Two valuers look at the same business. One uses recent sales of similar firms. The other discounts forecast cash flows. They get different numbers, and both can be right, because they answer different questions: what would a willing buyer pay, what is it worth to this owner, what would it fetch in a forced sale.
The International Valuation Standards give valuers a common language for stating what is being valued, on what basis and by what method.
This topic covers the International Valuation Standards Council (IVSC) and its standards, bases of value and premises of value, the market, income and cost approaches, valuation for financial reporting, and the four asset standards in the syllabus: IVS 200 (businesses and business interests), IVS 210 (intangible assets), IVS 410 (development property) and IVS 500 (financial instruments), with their methods and examples. The previous topic covered adjusted present value.
The next covers business valuation with asset and income methods. Neither the May 2014 nor the November 2014 Pathfinder sets a stand-alone question on this topic.
In 30 seconds
The IVSC sets International Valuation Standards (IVS): a framework, general standards and asset standards. A valuation states its basis of value (market value, market rent, equitable value, investment value, synergistic value, liquidation value, fair value) and its premise (highest and best use, current use, orderly liquidation, forced sale). The three approaches are market (comparable prices), income (discounted cash flows) and cost (replacement cost less obsolescence).
IVS 200: business value as enterprise value, invested capital, operating value or equity value; match cash flows and discount rate (pre-interest flows at WACC, equity flows at cost of equity). IVS 210: intangibles by excess earnings, relief from royalty, with-and-without or greenfield. IVS 410: development property by market or residual method (completed value less costs). IVS 500: financial instruments by market (including P/E multiples) or income approach. Financial reporting follows IFRS, not IVS.
Key terms in plain English
| Term | What it means |
|---|---|
| Basis of value | The fundamental premise on which a valuation is reported |
| Premise of value | The assumed use of the asset |
| Enterprise value | Equity plus debt less cash |
| Contributory asset | An asset needed to earn the cash flows of an intangible |
| Residual method | Completed value less all costs to complete and sell |
| Lack of liquidity adjustment | A discount because unquoted shares are harder to sell |
| Control premium | The extra price paid for control of a business |
Syllabus check
This topic is in syllabus area B (business analysis). It covers:
- the role of international valuation standards;
- IVS 200 businesses and business interests, IVS 210 intangible assets, IVS 410 development property and IVS 500 financial instruments.
CAMA 2020 and valuation
The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria.
| Section | What it says | Link to this topic |
|---|---|---|
| s. 305 | A director must act in good faith in the best interests of the company | Valuations should be fair and reasoned, for the benefit of the company |
| s. 308 | A director must use the care, diligence and skill of a reasonably prudent director | Directors should test the assumptions behind any valuation |
| s. 377(1) and s. 378 | Directors prepare statements that follow IFRS and give a true and fair view | Decisions later affect reported assets, profit and cash |
| s. 385 | The directors’ report covers performance and risk | Major plans and risks are reported to shareholders |
Valuation also matters in company law. For a scheme of arrangement, ss. 715 to 717 of CAMA 2020 require the terms, valuation reports and independent expert opinions to be circulated to the members and creditors affected.
The standards
The IVSC is the global standard setter for valuation practice. IVS are arranged as the IVS framework, general standards and asset standards. They apply to assets, liabilities and groups of them. The general standards are not examinable, but their content explains the asset standards.
Bases of value
A basis of value describes the premise of the reported value. Most share an assumed transaction, date and parties.
- Market value: the estimated amount for which an asset should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing, with both acting knowledgeably, prudently and without compulsion.
- Market rent: the same idea for a lease of real property.
- Equitable value: the price between identified parties that reflects their respective interests.
- Investment value: the value to a particular owner for individual objectives.
- Synergistic value: the combined value of two or more assets that exceeds the sum of the separate values.
- Liquidation value: the amount from selling assets piecemeal, ignoring going-concern benefits.
- Fair value as defined in IFRS 13 is also described.
Premises of value
- Highest and best use: the use that produces the highest value, usually for non-financial assets.
- Current (existing) use: the way the asset is used now.
- Orderly liquidation: a sale of a group of assets over a reasonable time.
- Forced sale: the seller is compelled to sell, so there is no proper marketing period.
Valuation approaches
- Market approach: compare with identical or comparable assets with known prices. Preferred when reliable, verifiable market data exist, for example recent sales or active trading. Even when not used, maximise market-based inputs such as discount rates.
