Valuation premises

A presentation on Valuation Premises

1. Valuation Premises
CA Dr Prithvi Ranjan Parhi
Chartered Accountant and Registered Valuer
CA Dr Prithvi Ranjan Parhi 1

2. CA Dr Prithvi Ranjan Parhi 2
What a company is worth depends on who wants to buy it.
-Michael Price

3. Premise of Value
Para 130.1 of IVS 104 Bases of Value
•APremiseofValueorAssumedUsedescribesthecircumstancesofhowanasset
orliabilityisused.
•DifferentbasesofvaluemayrequireaparticularPremiseofValueorallowthe
considerationofmultiplePremisesofValue.
•SomecommonPremisesofValueare:
1.HighestAndBestUse,
2.CurrentUse/ExistingUse,
3.OrderlyLiquidation,and
4.ForcedSale.
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4. Premise of Value
Para 37 & 38 of ICAI-VS 102 Bases of Value
•PremiseofValuereferstotheconditionsandcircumstanceshowanassetis
deployed.
•Inagivensetofcircumstances,asinglepremiseofvaluemaybeadoptedwhileinsome
situationsmultiplepremisesofvaluemaybeadopted.
•Somecommonpremisesofvalueareasfollows:
1.HighestAndBestUse;
2.GoingConcernValue;
3.AsIsWhereIsValue;
4.OrderlyLiquidation;Or
5.ForcedTransaction.
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5. CA Dr Prithvi Ranjan Parhi 5
Valuation Premises
1. Highest And Best Use
2. Current Use/Existing Use
3. Orderly Liquidation
4. Forced Sale
As per IVS 104 : Bases of ValueAs per ICAI-VS 102 :Valuation Base
1. Highest And Best Use Value
2. Going Concern Value
3. As Is Where Is Value
4. Orderly Liquidation
5. Forced Transaction

