valuation Discounts and Premiums Applied? Concluding the Value Estimate.
Explicit Weighting. Implicit Weighting. Final Value Estimate.
Summary.

PART V Writing and Reviewing Business Valuation Reports 483

20. Writing the Business Valuation Report 485

Overview of the Business Valuation Report. USPAP Reporting Standards.
Written Business Valuation Reporting Standards. Oral Business Valuation Reporting Standards.
USPAP Ethics Provisions. Retention of Valuation Reports and Work Paper Files.
Confidentiality Provision. Internal Revenue Service Business Valuation Guidelines.
Valuation Industry Reporting Standards. American Society of Appraisers.
The Canadian Institute of Chartered Business Valuators.
National Association of Certified Valuation Analysts. Institute of Business Appraisers.
American Institute of Certified Public Accountants.
Guidelines for Effective Report Writing. What Causes Ineffective Report Writing?
Make the Report "Incisive".
Summary. Bibliography.

21. Sample Report 501

Introduction. Description of the Assignment. Summary Description of the Company.
Capitalization and Ownership. Sources of Information. Analysis of the U.S. Economy.
Overview. Outlook. Analysis of the Poultry Processing Industry. Overview. The Current Market.
Exports. Identification of Guideline Companies. Overview. Descriptions of Selected Guideline Companies.
Financial Statement Analysis. Overview. Balance Sheets. Income Statements.
Cash Flow Statements. Adjustments. Financial and Operating Ratios.
Valuation of Common Stock. Overview. The Guideline Publicly Traded Company Method.
The Discounted Cash Flow Method. Overall Valuation Conclusion. Discount for Lack of Marketability.
Summary and Conclusion of Empirical Research. Selection of the Applicable Lack of Marketability
Discount for a Warm Chicken Noncontrolling Ownership Interest.

22. Reviewing a Business Valuation Report 535

Identification of the Subject Property. Relevant Dates. Definition of Value.
Standard of Value. Reason for the Selected Standard of Value.
Purpose of the Valuation. Actual or Assumed Ownership Characteristics.
Degree of Marketability. Degree of Ownership Control. Basic Company Information.
Economic and Industry Outlook. Sources of Information. Site Visits.
Management Interviews. Economic and Industry Data. Company Financial Statements.
Income Approach Data. Market Approach Data. Asset-Based Approach Data.
Financial Statement Analysis. Financial Statement Adjustments. Comparative Financial Statement Analysis.
Valuation Methodology. Income Approach. Market Approach. Asset-Based Approach-Asset Accumulation Method.
Asset-Based Approach-Capitalized Excess Earnings Method.
Are the Data Used Appropriate for the Valuation Date?
Cost of Capital Data. Market Approach Data. Asset-Based Approach Data.
Valuation Synthesis and Conclusion. Analyst's Qualifications. Professional Accreditations.
Education. Professional Association Memberships.
Experience and Professional Involvement. Appraisal Certification.
Statement of Contingent and Limiting Conditions. Overall Evaluation.

PART VI Valuing Specific Securities and Interests 545

23. Valuing Debt Securities 547

Common Situations Requiring Valuation of Debt Securities. Purchase or Sale for Cash.
Exchange of Equity for Debt. Gift and Estate Taxes.
Allocation of Total Enterprise Value among Classes of Securities.
Adjusting a Balance Sheet for Debt Securities Owned or Owed. Lease Financing.
Method of Valuation. Amount and Timing of Future Payments.
Estimation of Yield to Maturity. Marketability Aspects of Closely Held Debt Securities.
Special Characteristics of Various Debt Securities. Call Provisions.
Sinking Fund Provisions. Collateral Provisions. Income Tax Status. Zero Coupon Debt.
Convertible Debt. Summary. Bibliography.

24. Valuing Preferred Stock 563

Common Situations Requiring Valuation of Preferred Stock. Purchase or Sale for Cash.
Exchange of Common Equity or Debt for Preferred Stock.
Gift and Estate Taxes. Allocating Total Enterprise Value among Classes of Securities.
Adjusting a Balance Sheet for Preferred Stock Owned or Outstanding.
Income Taxes-Code Section 409A. Special Characteristics of Closely Held Preferred Stocks.
Dividend Rate. Liquidation Preference. Cumulative versus Noncumulative Dividends.
Redeemable versus Nonredeemable. Put Option. Voting versus Nonvoting.
Participating versus Nonparticipating. Convertible versus Nonconvertible.
Method of Valuation. Assessing Dividend and Liquidation Payment Risk. Comparison with
Publicly Traded Preferred Stocks. Capitalizing the Income Stream.
Marketability Aspects of Closely Held Preferred Stock. Revenue Ruling 83-120. Summary.
Bibliography.

25. Introduction to Valuing Stock Options 585

Common Situations Requiring Valuation of Options. Terminology.
The Basic Call Option Equation. The Black-Scholes Option Model.
European Options on Non-dividend-Paying Stocks.
European Options on Dividend-Paying Stocks-The Merton Model.
American Call Options-The Pseudo-American Call Option Model.
Empirical Tests of Black-Scholes Options Models.
Valuing Options on the Stock of Closely Held Companies.
The Binomial Model for American Call Options. Introduction. Methodology.
Employee Incentive Stock Options. Using Option Pricing to Value the Built-in Gains (BiG) Tax Liability.
Real Options. Summary. Bibliography.

26. Valuing S Corporation Stock and Interests in Other Pass-Through Entities 613

Case Law History. Gross v. Commissioner. Wall v. Commissioner.
Estate of Heck v. Commissioner. Estate of Adams v. Commissioner.
Empirical Research on Sales of Controlling Interests. Erickson-Wang Study.
Mattson, Shannon, and Upton Study. Summary of Empirical Research.
Models for Valuation of S Corporation Minority Interests.
Summary. Bibliography.