- Income approach: discount future cash flows to present value. It needs the relevant cash flows, an explicit forecast period, a terminal value and a discount rate.
- Cost approach: the current replacement or reproduction cost, less physical deterioration and obsolescence.
Financial reporting: IVS is broadly consistent with IFRS but may allow approaches IFRS does not. Valuation for financial reporting must follow IFRS. Valuation for other purposes, such as an offer price, need not.
IVS 200: businesses and business interests
Business valuations serve acquisitions, mergers and sales, tax, litigation, insolvency and financial reporting. The subject may be an entire entity, shares, a controlling or non-controlling interest, or a business activity. Value may be expressed as:
- enterprise value: equity plus debt, less cash;
- total invested capital value: the money invested, often total assets less current liabilities and cash;
- operating value: the value of the operations, excluding non-operating assets and liabilities;
- equity value: the value to shareholders.
The market approach draws on public stock markets, the acquisition market and prior transactions in the business’s own shares. The income approach must be consistent: enterprise value comes from cash flows before interest discounted at the WACC; equity value comes from cash flows after interest discounted at the cost of equity. Adjust historic cash flows to what a buyer expects.
The cost approach is rarely used, but may suit start-ups with unreliable profits or businesses that are not going concerns.
ICAN’s two-stage dividend example. Y Ltd pays ₦10,000 at time 1, growing 10% for two years and then 5% for ever. The cost of capital is 8%.
- Dividends: ₦10,000; ₦11,000; ₦12,100; then ₦12,705 at time 4.
- Value at time 3 of the later dividends = 12,705 ÷ (0.08 − 0.05) = ₦423,500.
- PV = 10,000 ÷ 1.08 + 11,000 ÷ 1.082 + (12,100 + 423,500) ÷ 1.083 = about ₦364,500.
IVS 210: intangible assets
Market evidence is rarely available, so the income approach is the most common. Methods:
- Excess earnings: the PV of cash flows attributable to the intangible after deducting required returns on contributory assets (working capital, fixed assets, workforce). Forecast revenues and costs; set a return on each contributory asset; deduct to leave the excess earnings; discount.
- Relief from royalty: the PV of the hypothetical royalties that would be paid to license the asset from a third party.
- With-and-without: the value of the business with the intangible less the value without it.
- Greenfield: the value of a business that has only the intangible, less the cost of buying, building or renting everything else it needs.
ICAN’s example. X Ltd’s know-how supports a product with ₦5m revenue and ₦2.5m operating expenses for five years. Non-current assets are ₦10m (10% required return) and working capital ₦5m (5%). Discount rate 15%.
- Excess earnings.
5.00 − 2.50 − 1.00 − 0.25 = ₦1.25m a year. - Annuity factor, 15%, five years = 3.352.
- Value of the intangible.
1.25 × 3.352 = ₦4.19m.
By relief from royalty at 5%, the royalty is 0.25m a year, so the value would be 0.25 × 3.352 = ₦0.84m, a different answer because the method and its inputs are different.
IVS 410: development property
Development property is where redevelopment gives the highest and best use or where improvements are planned or in progress. Two approaches: the market approach, which needs frequent exchanges of similar properties and is rarely possible, and the residual method (a hybrid): estimated value of the completed property less all costs to complete and sell it, including construction, finance and marketing costs. In practice, the developer’s profit is deducted as well.
IVS 500: financial instruments
A financial instrument is a contract that creates rights or obligations to receive or pay cash or other consideration, or an equity instrument. The valuer must consider the class of instrument, whether individual or portfolio, and the unit of account. All three approaches may apply.
- Market approach: a price from a liquid exchange near the valuation date is normally the best indicator for an identical instrument. For unquoted equity, use trading multiples (such as a peer’s P/E, adjusted for a lack of liquidity) or transaction multiples (from M&A deals, which include a control premium that may need adjusting).
- Income approach: discounted cash flow with a rate that reflects time value and risks such as terms (subordination), credit risk, liquidity, regulatory change and tax status.
ICAN’s example. X Ltd’s profit after tax is ₦120,000 after a non-recurring expense of ₦30,000. A peer trades at a P/E of 17.
- Future maintainable earnings.
120,000 + 30,000 = ₦150,000. - Unadjusted value.
17 × 150,000 = ₦2,550,000. - With a lack-of-liquidity discount of 10%, 20% or 30%: ₦2,295,000, ₦2,040,000 or ₦1,785,000.
