Case Study: BV 4th Edition - Detailed Income Approach Analysis

This case study analyzes the income approach for business valuation (BV), specifically referencing the 4th Edition. The analysis meticulously examines various aspects of the income approach, including whether it was used, and if not, the justification provided. It assesses the clarity of income types (net income, operating income, etc.) and the support for determining the company's earnings capacity. The study delves into the discount rate's support, ongoing earnings capacity calculations, and the discussion of cost of capital components. It scrutinizes the selection of a safe rate, the relationship between discount and capitalization rates, growth assumptions (short-term and long-term), and the reconciliation of these assumptions with economic, industry, and company statements. Furthermore, the case study explores the discounted cash flow (DCF) method, including the type of cash flow used, disclosure of management's projections, reasonableness testing of projections, depreciation and capital expenditures, and the impact of non-operating assets and liabilities. It also examines the discount or capitalization rate, including the weighted average cost of capital (WACC) and the capital asset pricing model (CAPM). The analysis evaluates the use of projections, including the detail and comparability of projected income statements, balance sheets, and statements of cash flows. The document concludes with a detailed report writing checklist from Appendix B of the BV 4th Edition.

BV: Case Analysis 4th Edition APPENDIX B
Report Writing Checklist
Appendix B – 1© 2007 -2018 IACVS
Income Approach Y N NA
If the income approach is not used for the final value, did valuation report address why? N
If the income approach is not used, skip this section NA
Is the type of income clearly defined? (Net income, operating income, net cash flow to equity, net cash
flow to invested capital, etc.)
NA
Is there adequate support for determining the earnings capacity of the company? NA
Is the discount rate adequately supported? NA
Discuss and provide calculations for ongoing earnings capacity. Explain the method used to arrive at the
future income capacity and discuss how the ongoing earnings capacity was selected.
NA
Is there an adequate discussion of the principles of cost of capital components? NA
Is the selection of a safe rate explained? NA
Is there an adequate discussion of the relationship of discount rate to capitalization rate? NA
Short-term and long-term growth assumptions NA
Reconciliation of the growth assumptions with economy, industry, and company statements NA
If applying a single period capitalization model how did you reconcile the growth assumptions? NA
Source of earnings used in forecasts NA
Explain the depreciation determined for the forecast period NA
Explain the amortization determination for the forecast period NA
Capital expenditures determined for the forecast period NA
Tax rate assumptions used; How they were justified NA
Explain each and every step involved in the analysis. NA
Can the analysis be replicated based on information in the report? NA
Discounted Cash Flow Method
If the DCF method not used, skip this section
Does the report adequately address the “type” of cash flow or earnings being used and why? Y
Is there adequate disclosure that management has provided the cash flow projections? (Who made them,
when, what for, what adjustments were made to the projections, etc.)
Y
Is there discussion of the analysis performed to test the reasonableness of the projections? Y
Is there adequate analysis and discussion of the projected depreciation expense? Y
Depreciation discuss how the future depreciation expense was calculated. Y
Is there adequate analysis and discussion of the projected capital expenditures, changes in working
capital, projected minimum cash balances, and projected changes in long-term debt?
Y
Are the projected capital expenditures larger than projected depreciation expense? NA
Has the report addressed the impact of non-operating assets and liabilities in the cash flow projections and
the impact on the final value?
Y
Was the income/expense from the non-operating assets removed from the company’s adjusted earnings? Y
Explain each and every step involved in the analysis. Y
Can the analysis be replicated based on information in the report? Y

BV: Case Analysis 4th Edition APPENDIX B
Report Writing Checklist
Appendix B – 2© 2007 -2018 IACVS
Discount or Capitalization Rate Y N NA
Weighted Average Cost of Capital
If the WACC is not used, skip this section Y
Is there adequate discussion of the WACC and when it is used? Y
Is there adequate disclosure of the sources of equity and debt (Cite publications, online, etc.)? Y
Is there adequate support for weighting the debt and equity? Is the basis for the weighting discussed? Y
Is there an adequate discussion of the iterative process? NA
Explain each and every step involved in the analysis. Y
Can the analysis be replicated based on information in the report? Y
Capital Asset Pricing Model
If CAPM is not used, skip this section N
Is the risk free rate of return effective as of the valuation date? Are the other components of the rate
effective either as of the valuation date or the year of the valuation date?
NA
Is the equity risk premium adequate? NA
Is the size premium adequate? NA
Is there adequate support for the beta? NA
Is there a discussion as to the Assumptions of the capital asset pricing model? NA
Is the discount/capitalization rate appropriate for the valuation? NA
Explain each and every step involved in the analysis. NA
Can the analysis be replicated based on information in the report? NA
Use of Projections
Are the projected income statements presented with adequate detail (Nominal, common sized, trends)? Y
Are the projected income statements presented in a form comparable to the historical financial
statements?
Y
Are the assumptions for the projected income statements adequately disclosed and are they reasonable? Y
Are the projected balance sheets presented with adequate detail (Nominal, common sized, trends)? Y
Are the projected balance sheets presented in a form comparable to the historical financial statements? Y
Are the assumptions for the projected balance sheets adequately disclosed and are they reasonable? Y
Are the projected statement of cash flows presented with adequate detail (Nominal, common sized,
trends)?
Y

BV: Case Analysis 4th Edition APPENDIX B
Report Writing Checklist
Appendix B – 3© 2007 -2018 IACVS