PART VII Valuations for Specific Purposes 625

27. Valuations for Gift and Estate Tax Purposes 627

Introduction. Current Tax Rates and Penalties. Appraiser Penalty and Potential for Blacklisting.
Guidelines for Federal Gift and Estate Tax Valuations. Weight to Be Accorded Various Factors.
Capitalization Rates. Average of Factors. Restrictive Agreements. Summary of Guidelines.
Chapter 14 Special Valuation Guidelines.
Valuing Recapitalizations and Senior Equity Interests under Section 2701.
Valuation Issues under Section 2702.
Buy-Sell Agreements and Leases (Including Operating Agreements of LLCs) or Sale of Options under Section 2703.
Valuation Rules for Lapsing Rights and Other Restrictions under Section 2704.
Locking in the Three-Year Gift Tax Statute of Limitations.
Shifting the Burden of Proof from the Taxpayer to the IRS. Valuation Issues in Estate and Gift Tax Planning.
Placing Family Assets in Corporate, Limited Liability Company, or Partnership Form.
Minimizing Taxes through a Series of Timely Minority Ownership Interest Transfers.
Loss of Key Person. Trapped-In Capital Gains Discounts.
Other Estate Planning Situations Requiring Valuations. Other Gift and Estate Valuation Issues.
Summary. Bibliography.

28. Estate and Gift Tax Court Cases 661

Standard of Value. Approaches to Value. Burden of Proof. Selection of Guideline Companies.
Buy-Sell Agreements. Covenants Not to Compete. Reliance on Subsequent Sales.
Subsequent Events and Data. Discount for Lack of Marketability (DLOM).
Discounts for Lack of Marketability-Controlling Ownership Interests.
Discount for Lack of Control (DLOC).
Blockage Discounts. Key Person Discount. Contingent Liability Discounts.
Combined Discounts. Premiums. Trapped-In Capital Gains Taxes.
S Corporations. Family Limited Partnerships. FLP Valuation Issues. Validity Issue.
Focus on Willing Seller as Well as on Willing Buyer. Inadequacy of the Valuation.
Must Use Empirical Data to Quantify Variables. Sufficiency of Data.
Summary. References.

29. Buy-Sell Agreements 707

Types of Buy-Sell Agreements. Valuation Provisions of the Buy-Sell Agreement.
Need for Clear Direction. Formula Approaches. Negotiation Among the Parties.
Independent Outside Appraisal. Understanding an Agreement's Pricing Philosophy.
Terms and Funding. Term Payment Provisions. Funding the Buy-Sell Agreement with Life Insurance.
Restrictions on Transfer. Buy-Sell Agreement Values for Estate and Gift Tax Valuation under Chapter 14.
Valuation Requirements under Section 2703. Bibliography.

30. Valuation for Income Tax Purposes 723

Introduction. Federal Income Tax Reasons to Conduct an Appraisal.
Valuation of Property Received in a Transaction. Determining Basis in a Property.
Joint Ownership of Property. Property Acquired from a Decedent.
Valuation Requirements for Charitable Contribution Deductions.
Documentation Requirements-Contributions of Property. Noncash Property Contributions.
Appraisals for Noncash Contributions. Year-End Charitable Gifting Considerations.
Limitations on Charitable Contribution Deductions. Valuation of Compensation.
Multifactor Tests. Independent Investor Test.
Valuation of Worthless and Abandoned Property. Worthless Securities.
Valuation Aspects of Section 165. Abandonment Loss for Nondepreciable Business Assets.
Worthless Stock Deduction. Summary of Worthless and Abandoned Property Valuation.
Valuation Aspects of Cancellation of Indebtedness Income.
Unfavorable Tax Consequences of Debt Restructuring.
Insolvency Provisions of Code Section 108. Insolvency Test Illustrative Example.
The "Costs" of Code Section 108. Valuation-Related Income Tax Penalties.
The Section 6695A Appraiser Penalties. The Section 6662 Accuracy-Related Penalties.
Negligence Penalty. Substantial Valuation Overstatement Penalty.
Substantial Overstatement of Pension Liabilities Penalty.
Definitions and Special Rules under Section 6664. Tax Return Preparer Penalties.
Summary of Valuation-Related Income Tax Penalties.
Valuation Aspects of Intercompany Transfer Pricing.
Key Features of the Final Section 482 Regulations. Special Circumstances. Multiple Year Data.
Purposes and Roles of Valuation and Economic Analysis Experts. Types of Experts.
Summary of Transfer Pricing Valuation Issues.
Valuation of Intellectual Properties for State Income Taxation Purposes.
Trademarks and Trade Names. Transfer of Intellectual Properties.
Creation of the Intellectual Property Holding Company.
Valuation of the Transferred Intellectual Properties.
Summary. Bibliography

31. Income Tax Court Cases 753

Introduction. General Valuation Methodology Issues. Pabst Brewing Company v. Commissioner.
Nathan and Geraldine Morton v. Commissioner. Caracci v. Commissioner. Gow v. Commissioner.
BTR Dunlop Holdings, Inc. v. Commissioner. Charitable Contribution Issues.
John T. and Linda L. Hewitt v. Commissioner. John C. Todd v. Commissioner.
Gerald D. and Catherine Leibowitz v. Commissioner. Koblick v. Commissioner.
Reasonable Compensation Issues. Multifactor Tests. LabelGraphics, Inc. v. Commissioner-9th Circuit.
B&D Foundations, Inc. v. Commissioner-10th Circuit. Brewer Quality Homes, Inc. v. Commissioner.
O.S.C. & Associates, Inc. v. Commissioner.
Law Offices-Richard Ashare, P.C. v. Commissioner.
Alpha Medical, Inc. v. Commissioner. Beiner, Inc. v. Commissioner.
E.J. Harrison and Sons, Inc. v. Commissioner. Independent Investor Test.
Exacto Spring Corporation v. Commissioner-7th Circuit. Menard, Inc. v. Commissioner.
Intangible Asset Valuation Issues. Nestle Holdings, Inc. v. Commissioner.
Bemidji Distribution Company v. Commissioner. Frontier Chevrolet Co. v. Commissioner.
DHL Corporation and Subsidiaries v.Commissioner.
Other Income Tax Issues. Purchase Price Allocation.
Indeck Energy Services, Inc. v. Commissioner. Present Value as Indicator of "For Profit" Status.
Walford v. Commissioner. Stock Warrant Valuation.
Kimberlin v. Commissioner. Valuation as Accounting Method.
In re Heilig Meyers Company. Summary