6. Premise of Value #1
–Highest and Best Use
Para 140 of IVS 104 Bases of Value
•Highestandbestuseistheuse,fromaparticipantperspective,thatwouldproduce
thehighestvalueforanasset.
•Althoughtheconceptismostfrequentlyappliedtonon-financialassetsasmany
financialassetsdonothavealternativeuses,theremaybecircumstanceswhere
thehighestandbestuseoffinancialassetsneedstobeconsidered.
•Thehighestandbestusemustbephysicallypossible(whereapplicable),financially
feasible,legallyallowedandresultinthehighestvalue.
•Ifdifferentfromthecurrentuse,thecoststoconvertanassettoitshighestandbest
usewouldimpactthevalue.
•Thehighestandbestuseforanassetmaybeitscurrentorexistingusewhenitis
beingusedoptimally.
•However,highestandbestusemaydifferfromcurrentuseorevenbeanorderly
liquidation.
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8. Premise of Value –Highest and Best Use
Para 140 of IVS 104 Bases of Value
•Thehighestandbestuseofanassetvaluedonastand-alonebasismaybedifferentfromits
highestandbestuseaspartofagroupofassets,whenitscontributiontotheoverallvalueofthe
groupmustbeconsidered.
•Thedeterminationofthehighestandbestuseinvolvesconsiderationofthefollowing:
a)Toestablishwhetherauseisphysicallypossible,regardwillbehadtowhatwouldbe
consideredreasonablebyparticipants.
b)Toreflecttherequirementtobelegallypermissible,anylegalrestrictionsontheuseofthe
asset,eg,townplanning/zoningdesignations,needtobetakenintoaccountaswellasthe
likelihoodthattheserestrictionswillchange.
c)Therequirementthattheusebefinanciallyfeasibletakesintoaccountwhetheranalternative
usethatisphysicallypossibleandlegallypermissiblewillgeneratesufficientreturntoatypical
participant,aftertakingintoaccountthecostsofconversiontothatuse,overandabovethe
returnontheexistinguse.
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9. Premise of Value # 2
-Current Use/Existing Use
Para 140 of IVS 104 Bases of Value
•Currentuse/existinguseisthecurrentwayanasset,
liability,orgroupofassetsand/orliabilitiesisused.
•Thecurrentusemaybe,butisnotnecessarily,alsothe
highestandbestuse.
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10. Premise of Value # 3
–Orderly Liquidation
Para 160 of IVS 104 Bases of Value
•Anorderlyliquidationdescribesthevalueofagroupofassets
thatcouldberealisedinaliquidationsale,givenareasonable
periodoftimetofindapurchaser(orpurchasers),withthe
sellerbeingcompelledtosellonanas-is,where-isbasis.
•Thereasonableperiodoftimetofindapurchaser(or
purchasers)mayvarybyassettypeandmarketconditions.
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11. Premise of Value # 4
–Forced Sale
Para 170 of IVS 104 Bases of Value
•Theterm“forcedsale”isoftenusedincircumstanceswhereasellerisundercompulsiontosellandthat,asa
consequence,apropermarketingperiodisnotpossibleandbuyersmaynotbeabletoundertakeadequate
duediligence.
•Thepricethatcouldbeobtainedinthesecircumstanceswilldependuponthenatureofthepressureonthe
sellerandthereasonswhypropermarketingcannotbeundertaken.
•Itmayalsoreflecttheconsequencesfortheselleroffailingtosellwithintheperiodavailable.
•Unlessthenatureof,andthereasonfor,theconstraintsonthesellerareknown,thepriceobtainableina
forcedsalecannotberealisticallyestimated.
•Thepricethatasellerwillacceptinaforcedsalewillreflectitsparticularcircumstances,ratherthanthoseof
thehypotheticalwillingsellerintheMarketValuedefinition.
•A“forcedsale”isadescriptionofthesituationunderwhichtheexchangetakesplace,notadistinctbasisof
value.
•Ifanindicationofthepriceobtainableunderforcedsalecircumstancesisrequired,itwillbenecessaryto
clearlyidentifythereasonsfortheconstraintontheseller,includingtheconsequencesoffailingtosellinthe
specifiedperiodbysettingoutappropriateassumptions.
•Ifthesecircumstancesdonotexistatthevaluationdate,thesemustbeclearlyidentifiedasspecial
assumptions.
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12. Premise of Value # 4
–Forced Sale
Para 170 of IVS 104 Bases of Value
•Aforcedsaletypicallyreflectsthemostprobablepricethataspecifiedpropertyis
likelytobringunderallofthefollowingconditions:
a)consummationofasalewithinashorttimeperiod,
b)theassetissubjectedtomarketconditionsprevailingasofthedateofvaluation
orassumedtimescalewithinwhichthetransactionistobecompleted,
c)boththebuyerandthesellerareactingprudentlyandknowledgeably,
d)thesellerisundercompulsiontosell,
e)thebuyeristypicallymotivated,
f)bothpartiesareactinginwhattheyconsidertheirbestinterests,
g)anormalmarketingeffortisnotpossibleduetothebriefexposuretime,and
h)paymentwillbemadeincash.
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13. Premise of Value # 4
–Forced Sale
Para 170 of IVS 104 Bases of Value
•General Standards –IVS 104 Bases of Value
•Salesinaninactiveorfallingmarketarenotautomatically“forcedsales”simply
becauseasellermighthopeforabetterpriceifconditionsimproved.
•Unlesstheselleriscompelledtosellbyadeadlinethatpreventspropermarketing,
thesellerwillbeawillingsellerwithinthedefinitionofMarketValue(seeparas
30.1-30.7).
•Whileconfirmed“forcedsale”transactionswouldgenerallybeexcludedfrom
considerationinavaluationwherethebasisofvalueisMarketValue,itcanbe
difficulttoverifythatanarm’slengthtransactioninamarketwasaforcedsale.
