GENERAL PROCEDURE FOR VALUATION in Visual Studio .NET

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442 GENERAL PROCEDURE FOR VALUATION
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the shares of the guideline companies Would it be signi cantly less attractive than shares of the guideline companies If the appraiser can answer both of these questions in the negative, he has probably arrived at a reasonable result (i) Discount for Lack of Marketability The value derived from the guideline analysis is the freely traded price, that is, the price at which the common stock of the subject company would trade if it had an active public market Clearly, lack of ready marketability makes a stock considerably less attractive than it would be if it were readily marketable This was recognized by the IRS in its Rev Rul 77 287 when, in discussing the value of unregistered shares of public companies, it stated: The discount from the market price provides the main incentive for a potential buyer to acquire restricted securities In recent years, appraisers have generally used transactions in the restricted shares of public companies as the best guideline for determining the appropriate discount for lack of marketability A number of studies have been made of this market, and they indicate a rather wide dispersion of discounts but most indicate a median discount of about 35 percent The two seminal studies, those of Maher and Moroney, indicated median discounts of 3473 percent and 33 percent respectively1 More recent studies have been made by Willamette Management Associates (median 312 percent) and Standard Research Consultants (45 percent) The change in the required holding period of restricted stock has limited the usefulness of this evidence in the valuation of nonpublic companies Willamette Associates has also analyzed the relationship of original public offering prices to arm s-length trades during the three years preceding the public offering, which suggests discounts in the 40 percent to 60 percent range (ii) Discount for Minority Interest The discount for lack of marketability should not be confused with a discount for minority interest This chapter has explained the use of publicly held guideline companies in making a judgment as to the value of stock in a nonpublic company The prices at which the common stocks of those guideline companies sell re ect minority interest values; therefore, the comparative analysis enables the appraiser to express an opinion about the price at which the stock of the subject closely held company would trade if it had an active public market (the freely traded value) It is therefore a minority interest value to begin with, and a minority interest discount is inappropriate However, the stock of a closely held company is lacking in marketability, and a discount for lack of marketability is appropriate (g) DISCOUNTED FUTURE BENEFITS APPROACHES A discounted future bene ts valuation involves two fundamental, dif cult, and very imprecise steps: 1 The long-term projection of the bene t 2 The determination of an appropriate discount rate, by which the future bene ts may be reduced to present value It is essential that the discount rate and the bene t be matched That is, a dividend or net-free cash ow discount rate must be applied to projected dividends or net-free cash ow An earnings discount rate must be applied to projected earnings The use of a net cash ow discount rate to discount earnings, for instance, is erroneous Data on past rates of return on publicly traded common stocks are readily available and can be used as a reference point in estimating the appropriate rate of return (dividend or net-free cash ow discount rate) of a subject company As a result, discounted future bene ts valuations are almost always done on the basis of cash ow The term net cash ow is often used, usually in the context of an enterprise valuation Because net cash ow is the total cash ow of the business
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J Michael Maher, Discounts for Lack of Marketability for Closely-Held Business Interests, Taxes The Tax Magazine, September 1976, pp 562 571 Robert E Moroney, Most Courts Overvalue Closely Held Stocks, Taxes The Tax Magazine, March 1973, pp 144 154
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