32. Valuations for Employee Stock Ownership Plans 809

General ESOP Framework. Types of ESOPs. Nonleveraged ESOPs.
Leveraged ESOPs. All Parties to a Leveraged ESOP Transaction Benefit.
Valuation of a Company for ESOP Purposes. Adequate Consideration.
Independence of the Appraiser and the Appraiser's Role. Reporting Requirements.
Valuation Approaches and Methods. ESOP-Specific Adjustments. ESOP Contributions.
Normalized Employee Benefit Costs.
Compensation Adjustments. ESOP Compensation Adjustment.
Control Premiums. Discount for Lack of Marketability. Put Option and Repurchase Liability.
Current Controversies. Posttransaction Value in Leveraged ESOPs.
Legislative and Regulatory Issues in ESOPs. Section 1042 Rollover.
409(1) Employer Securities. Principal Deductibility and Code Section 415.
Code Section 133 Interest Exclusion. The IRS Audit Guidelines.
ESOP Specific Plan Administration Issues. Allocations to Participant Accounts.
Distribution Policy. Diversification. Finance Issues in Leveraged ESOPs.
Repurchase Liability. Repurchase or Recycling. Redemption. Managing the Repurchase Liability.
Methods of Funding. Fiduciary Issues in ESOPs. Voting Issues.
Trustee's Voting Rights. Circularity of Control.
Independent, Directed, or Internal Trustee. Accounting for ESOPs.
Nuances of S Corporation ESOPs. Limitations on S Corporation Tax Benefits.
Voting Issues. Form of Distribution. S Corporation Distributions.
Steps to Implementing an ESOP.
Summary. Bibliography

33. ESOP Court Cases 837

Introduction. Sommers Drug Stores. Introduction. The Facts of the District Court Case.
The Facts of the Appeal. The Plaintiff's Position. The Defendants' Position.
Commentary and Conclusion. U.S. News & World Report. Introduction. The Facts of the Case.
The Valuation Issues. The District Court's Decision. The Appeals Court's Decision.
Commentary and Conclusion. Andrade v. Parsons. Introduction. The Facts of the Case.
The District Court's Decision. The Appeals Court's Decision. Commentary and Conclusion.
Reich v. Valley National Bank of Arizona. Introduction. The District Court's Findings.
Commentary and Conclusion. Howard v. Shay. Introduction. The Facts of the Case.
The District Court's Decision. The District Court's Decision-Commentary and Conclusion.
The Appeals Court's Decision. The District Court Retrial.
The District Court Retrial-Commentary and Conclusion.
Eyler v. Commissioner. Introduction. The Issues of the Case. The Facts of the Case.
The Issues before the Court. The Petitioner's Position. The Appeals Court Decision-The Valuation Issues.
The Appeals Court Decision-The Fiduciary Issues. Commentary and Conclusion. Davis v. Torvick.
Introduction. The Facts of the Case. The Issues of the Case. The Plaintiffs' Position.
The Defendants' Position. The District Court's Decision. Commentary and Conclusion.
Henry v. Champlain Enterprises. Introduction. The Facts of the Case. The Issues of the Case.
The District Court's Decision. Commentary and Conclusion. Eckelkamp v. Beste. Introduction.
The Facts of the Case. The District Court's Decision. The Appeals Court's Decision.
Commentary and Conclusion. Horn v. McQueen. Introduction. The Facts of the Case.
The District Court's Decision. Commentary and Conclusion. Chao v. Hall Holding Co., Inc. Introduction.
The Facts of the Case. The District Court's Decision. The Appeals Court's Decision.
Commentary and Conclusion. Keach v. U.S. Trust Co. Introduction. The Facts of the Case.
The Issues before the District Court. The District Court's Decision.
The Issues before the Appeals Court. The Appeals Court's Decision. Commentary and Conclusion.
Armstrong v. LaSalle Bank National Ass'n. Introduction.
The Facts of the Case. The District Court's Decision. The Appeals Court's Decision.
Commentary and Conclusion. Kennedy v. Trustmark National Bank. Introduction. The Facts of the Case.
The District Court's Decision. Commentary and Conclusion.
Summary

34. Valuations for Ad Valorem Taxation 873

Introduction. Definitions of Ad Valorem Taxation Terminology.
Market Value as the General Basis of Property Assessment. The Property Tax Valuation Process.
The Property Tax Equalization Process. Assessment Ratio Studies.
Use of Assessment Ratio Studies in Administrative Appeals and Litigation.
The Property Tax Unitary Valuation Process. The Property Tax Appeal Process.
Steps in the Ad Valorem Taxation Valuation Process.
The Assessing Authority's Objective. The Property Owner's Objective.
The Independent Valuation Analyst's Objective. Special Topics.
Identification and Quantification of Functional Obsolescence.
Identification and Quantification of the Economic Component of External Obsolescence.
Issues in Unit Valuation for Ad Valorem Purposes. Jurisdictional Differences.
Value Excluded from the Taxable Unit.
Identification and Valuation of Intangible Assets in the Unit Method of Assessment.
Alternatives to Use of Stock Market Data.
Problems with the Use of Stock Market Data in Property Tax Valuations. Introduction.
Income Approach Valuation Issues. Resolving Circularity Due to Property Tax Expenses.
Differences in the Risk and Expected Return Investment Characteristics between Operating Property and Negotiable Securities. Capitalization of Leased Equipment Rental Expense. Introduction. Operating Lease Rental Expense.
Summary. Bibliography

35. Dissenting Stockholder and Minority Oppression Actions 905

Dissenting Stockholder Actions.
Interpretation of the Fair Value Standard in Dissent Cases. "That which Has Been Taken".
The Delaware Block Method. Should Consider All Relevant Factors. Requirement for Entire Fairness.
Fair Consideration. Procedural Fairness. Consequences of Lack of Entire Fairness.
Minority Interest Dissolution Actions. Interpretation of the Fair Value Standard in Dissolution Cases.
Summary. Bibliography