The rules in more depth
Why the basis of value must be stated
The same asset has different values on different bases. Without a basis, the number cannot be understood or compared.
Why the cash flow and the discount rate must match
Cash flows before interest belong to all providers of capital, so they are discounted at the WACC. Cash flows after interest belong to shareholders, so the cost of equity applies.
Why intangibles use the income approach
They are rarely traded, so there are few comparables, but they generate identifiable income.
Why transaction multiples need adjusting
They include a premium for control that a minority holder does not receive.
Why valuation for reporting differs
Financial reporting has fixed rules, while a negotiation can use any reasonable method.
Effect on analysis
State the purpose, basis, premise, approach and method, give the numbers and comment on sensitivity.
Worked examples
Example 1: matching flows and rates. A valuer has free cash flows before interest and wants an enterprise value.
- The flows are before interest, so they belong to all capital providers.
- Discount at the WACC.
- To get equity value, deduct the market value of debt, or use flows after interest at the cost of equity.
Example 2: excess earnings. A brand supports revenue of ₦8m and costs of ₦4m a year for five years. Required returns: fixed assets ₦12m at 10% and working capital ₦4m at 5%. Discount rate 15%.
- Excess earnings.
8 − 4 − 1.2 − 0.2 = ₦2.6m. - Annuity factor = 3.352.
- Value = 2.6 × 3.352 = ₦8.72m.
Example 3: residual method. A completed scheme is valued at ₦300m. Construction costs ₦150m, finance ₦18m, marketing ₦9m and the developer’s profit 15% of value (₦45m).
- Total costs and profit.
150 + 18 + 9 + 45 = ₦222m. - Residual value of the site = 300 − 222.
- Residual value = ₦78m.
Example 4: a trading multiple. A private company earns ₦200,000 after tax, including a one-off gain of ₦40,000 after tax. A quoted peer has a P/E of 12. A 20% lack-of-liquidity discount is used.
- Maintainable earnings.
200,000 − 40,000 = ₦160,000. - Value before discount.
12 × 160,000 = ₦1,920,000. - After a 20% discount = ₦1,536,000.
How to score full marks
- State the purpose, the basis and the premise of value.
- Name the approach and justify it from the data available.
- Match cash flows to discount rates.
- Adjust earnings for non-recurring items and multiples for liquidity and control.
- Show each step of excess earnings or the residual method.
- Comment on the assumptions and the range of values.
Common mistakes in the exam
- Giving a value without a basis.
- Discounting pre-interest cash flows at the cost of equity.
- Forgetting contributory assets in excess earnings.
- Using a quoted peer’s P/E without a liquidity adjustment.
- Applying IVS to financial reporting in place of IFRS.
- Using the cost approach for a normal going concern.
Quick revision
- IVS: framework, general standards, asset standards (200, 210, 410, 500).
- Bases: market value, market rent, equitable, investment, synergistic, liquidation, fair value.
- Approaches: market, income, cost.
- IVS 200: EV at WACC; equity at cost of equity.
- IVS 210: excess earnings, relief from royalty, with-and-without, greenfield.
- IVS 410: residual method. IVS 500: multiples and DCF.
- CAMA 2020: ss. 305, 308, 377(1), 378, 385.
Practice questions
These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.
Recall check: multiple choice
Recent ICAN papers are written, although older papers such as May 2014 included multiple-choice questions. These questions are for quick recall. The written questions that follow are closer to the exam.
Question 1. The body that issues International Valuation Standards is the:
- IVSC
- IASB
- IESBA
- FRCN
Show the answer
A. The International Valuation Standards Council.
Question 2. Market value assumes a:
- Willing buyer and willing seller at arm’s length
- Forced sale
- Single buyer
- Distressed owner
Show the answer
A. With proper marketing.
Question 3. Synergistic value arises when:
- Combined value exceeds the sum of the parts
- Assets are sold piecemeal
- The seller is compelled
- Tax is zero
Show the answer
A. A combination effect.
Question 4. Enterprise value is found by discounting pre-interest cash flows at the:
- WACC
- Cost of equity
- Risk-free rate
- Cost of debt only
Show the answer
A. Equity flows use the cost of equity.
Question 5. Excess earnings deduct returns on:
- Contributory assets
- Dividends
- Tax
- Goodwill only
Show the answer
A. To isolate the intangible.
Question 6. Relief from royalty values an intangible using:
- Hypothetical royalties
- Replacement cost
- Book value
- Dividends
Show the answer
A. What a licence would cost.
Question 7. The residual method of valuing development property is:
- Completed value less costs to complete and sell
- Cost plus margin
- Book value
- Rent only
Show the answer
A. Used in IVS 410.
Question 8. A trading multiple for unquoted shares is adjusted for:
- Lack of liquidity
- Inflation
- Tax rate
- Dividends
Show the answer
A. They are harder to sell.
Question 9. Valuation for financial reporting must follow:
- IFRS
- Any method
- Only IVS
- The tax rules
Show the answer
A. IVS may differ.
Question 10. Which section of CAMA 2020 sets the director’s duty of care and skill?
