Inputs to Valuation Methods

SFAS 157 establishes a hierarchy of inputs that may be used in determining

fair values. Inputs are the various pieces of data that are utilized in arriving

at a fair value. In some cases, only a single input is necessary. In other cases,

many different inputs are used in arriving at a value.

Inputs can be classified as either observable or unobservable. Observable

inputs are inputs that reflect the assumptions that market participants

would use in pricing the asset or liability developed based on market data

obtained from sources independent of the reporting entity. Examples of

observable inputs include the following seven:

1. Market prices from active markets for identical securities (e.g., publicly

traded stocks and mutual funds)

2. Market prices for similar assets or liabilities

3. Historical rates of interest

4. Historical rates of inflation

5. Default rates

6. Business valuation multiples used in recorded sales of other businesses

7. Real estate market prices based on square feet and location

Unobservable inputs are inputs that reflect the reporting entity’s own

internal assumptions about the assumptions that market participants would

use in pricing the asset or liability based on the best information available

in the circumstances. Examples of unobservable inputs include the

following three:

1. Projections of future cash flows, revenues, expenses, earnings, volume

of production, and so on
2. Self-assessed risk factors (e.g., default risk, etc.) that are applied

in connection with valuing certain items (e.g., valuing one’s own

debt)

3. Other extrapolations of historical or verifiable information, such as

growth rates

Some inputs may fall into either the observable or unobservable

category, depending on whether market participants would likely have

access to the information. For example, terms of licenses, contracts, and