36. Dissenting Stockholder and Minority Oppression Court Cases 915

Readers Must Interpret Cases Carefully. Fair Value Is Not Fair Market Value.
Premise of Value. Breach of Fiduciary Duty Expands Plaintiffs' Potential Damages.
Approaches to Value. Should Consider Market Value, Asset Value, and Investment Value.
Market Approach. Guideline Merged and Acquired Company (Transaction) Method.
Discounted Cash Flow Method. Net Asset Value. Excess Earnings Method.
Weighting of Methods. Discounts and Premiums. Lack of Control Discounts Rejected.
Lack of Control Discounts Accepted. Ownership Control Premium Accepted.
Lack of Marketability Discounts Rejected. Lack of Marketability Discounts Accepted.
Lack of Combinatorial Value Discount Rejected. Discounts for Trapped-In Capital Gains.
Discounts Left to Court's Discretion. Sufficiency of Valuation Evidence.
"Dr. Pangloss and Mr. Scrooge". Summary

37. Valuations for Marital Dissolution Purposes 943

The Marital Estate. Community Property. Equitable Distribution.
Active or Passive Appreciation During Marriage.
Active or Passive Post-Valuation Date Appreciation. Standard of Value. Investment Value.
Fair Market Value. Intrinsic Value. Fair Value. Internal Contradictions in the Case Law.
Valuation Date. Discovery. Goodwill. Valuation Methods. Income Approach.
Market Approach. Asset-Based Approach. The Capitalized Excess Earnings Method.
Usually Employ More Than One Method. Compensation. Noncompete Covenants. Buy-Sell Agreements.
Treatment of Trapped-In Capital Gains Taxes. Valuation Discounts and Premiums.
The Role of the Analyst. "Jointly Retained" Assignments. Adequacy of Evidence.
Summary. Bibliography

38. Marital Dissolution Court Cases 963

Standards of Value. Fair Market Value. Fair Value. Investment Value.
Premise of Value. Active versus Passive Appreciation. "Active" Appreciation as a Marital Asset.
"Active" Appreciation Must Be Proven. Valuation Date. Goodwill.
The "Market Value of Goodwill" Paradox. Personal Goodwill Not a Marital Asset in Many States.
Personal Goodwill Is a Marital Asset in Many States. Other Goodwill Issues.
The "Double Dipping" Issue. Valuation Methods in the Family Law Courts.
The Size Argument. The Liquidity Argument. The Risk Argument.
The Cost of Flotation Argument. Noncompete Covenants. Buy-Sell Agreements.
Cases Rejecting Buy-Sell Agreements. Cases Finding Buy-Sell Price Controlling.
Buy-Sell Agreement May Be Considered.
Discounts for Lack of Control and Lack of Marketability.
Discount for Lack of Control. Discount for Lack of Marketability.
Adequacy of Evidence. The Need for a Solid Record. Preserving the Record.
Inadequate Evidence. Greater Weight Given to Valuation Professionals.
Rejection of Unqualified Experts and Unaccepted Methodolgies.
Appraiser's Due Diligence Duties.
Treatment of Tax Liabilities. Summary

39. Fair Value for Financial Reporting 1005

Definition of Fair Value. Differences from Fair Market Value.
Disclosures

PART VIII Litigation and Dispute Resolution 1009

40. Litigation Support Services 1011

Valuation-Related Controversy Matters. Types of Litigation. Contract Disputes.
Commercial Torts. Business Interruption Claims. Antitrust Claims.
Shareholder Disputes and Securities Litigation. Marital Dissolution.
Personal Injury or Wrongful Termination Cases. Estate, Gift, and Income Taxes.
State and Local Property Taxes. Bankruptcy/Insolvency/Reorganization.
Intellectual Property Rights Infringement. Engaging the Appraiser. Qualifications.
Conflicts of Interest. Engagement Agreement. Discovery. Assessing the Case.
Business Appraisal Discovery. Permanent Files. Accountant's Files. Bank Files.
Invoices. Interrogatories. Depositions. Research. Calculating the Amount of Damages.
The Before-and-After Method. The Yardstick (Comparable) Method.
Sales Projections ("But For") Method. Mitigation. Summary of Damages.
Work Product. Affidavits. Written Reports.
Critique of the Opposition. Expert Testimony. Rebuttal.
Assistance in Preparing Briefs. Summary

41. Expert Testimony 1031

Background Preparation. Basic Preparation and Documentation. Federal Rules of Civil Procedure.
State Rules Are Often Less Stringent. Discovery. Reading Prior Cases and Articles.
Federal Rules of Evidence Regarding Expert Testimony. Use of Hearsay Evidence.
Challenges to Testimony per Daubert/Kumho. Daubert. General Electric v. Joiner.
Kumho Tire Company. Other Cases Rely on Daubert Factors. Depositions.
What to Bring to the Deposition. Deposition Testimony. After the Deposition.
Outlining Courtroom Testimony. Qualifying the Witness. Description of the Assignment.
Summary of Conclusion. Description of Steps Taken. Findings. Final Conclusion. Exhibits.
Preparation with the Attorney. In the Courtroom. General Guidelines for Testimony.
Direct Examination. Cross-Examination. Redirect Examination. Rebuttal Testimony.
Exclusion of Witnesses. Courts' Expectations Regarding Expert Testimony. Summary. Bibliography

42. Arbitration and Mediation 1053

Advantages of ADR over Court Trial. Situations Suitable for Arbitration.
Corporate and Partnership Dissolutions and Buyouts of Minority Interests.
Dissenting Stockholder Actions. Damage Cases. Divorces.
The Arbitration Agreement. Factors Specified in the Arbitration Agreement.
Factors Left to the Arbitrators' Discretion. Other Factors to Address.
Selection of Arbitrators. Criteria for Selection. Procedure for Selection.
American Arbitration Association Procedure. Engagement and Compensation of Arbitrators.
The Arbitration Process. Review of Arbitration Document.
Initial Communication among Arbitrators. Field Visit. Hearings. The Valuation Meeting.
Reporting the Results of the Arbitration. Mediation.
How Mediation Differs from Arbitration and Litigation.
Self-Determination is the Fundamental Principle. Role of the Business Valuation Expert in Mediation.
Mediation in Family Law. Mediation in Federal Tax Disputes. Summary.
Bibliography. Professional Arbitration and Mediation Organizations