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14. ICAI Valuation Standards
102-Valuation Bases
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15. Premise #1
Highest and Best Use
•39.Thehighestandbestuseofanon-financialassettakesintoaccounttheuseof
theassetthatisphysicallypossible,legallypermissibleandfinanciallyfeasible.as
follows:
a)ausethatisphysicallypossibletakesintoaccountthephysicalcharacteristics
oftheassetthatmarketparticipantswouldtakeintoaccountwhenpricingthe
asset(e.g.,thelocationorsizeofaproperty);
b)ausethatislegallypermissibletakesintoaccountanylegalrestrictionsonthe
useoftheassetthatmarketparticipantswouldtakeintoaccountwhenpricing
theasset(e.g.,thezoningregulationsapplicabletoaproperty);
c)ausethatisfinanciallyfeasibletakesintoaccountwhetherauseoftheasset
thatisphysicallypossibleandlegallypermissiblegeneratesadequateincome
orcashflows(takingintoaccountthecostsofconvertingtheassettothatuse)
toproduceaninvestmentreturnthatmarketparticipantswouldrequirefroman
investmentinthatassetputtothatuse.
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16. Premise #1
Highest and Best Use
•40.Highestandbestuseisdeterminedfromtheperspectiveofmarket
participants,eveniftheentityintendsadifferentuse.
•However,anentity'scurrentuseofanon-financialassetispresumedtobeits
highestandbestuseunlessmarketorotherfactorssuggestthatadifferentuseby
marketparticipantswouldmaximisethevalueoftheasset.
•41.Toprotectitscompetitiveposition,orforotherreasons,anentitymayintend
nottouseanacquirednon-financialassetactivelyoritmayintendnottousethe
assetaccordingtoitshighestandbestuse.
•Nevertheless,thevaluershallmeasurethefairvalueofanonfinancialasset
assumingitshighestandbestusebymarketparticipants.
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17. •42.Thehighestandbestuseofanon-financialassetestablishesthevaluationpremiseusedtomeasurethe
fairvalueoftheasset,asfollows:
•(a)thehighestandbestuseofanon-financialassetmightprovidemaximumvaluetomarketparticipants
throughitsuseincombinationwithotherassetsasagroup(asinstalledorotherwiseconfiguredforuse)or
incombinationwithotherassetsandliabilities(e.g.,abusiness).
•(i)ifthehighestandbestuseoftheassetistousetheassetincombinationwithotherassetsorwithotherassetsandliabilities,the
fairvalueoftheassetisthepricethatwouldbereceivedinacurrenttransactiontoselltheassetassumingthattheassetwouldbe
usedwithotherassetsorwithotherassetsandliabilitiesandthatthoseassetsandliabilities(i.e.itscomplementaryassetsandthe
associatedliabilities)wouldbeavailabletomarketparticipants;
•(ii)liabilitiesassociatedwiththeassetandwiththecomplementaryassetsincludeliabilitiesthatfundworkingcapital,butdonot
includeliabilitiesusedtofundassetsotherthanthosewithinthegroupofassets;
•(iii)assumptionsaboutthehighestandbestuseofanonfinancialassetshallbeconsistentforalltheassets(forwhichhighestand
bestuseisrelevant)ofthegroupofassetsorthegroupofassetsandliabilitieswithinwhichtheassetwouldbeused.
•(b)thehighestandbestuseofanon-financialassetmightprovidemaximumvaluetomarketparticipantson
astand-alonebasis.Ifthehighestandbestuseoftheassetistouseitonastandalonebasis,thefairvalue
oftheassetisthepricethatwouldbereceivedinacurrenttransactiontoselltheassettomarketparticipants
thatwouldusetheassetonastand-alonebasis.
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18. Premise #1
Highest and Best Use
•43.Wherethehighestandbestuseisdifferentfromtheexistinguse,
costs,tobeincurred,ifanyforconversionofanassettoitshighestand
bestuseneedtobeconsideredfordeterminationofvaluebasedon
highestandbestuse.
•44.Incertaincases,assessmentofhighestandbestusemayinvolve
considerablesubjectivity/technicalaspectsandthevaluermaybase
hisassessmentconsideringinter-aliarelevantinputsfromtheclient,
informationavailableinpublicdomain,etc.
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19. Premise #2
Going Concern Value
•45.Goingconcernvalueisthevalueofabusinessenterprise
thatisexpectedtocontinuetooperateinthefuture.
•46.TheintangibleelementsofGoingConcernValueresult
fromfactorssuchashavingatrainedworkforce,an
operationalplant,thenecessarylicenses,marketingsystems,
andproceduresinplaceetc.
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20. Premise #3
As-is-where-is Basis
•47.As-is-where-isbasiswillconsidertheexistinguseofthe
assetwhichmayormaynotbeitshighestandbestuse.
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21. Premise #4
Orderly Liquidation
•48.Anorderlyliquidationreferstotherealisablevalueofanasset
intheeventofaliquidationafterallowingappropriatemarketing
effortsandareasonableperiodoftimetomarkettheassetonan
as-is,where-isbasis.
•49.Thereasonableperiodoftimetomarkettheassetwouldvary
basedonthemarketconditions,natureoftheasset,etc.
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22. Premise #5
Forced transaction
•50.Forcedtransactionisatransactionwhereaselleris
underconstraintstosellanassetwithoutappropriate
marketingperiodorefforttomarketsuchasset.
•51.Saleinthemarketthatisnotactivecannotbe
presumedtobeforcedtransactionwithoutassessing
thesellerspecificcircumstances.
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23. Thank You
CA Dr Prithvi Ranjan Parhi 23