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PART 4--STUDY QUESTIONS (Questions followed by [A] are answered in part V.)

 
  1. What is meant by the fair market value of a business? (2.2)









  2. Identify the factor prescribed by the IRS for valuing a closely held business interest. (2.2-2.3)









  3. Describe the book value of a business, and explain why it is generally not the same as the fair market value. (2.3-2.4)









  4. What is an intangible asset? (2.3, 2.5)









  5. The value of the goodwill of a business is generally excluded from its book value.

    1. Describe how an estimate of the value of goodwill might be reached.

    2. Why is the value of goodwill irrelevant for a piecemeal forced sale of the business? (2.5-2.6)

  6. What is the basis for the capitaliza-tion-of-earnings concept of business value? (2.6-2.9)









  7. Briefly describe the capitalization-of-earnings technique of valuation, focusing on the two factors used in the calculation. (2.6-2.9)









  8. Zilch Industries is considering a sale of its stock to Octopus Industries, Inc., and is trying to arrive at a fair asking price for the stock by using the capitalization-of-earnings method. Explain the relevance, if any, of the following factors in applying the capitalization-of-earnings method. [A]

    1. Zilch Industries is engaged in supplying materials to the toy industry, a volatile and fad-ridden business.
    2. The two chief officers of the company are Bill and Angelo Zilch, who together hold 80 percent of Zilch's stock.
    3. Zilch's best year in its 60-year history was a year in which it supplied an essential material for the manufacture of hula hoops.
    4. Zilch's worst year occurred several years ago when its upstate New York facility was swept into the Niagara River during a hurricane. (2.6-2.9)








  9. Explain how the discounted-future-earnings (DFE) method differs from the basic capitalization technique. (2.9-2.11)









  10. Describe some problems in forecasting future earnings, and explain the necessity of weighing the forecast. (2.9)









  11. Describe some considerations in choosing the appropriate discount rate for the DFE method. (2.10-2.11)









  12. Explain why valuation by comparison of ratios is sometimes used, and give examples of such methods. (2.12-2.13)









  13. The value of Aardvark Industries has recently been determined by a prestigious consulting firm to be $1 million. There are 1,000 shares of Aardvark's stock of all classes outstanding (950 common and 50 preferred). Explain why the value of the following blocks of stock might not be determined simply by computing the ratio of shares held by the shareholder to the total shares of Aardvark stock outstanding and multiplying that by $1 million. [A]

    1. a 400-share common-stock interest held by the estate of the late Morris Aardvark
    2. a 550-share common-stock interest held by Bertha Aardvark, Morris's sister
    3. a 50-share preferred-stock interest held by Frank Slick, the Aardvarks' attorney (2.14-2.16)

  14. Certain methods of valuation may be more appropriate in one situation than another. Give some situations in which the following would be preferable or would work better:

    1. the adjusted-book-value method
    2. the capitalization-of-earnings method (2.17-2.18)

  15. Note in the example beginning on page 12 of the reading that the value for Hypo Enterprises determined by the DFE method was $914,890. Refer to the adjusted balance sheet (not including intangibles) for Hypo Enterprises on page 7 of the reading. What value for intangibles would be suggested by this result from the DFE method? Explain. [A] (2.18-2.20)

  16. Explain the relationship, if any, between the unadjusted book value of assets and the proceeds that might be received from these assets in a forced sale pursuant to a liquidation. (2.18-2.20)

  17. Describe the requirements for a price determined through the provisions of a buy-sell agreement to be binding on the IRS in a valuation dispute. (2.19-2.21)

  18. The methods for determining the value of a business interest should be included in the valuation provision of a buy-sell agreement.

    1. Discuss the methods that are typically used for this purpose.
    2. What problems must be addressed with respect to each method? (2.19-2.21)

  19. Discuss the possible sanctions that may be imposed on (i) a taxpayer and (ii) an appraiser for an inaccurate valuation for tax purposes. (2.22)

 

 

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