Appendix A International Glossary of Business Valuation Terms 1069

Index xxxx

List of Exhibits

1-1 Uniform Standards of Professional Appraisal Practice Table of Contents

1-2 Professional Accreditation Criteria

1-3 American Society of Appraisers (ASA)

1-4 Institute of Business Appraisers (IBA)

1-5 National Association of Certified Valuation Analysts (NACVA)

1-6 American Institute of Certified Public Accountants (AICPA)

1-7 The Canadian Institute of Chartered Business Valuators

1-8 53 FR 17632, Department of Labor

2-1 Valuation Engagement Questionnaire and Checklist

2-2 Examples of Matching the Purpose of the Valuation with the Standard of Value

2-3 Sample Professional Services Agreement

4-1 Preliminary Documents and Information Checklist for Business Valuation of Typical Corporation

6-1 Sample Page from Almanac of Business and Industrial Financial Ratios

6-2 Sample Page from RMA Annual Statement Studies

7-1 Cost of Goods Sold-FIFO and LIFO Methods

7-2 Adjusting LIFO to FIFO

7-3 Alternative Depreciation Methods

7-4 Example of the Effect of the Variety of Accounting Principles on Reported Income

9-1 Arithmetic of Discounting vs. Compounding

9-2 Schematic Diagram and Example of Elements of a Discount Rate Applicable to Expected Net Cash Flow Available to Common Equity

9-3 Illustrative Example of One Common Method for the Calculation of Beta

9-4 Security Market Line

9-5 Computing Unlevered and Relevered Betas

9-6 Companies Ranked by Market Value of Equity

9-7 Companies Ranked by Market Value of Equity-Premium Over CAPM

9-8 Companies Ranked by Operating Margin

9-9 Comparison of Median Valuation Multiples

9-10 Explanation of APT Risk Factors

9-11 Key Variables in Estimating the Cost of Capital

9-12 SBBI Discussion of Arithmetic versus Geometric Mean for Calculating the Expected Equity Risk Premium for Estimating Cost of Capital (Discount Rate)

9-13 Beta Measurement Problems

9-14 Sample Page from Cost of Capital Yearbook

9-15A Global Consulting, Inc.

9-15B Illustrative Example of Discount Rate Applicable to Equity

9-15C Estimation of Value of Equity (Discounted Cash Flow Method)

9-15D Estimation of Weighted Average Cost of Capital

9-15E Estimation of Market Value of Invested Capital (Discounted Cash Flow Method)

9-16 Differences between Net Cash Flow Discount Rate and Net Income Discount Rate

10-1 Equivalence of Discounted Economic Income Method and Capitalized, Economic Income Method under Constant Growth Rate Scenario

11-1 Mechanisms for Going Public in the United States

11-2 Correlation between Price/Revenues and Return on Revenues

11-3 Price/Revenues Compared to Return on Revenues

11-4 Market Value of Invested Capital Valuation Using Guideline Publicly Traded Companies with Different Capital Structures than the Subject Company $000s

11-5 Steps in the Guideline Publicly Traded Company Method

12-1 Example Application of Merger and Acquisition Method, Analysis of Selected Transactions Involving Building Material Retailers

12-2 Comparison of Private and Public Company Transaction Databases as of June 29, 2007

13-1 Revenue Ruling 68-609

13-2 Client Corporation Business Enterprise Value Capitalized Excess Earnings Method

13-3 Small Close Corporation, Summary Balance Sheet (Historical Cost Basis)

13-4 Small Close Corporation, Summary Income Statement

13-5 Small Close Corporation, Calculation of Net Cash Flow

13-6 Small Close Corporation, Application of Capitalized Excess Earnings Method

14-1 Revenue Procedure 77-12

14-2 Seller Company, Inc., Statement of

Financial Position as of December 31, 2006

14-3 Seller Company, Inc., Business Enterprise Valuation/Asset-Based Approach/Asset Accumulation Method

15-1 "Levels of Value" in Terms of Characteristics of Ownership

15-2 Which Value Is Fair Market Value for 100 Percent?

15-3 Price to Earnings Multiples and Percent Offered over S&P 500, 1993-2005

15-4 Median TIC/EBIT Based on Transaction Type

15-5 Control Transactions at Discounts from Public Price, Third Quarter 1998

15-6 Percent Mean and Median Premium Paid

16-1 Percent Mean and Median Premium Paid and Implied Minority Discount

17-1 Table XIV-45 of SEC Institutional Investor Study: Discount by Trading Market

17-2 Table XIV-47 of SEC Institutional Investor Study: Discount by Size of Transaction and Sales of Issuer

17-3 Gelman Study, Distribution of Price Discounts

17-4 Analysis of Restricted Stock Discounts by Revenue Size, Based upon Data from the Management Planning, Inc., Study

17-5 Johnson Study

17-6 LiquiStat™ Discounts for Restricted Stocks

17-7 Summary of Restricted Stock Studies

17-8 Revenue Ruling 77-287

17-9 The Value of Marketability as Illustrated in Initial Public Offerings of Common Stock

17-10 Valuation Advisors' Lack of Marketability Discount Study™ Transaction Summary Results by Year from 1999-2006

17-11 Median P/E Offered Public versus Private 1990-2005

18-1 Tax Court Cases Accepting Key Person Discount

18-2 Studies of Voting versus Nonvoting Stock

18-3 Summary of Selected Tax Cases Involving Blockage Discounts

19-1 Illustrative Business Enterprise, Inc., Fair Market Value of Total Equity, Valuation Synthesis and Conclusion, Example of Outlier Phenomenon As of December 31, 2000

19-2 Illustrative Business Enterprise, Inc., Fair Market Value of Total Equity, Valuation Synthesis and Conclusion, Example of Explicit Weighting As of December 31, 2000

19-3 Illustrative Business Enterprise, Inc., Fair Market Value of Total Equity, Valuation Synthesis and Conclusion, Example of Implicit Weighting As of December 31, 2000