- Section 308
- Section 400
- Section 405
- Section 409
Show the answer
A. Directors should test the assumptions behind a decision.
Written questions
Question 11 (10 marks). (a) Distinguish a basis of value from a premise of value, giving two examples of each. (6 marks) (b) Describe the three valuation approaches. (4 marks)
Question 12 (20 marks). (a) A brand supports revenue of ₦8m and costs of ₦4m a year for five years. Fixed assets of ₦12m require 10% and working capital of ₦4m requires 5%. Discount at 15% (annuity factor 3.352). Value the brand by excess earnings. (6 marks) (b) A completed development is worth ₦300m. Construction costs ₦150m, finance ₦18m, marketing ₦9m and developer’s profit ₦45m. Calculate the residual value of the site.
(4 marks) (c) A private company has maintainable earnings of ₦160,000. A peer has a P/E of 12. Apply a 20% lack-of-liquidity discount. (4 marks) (d) Explain how cash flows and discount rates must be matched in an income approach valuation of a business. (6 marks)
Question 13 (10 marks). (a) Describe four levels at which the value of a business may be expressed. (4 marks) (b) Explain when the cost approach might be used for a business. (3 marks) (c) Explain why valuation for financial reporting differs from valuation for an offer price. (3 marks)
Model answers
Show the model answer to Question 11
(a) Basis and premise (6 marks). A basis of value is the fundamental premise of the reported value, with an assumed transaction, date and parties. (2) Examples: market value; liquidation value; synergistic value. (1) A premise of value is the assumed use of the asset. (2) Examples: highest and best use; forced sale. (1)
(b) Approaches (4 marks). Market: compare with identical or similar assets with known prices. (1.5) Income: discount future cash flows to present value. (1.5) Cost: replacement or reproduction cost less deterioration and obsolescence. (1)
Show the model answer to Question 12
(a) Brand (6 marks).
- Excess earnings.
8 − 4 − (10% × 12 = 1.2) − (5% × 4 = 0.2) = ₦2.6m. (4) - Value = 2.6 × 3.352 = ₦8.72m. (2)
(b) Residual (4 marks).
- Costs and profit.
150 + 18 + 9 + 45 = ₦222m. (2) - Residual value.
300 − 222 = ₦78m. (2)
(c) Multiple (4 marks).
- 12 × 160,000 = ₦1,920,000. (2)
- After a 20% discount = ₦1,536,000. (2)
(d) Matching (6 marks). Cash flows before interest belong to all providers of capital, so they give an enterprise value and are discounted at the WACC. (2.5) Cash flows after interest belong to shareholders, so they give an equity value and are discounted at the cost of equity. (2.5) Pre-tax or post-tax flows must be matched with a consistent rate. (1)
Show the model answer to Question 13
(a) Levels (4 marks). Enterprise value (equity plus debt less cash); total invested capital value; operating value (excluding non-operating assets and liabilities); equity value. (1 each)
(b) Cost approach (3 marks). For a start-up whose profits and cash flows cannot be reliably forecast and whose comparables are unreliable. (1.5) For a business that is not a going concern. (1.5)
(c) Reporting (3 marks). Financial reporting valuations must follow the rules of IFRS. (1.5) A valuation for an offer price can use any suitable method, so IVS may allow approaches that IFRS does not. (1.5)
Pathfinder on IVS bases of value, approaches and IVS 200, 210, 410 and 500
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
Neither the May 2014 nor the November 2014 Pathfinder sets a stand-alone question on this topic. The standards are a newer part of the syllabus, so expect scenario questions that ask for a basis, an approach and a method. Worked examples 1 to 4 show how to apply them.
Revise first: Worked examples
See the sections on the bases of value and the three approaches.
Revise first: The standards
Source: ICAN Pathfinder, Strategic Financial Management. Diets covered: No stand-alone question in the May 2014 or November 2014 Pathfinder.
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