Chapter 3
Liquidation Based
Valuation
Amad
Amora
Bayog-ang
Binondo
Lapiña
Mabaylan
Mandawe
Liquidation-Based Valuation
For most companies, the value generated by assets working
together and by human capital applied to managing those
assets makes estimated going - concern value greater than
liquidation value. This captured in the free cash flow
forecasts and other items that are considered and
calculated in the previous modules. However, if there will be
circumstances that occur which doubts the going-concern
ability of a business, using going-concern value may not be
appropriate anymore as the future cash flows will not be
realizable anymore. An alternative approach is the use of
liquidation value.
Liquidation Value
According to the CFA Institute, liquidation
value refers to the value of a company if it
were dissolved and its assets sold individually.
Liquidation value represents the net amount
that can be gathered if the business is shut
down and its assets are sold piecemeal. In
some texts, liquidation value is also known as
net asset value.
Situations to Consider Liquidation Value
1. Business Failures
Business failure is the most common reason
why businesses close or liquidate.
Most corporations only have finite number of
2. Corporate/Project End of Life
years to operate as stated in their Articles of
Incorporation. This is also similar in the case of
projects like joint ventures with finite life.
In some industries like mining and oil,
3. Depletion of Scarce Resources
availability of scarce resources significantly
influences firm value. Oftentimes, these are
also industries that are highly regulated by
the government.
General Principles on Liquidation Value
1. If the liquidation value is above income approach valuation
(based on going-concern principle) and liquidation comes into
consideration, liquidation value should be used.
2. If the nature of the business implies limited lifetime (e.g. a
quarry, gravel, fixed-term company, etc.), the terminal value
must be based on liquidation. All costs necessary to close the
operations (e.g. plant closure costs, disposal costs, rehabilitation
costs) should also be factored in and deducted to arrive at the
liquidation value.
General Principles on Liquidation Value
3. Non-operating assets should be valued by liquidation method
as the market value reduced by cost of sale and taxes. Since they
are not part of the firm’s operating activities, it might be
inappropriate to use the same going concern valuation technique
used for business operations. If such result is higher than net
present value of cash flows from operating the asset, the
liquidation value should be used.
4. Liquidation value must be used if the business continuity is
dependent on current management that will not stay.
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Types of Liquidation
Orderly Liquidation Forced Liquidation
Assets are sold strategically over an Liquidation process, at which the asset
orderly period to attract and generate or assets are sold as quickly as possible,
the most money for the assets. This such as at an auction. Liquidation is
liquidation process will expose assets for done immediately especially if creditors
sale on the open market, with a have sued or a bankruptcy is filed.
reasonable time allowed to find a Assets are sold in the market at the
purchaser, both buyer and seller having soonest time possible which result in
knowledge of the uses and purposes to lower prices because of the rush sale.
which the asset is adapted and for which This ultimately drives down liquidation
it is capable of being used, the seller value.
being compelled to sell and the buyer
being willing, but not compelled, to buy.
Calculating Liquidation Value
PV of Sale of Assets
Less: PV of Closure Costs and
Payment for Liabilities
Less: Tax Charges for the
Transaction and Other Liquidation
Costs
Liquidation Value