20-1 USPAP Standard 10-Business Appraisal, Reporting

20-2 IRS Business Valuation Reporting Guidelines

21-1 Warm Chicken Company, Valuation Summary

21-2 Warm Chicken Company, Summary of Shares Outstanding

21-3 Warm Chicken Company, Historical and Common-Size Balance Sheets

21-4 Warm Chicken Company, Historical and Common-Size Income Statements

21-5 Warm Chicken Company, Historical Cash Flow Statements

21-6 Warm Chicken Company, Historical Ratio Analysis

21-7 Warm Chicken Company, Comparative Ratios

21-8 Warm Chicken Company, Pro Forma Adjustments and Representative Financial Fundamentals

21-9A Warm Chicken Company, Market Approach, Guideline Publicly Traded Company Method, Market Value of Invested Capital

21-9B Warm Chicken Company, Market Approach, Guideline Publicly Traded Company Method, Earnings before Interest and Taxes

21-9C Warm Chicken Company, Market Approach, Guideline Publicly Traded Company Method, Earnings before Interest, Taxes, Depreciation, and Amortization

21-9D Warm Chicken Company, Market Approach, Guideline Publicly Traded Company Method, Revenues

21-9E Warm Chicken Company, Market Approach, Guideline Publicly Traded Company Method, Revenue Performance Ratios

21-9F Warm Chicken Company, Market Approach, Guideline Publicly Traded Company Method, Book Value of Invested Capital and Performance Ratios

21-9G Warm Chicken Company, Market Approach, Guideline Publicly Traded Company Method, Definitions, Footnotes, and Sources to Exhibits

21-10 Warm Chicken Company, Market Approach, Guideline Publicly Traded Company Method, Valuation Summary

21-11 Warm Chicken Company, Pro Forma Consolidated Income Statements

21-12 Warm Chicken Company, Weighted Average Cost of Capital

21-13 Warm Chicken Company, Discounted Cash Flow Method

23-1 Key Ratios Formulas

23-2 Standard & Poor's Rating Methodology

24-1 Preferred Stock Yield Comparison

24-2 Value of Sinking Fund Preferred

24-3 Preferred Stock Dividend and Liquidation Payment Risk Rations

24-4 Standard & Poor's Preferred Stock Rating Definitions

24-5 Nonconvertible Preferred Stock Yields as of March 2006

24-6 Nonconvertible, Nonsinking Fund, Fixed Rate, Cumulative Preferred Stock Excluding Utilities and Financial Institutions (Banks, Investment Companies, and REITS)

24-7 Revenue Ruling 83-120

25-1 Calculation of Stock Price Volatility

25-2 Average Pricing Errors by Time to Expiration and the Degree of In or Out of the Money

25-3 Stock Price Lattice

25-4 Call Option Price Lattice

25-5 Calculating Binomial Model Stock Values in Microsoft Excel

25-6 Calculating Binomial Model Stock Values-Example Using 6-Month Periods

25-7 Call Option Price Lattices

27-1 Year-by-Year Changes in Federal Transfer Taxes (Assuming No Further Changes in the Law)

27-2 Undervaluation Penalties

27-3 Revenue Ruling 59-60

27-4 Revenue Ruling 93-12

28-1 Subsequent Event Court Cases (as of January 25, 2007)

29-1 Sample Valuation Provision for Buy-Sell Agreement (Corporation Stock Redemption Example)

30-1 Taxable Transactions Requiring Valuations

30-2 Comparison of the "Cost" of a Charitable Gift of Appreciated Stock versus a Charitable Gift of Cash

30-3 Real Estate Development Corporation, Analysis of Assets and Liabilities as of Date of Debt Discharge

32-1 Leveraged ESOP Transaction

32-2 Annual ESOP Cash Flows

32-3 Illustrative Example of the Allocation of ESOP Shares

32-4 Repurchase of Shares from Participants

32-5 Redemption of ESOP Shares by the Company

34-1 Differences between Securities Exchange Markets and Real Estate/Personal Property Exchange Markets

34-2 Intrinsic Differences between Securities and Operating Real Estate/Personal Property

35-1 Delaware Block Method, Sample Valuation Conclusion

35-2 Dissolution Statutes

36-1 States That Adopted the RMBCA Definition of Fair Value

36-2 Example of Mathematical Weighting

38-1 Goodwill in Divorce

41-1 Federal Rules of Evidence Rules

About the Authors

Shannon P. Pratt, CFA, FASA, MCBA, MCBC, CM&AA, is a well-known authority in the field of business valuation and has written numerous books that articulate many of the concepts used in modern business valuation around the world.

Shannon Pratt is Chairman and CEO of Shannon Pratt Valuations, Inc., a business valuation firm headquartered in Portland, Oregon. He is also a member of the board of directors of Paulson Capital Corporation, an investment banking firm that specializes in small-cap IPOs.

Over the last 35 years, he has performed valuation engagements for mergers and acquisitions, employee stock ownership plans (ESOPs), fairness opinions, gift and estate taxes, incentive stock options, buy-sell agreements, corporate and partnership dissolutions, dissenting stockholder actions, damages, marital dissolutions, and many other business valuation purposes.

He has testified in a wide variety of federal and state courts across the country and frequently participates in arbitration and mediation proceedings.

He holds an undergraduate degree in business administration from the University of Washington and a doctorate in business administration, majoring in finance, from Indiana University. He is a Fellow of the American Society of Appraisers, a Master Certified Business Appraiser, a Chartered Financial Analyst, a Master Certified Business Counselor, and is certified in mergers and acquisitions.

Dr. Pratt's professional recognitions include being designated a life member of the Business Valuation Committee of the American Society of Appraisers, a life member of the American Society of Appraisers, past chairman and a life member of the ESOP Association Advisory Committee on Valuation, a life member of the Institute of Business Appraisers, the Magna Cum Laude in Business Appraisal award from the National Association of Certified Valuation Analysts, and the distinguished service award of the Portland Society of Financial Analysts. He recently completed two three-year terms as trustee-at-large of the Appraisal Foundation.

Dr. Pratt is the coauthor of Valuing Small Businesses and Professional Practices, 3rd edition, published by McGraw-Hill. He is the coauthor with Roger Grabowski of the forthcoming Cost of Capital: Applications and Examples, available in 2008, the coauthor with Jay Fishman and William Morrison of Standards of Value, author of The Market Approach to Valuing Businesses, 2nd edition, Business Valuation Body of Knowledge, Business Valuation Discounts and Premiums, and coauthor with the Honorable David Laro of Business Valuation and Taxes: Procedure, Law and Perspective, all published by John Wiley & Sons, and The Lawyer's Business Valuation Handbook, published by the American Bar Association. He is also coauthor of Guide to Business Valuations, 17th edition, published by Practitioners Publishing Company.

He is publisher emeritus of a monthly newsletter, Business Valuation Update (primarily for the professional appraisal community).

Dr. Pratt develops and teaches business valuation courses for the American Society of Appraisers and the American Institute of Certified Public Accountants, and frequently speaks on business valuation at national legal, professional, and trade association meetings. He also developed and often teaches a full-day seminar (sometimes divided into two partial days) on business valuation for judges and lawyers.

Alina V. Niculita, CFA, MBA, is president and COO of Shannon Pratt Valuations, Inc. She is a Chartered Financial Analyst and a candidate for the ASA designation in business valuation. She is also a member of the CFA Institute, the American Society of Appraisers, and the Licensing Executives Society.

At Shannon Pratt Valuations, Ms. Niculita works on all aspects of case management including the fundamental aspects of business valuation and economic analysis and report writing. Ms. Niculita has been involved in business valuation engagements for various purposes such as transactions in company stock, estate and gift taxes, and litigation support. Ms. Niculita has also worked on valuations of intangible assets and fairness and solvency opinions. Ms. Niculita is a coauthor of Business Valuation Body of Knowledge Workbook, 2nd edition, and the Cost of Capital Workbook.

Before joining Shannon Pratt Valuations, Ms. Niculita was a financial editor of publications and resources for valuation professionals for Business Valuation Resources including being the managing editor of Shannon Pratt's Business Valuation Updatec, BVLibrary™, and the Economic Outlook Update™. Ms. Niculita received a dual MBA in finance from the Joseph M. Katz Graduate School of Business, University of Pittsburgh, and from the Czech Management Center, Czech Republic. She also received a B.S. in economics with a concentration in banking and finance from the Academy of Economic Studies, Bucharest, Romania.

About the Contributing Authors

Noah J. Gordon, Esq.,

in addition to serving as project manager for this edition, updated the court cases chapters in Part VII,"Valuations for Specific Purposes."

He is Legal Counsel for Shannon Pratt Valuations, Inc., where he is regularly involved with business valuations. He was the associate editor of Shannon Pratt's Business Valuation Update, R Economic Outlook Update,™ and BV Q&A Update™ for Business Valuation Resources. Mr. Gordon also was an executive editor with Wolters Kluwer/Aspen Publishers and a managing editor with Prentice-Hall in those publishers' legal publications divisions. He has served as a contributing author and editor of several legal treatises and publications, and regularly contributes to various business valuation publications. Most recently, he has contributed to Guide to Business Valuations, 17th edition (2007), Standards of Value (2006), and the second edition of The Market Approach to Valuing a Business (2005). He also maintains a freelance editorial business. Mr. Gordon is admitted to the bars of Oregon, New York, New Jersey, the District of Columbia, and the United States Supreme Court. He holds a Bachelor of Arts in Political Science and a Bachelor of Arts in French Literature from Haverford College, and a Juris Doctor from the Benjamin N. cover flipozo School of Law.

Curtis R. Kimball, CFA, ASA,

updated the chapter "Valuations for Gift and Estate Tax Purposes." Mr. Kimball is a managing director of Willamette Management Associates, a nationally prominent valuation and financial advisory firm, and director of WMA's Atlanta regional office. He is a Chartered Financial Analyst (CFA) of the CFA Institute, an Accredited Senior Appraiser (ASA) of the American Society of Appraisers in business valuation, and a member of the Institute of Business Appraisers. He has been valuing companies and interests in companies, intangible assets, and other property for a variety of purposes for over 30 years and was formerly with Wachovia Bank and, later, the Citizens & Southern Trust Company (now Bank of America) prior to joining WMA in 1988. He holds a B.A. in Economics from Duke University and an M.B.A. from Emory University. He is a contributing author to several standard reference works on private business valuation including Valuing Small Businesses and Professional Practices, Financial Valuation: Businesses and Business Interests (1997 update), Business Valuation Discounts and Premiums, and The Business Valuation Handbook, 2nd edition. He also acts as WMA's national director for wealth management valuations including estate, gift, buy-sell agreement, trust, fiduciary liability, marital, and charitable issues. Mr. Kimball has appeared as an expert witness on valuation issues in U.S.

District Court, U.S. Tax Court, U.S. Bankruptcy Court, and other venues. His most recent appearances include the U. S. Tax Court cases Estate of Georgina T.Gimbel (Reliance Steel and Aluminum Company), Estate of H. A. True, Jr. and Jean D. True et al v. Commissioner (True Ranches and True Oil Company), and Estate of Harriet Mellinger v. Commissioner (Frederick's of Hollywood). M. Mark Lee, CFA, updated the chapter "Introduction to Valuing Stock Options."

He is a principal of Eisner LLP with over 37 years of experience in business valuation, corporate finance, and fairness opinions. Mr. Lee was a Senior Managing Director of Sutter Securities Incorporated and ran its New York office. In addition, his responsibilities have included serving as Principal-in-Charge of the Valuation Services Practice of KPMG LLP's Northeastern Region, establishing KPMG LLP's fairness opinion practice, and serving as Vice-Chairman of Bear, Stearns & Co. Inc.'s Valuation Committee, which was responsible for reviewing the firm's fairness opinions and valuations. He has participated in tax and acquisition negotiations, as well as provided testimony and trial support. He has authored numerous articles on business valuation and has made many presentations before attorneys, trade associations, educational groups, and associations of business valuation experts. He is an adjunct assistant professor teaching business valuation at the New York University School of Continuing and Professional Studies.

Angelina McKedy

updated the chapters "Researching Economic and Industry Information," "Analyzing Financial Statements," and "Financial Statement Ratio Analysis." She is a senior analyst for Shannon Pratt Valuations, Inc. She has assisted in performing valuation assignments for litigation support and dispute resolution (including dissenting stockholder suits and marital dissolution cases), solvency opinions, and fairness opinions. In addition to her business valuations work, she also provides stock portfolio management. Ms. McKedy worked as a financial research analyst for Business Valuation Resources, where she was the project manager for the BVPapersR database, compiled statistical data for the Economic Outlook UpdateR, and wrote numerous abstracts on current and relevant business valuation books and articles for Shannon Pratt's Business Valuation Update.® She has contributed to many of Shannon Pratt's books, and regularly contributes to Guide to Business Valuations. She holds a Bachelor of Science, Business Administration with an emphasis in Finance, Portland State University, and is a Candidate Member of the American Society of Appraisers.

Chad P. Phillips, CFA,

updated the chapters "Market Approach: Guideline Merged and Acquired Company Method" and "Sample Report." He is a member of the Valuation Services Group and Dealer Services Group of Moss Adams LLP. Mr. Phillips provides valuation consulting for business succession; gift, transfer and estate reporting; purchase or sale; buy/sell agreement requirements; shareholder dispute; purchase price allocation; joint ventures; marital dissolution; and corporate planning. Valuation projects include operating companies, family limited partnership,

limited liability companies, and intangible assets. Mr. Phillips is a Chartered Financial Analyst (CFA), and has presented on a number of valuation related topics to industry groups, organizations, and service providers alike.

Kimberly Short,

in addition to assisting with research, editing, and obtaining the reprint permissions for this edition, updated Appendix A. She is a financial analyst with Shannon Pratt Valuations, Inc. She has assisted Shannon Pratt and Roger Grabowski in researching and editing Cost of Capital, 3rd edition. She holds a Bachelor of Science in Business Administration, with an emphasis in Finance, from Portland State University.

Doug Twitchell

updated the chapter "Gathering Company Data." He is the publisher at Business Valuation Resources, LLC, where he has worked for over a decade. He is the cofounder of the Pratt's Stats™ database and has contributed to the Business Valuation Update™ newsletter and several of Shannon Pratt's books.

He holds a Bachelor of Science in Mechanical and Industrial Engineering from Clarkson University, a Masters degree in Business Administration from Portland State University, and an advanced graduate certificate in Computational Finance from the Oregon Health & Science University's Oregon Graduate Institute School of Science & Engineering.

Foreword

When I decided to get serious about the field of business valuation, the original book I bought was the first edition of Valuing a Business by Dr. Shannon Pratt. I spent my weekends that summer reading it cover to cover, sitting on the beach (if you can imagine) with my highlighter in hand, eagerly soaking up the valuable lessons along with the sun and the sand. For years, I used the first edition as my "go-to" source, as it held all my notes and highlighted text that I wanted to be able to quickly reference. That dog-eared edition still sits in our now fully stocked valuation library, right next to the second, third, and fourth editions. As each edition came out, it was a little thicker than the edition before, and each one offered a little more depth, complexity, and subject matter for valuation analysts and users of valuation reports alike to benefit from. Since Dr. Pratt's first edition of Valuing a Business was published in 1981, he has educated the valuation profession, attorneys, and the courts. He has been a leader in the formulation not only of the literature that many of us turn to for guidance, but also in participating in the collection of data that is the very foundation upon which appraisers rely. This leadership continues with the fifth edition of Valuing a Business, offering the reader a comprehensive view of the current state of business valuation, from the perspective of one of the profession's most prolific and well-known experts.

The book is as useful to appraisers beginning their appraisal career, as I used it many years ago, as it is to seasoned appraisal professionals. Written in plain English, it is also useful to nontechnical readers and users of valuation reports who may need guidance in understanding the report they are reading. It is also helpful to owners of businesses who wish to gain an understanding of the valuation process. Beginning with the basics, Valuing a Business takes the reader through the important elements that are necessary to arrive at an opinion of value. Valuation methodology, including some of the latest thinking from thought-leaders in the field of valuation, are discussed in detail.

Certain chapters have been significantly updated and expanded, including the chapters "Discounted Future Economic Income Method," "Estate and Gift Tax,"and "Valuing Stock Options." There are greatly enhanced discussions relating to levels of value and noncontrol and other discounts, and discounts for trapped-in gains. There is an extremely valuable guide to the definition of fair value by state. Other new sections have been added, including a section on S corporation valuation and a chapter on buy-sell agreements. The new USPAP standards are discussed, and updated discussions on the standards and credentials of the various valuation organizations are provided.

A significant number of new and important court cases have been added since the fourth edition. Many tax court cases have come out that practitioners need to be aware of in the areas of Chapter 14, trapped-in capital gains, and S corporations. In addition, several new cases on reasonable compensation have been added.

As this is an identified area of focus with the I.R.S., there is considerable guidance offered by these additional cases that the professional practicing in this area should take note of. The chapters on divorce and dissent and oppression have been supplemented as well with recent decisions. Without a doubt, one of the most notable things about the book is its impressive bibliography following most chapters. These bibliographies have grown enormously since the first edition, providing the profession with perhaps the most comprehensive body of knowledge, organized by topic, that is available anywhere. This in itself is an extremely valuable resource that should not be overlooked. I speak from personal experience on this point: In my initial years of valuation (and before so much information was available online), I spent countless hours in the University of Maine library searching for articles, using the bibliographies at the end of each chapter of Dr. Pratt's first edition of Valuing a Business.I found many of these articles, and it was from these readings that I augmented my early "advanced business valuation training." Today, these updated bibliographies include references to the latest economic, industry, financial, and valuation research sites available on the Web. As our body of knowledge has expanded, so too have the many resources available to us. The fifth edition provides a comprehensive guide not only to where to find it, but what you'll find.

Like every edition before it, this fifth edition of Valuing a Business will be acquired for our valuation library, used on a daily basis, read by staff, referred to often, and used to help teach. We owe a debt of gratitude to Dr. Pratt for this additional contribution to our growing body of knowledge.

Nancy Fannon, ASA, CPA-ABV, MCBA

Fannon Valuation Group

Portland, Maine