Lesson 4 - LIQUIDATION BASED VALUATION Unit 2 – Uses and Calculation of Liquidation

Value

Overview:
This lesson will discuss the uses of liquidation value especially in investment analysis
and illustrate how the liquidation value is calculated.

Learning Objectives:
After successful completion of this lesson, you should be able to:
1. Determine the liquidation value to be used in investment analysis.
2. Calculate the liquidation value.

Course Materials:
Liquidation value method is also used by analysts as a benchmark in making investment
decisions. Most analysts and investors are looking for a profitable companies and as perceived,
companies with high profitability have less chances of liquidating, thereby, liquidation value is
lower than its prevailing market price per share. On the other hand, when firms are experiencing
decline or an industry is consistently declining, liquidation value will be higher than its market
share price which often leads to total closure or liquidation of the business. Share price often
reflects growth prospects of the company which is a consideration that liquidation value does
not have. Investors of the firms usually buy the shares at prevailing market price and sell the
company at the higher liquidation value. This results in risk-free arbitrage profit for corporate
investors.

Calculating Liquidation Value

Liquidation value considers the present value of the sums that can be obtained through the
disposal of the assets of the firm in the most appropriate way, net of the sums set aside for the
closure costs, repayment of the debts and settlement of all liabilities, and net of the tax charges
related to the transaction and the costs of the process of liquidation itself. It can also be
computed on a per share basis by dividing total liquidation value by outstanding ordinary shares
and be considered together with other quantitative and qualitative metrics to justify business
decisions to be made.
Liquidation Value = PV of Sale of Assets – PV of Closure Costs and Payment for liabilities-
Tax Charges for the Transaction and Other Liquidation Costs

To illustrate:

To compute for the adjusted value of the assets, the current book values should be multiplied by
the assumed realizable value if they are liquidated. Then the liabilities should be deducted from
the asset adjusted value to arrive at the liquidation value or net asset value.
 Asset
Adjusted Value Php 5,605,000
Less: Total Liabilities to be settled

2,000,000 Liquidation Value –

Pavement Co. Php 3,605,000
Number of Outstanding Shares /
250,000 Liquidation Value per
Share Php 14.42
Once the company will be liquidated, SH will receive 14.42 per share

Type of Liquidation
1. Orderly liquidation – assets are sold strategically over an orderly
period to attract and generate the most money for the assets. This
process will expose assets for sale on the open market, with a
reasonable time allowed to find a purchaser, both buyer and
seller having knowledge of the users and purposes to which the
asset is adapted and for which it is capable of being used, the
seller being compelled to sell and the buyer being willing, but not
compelled to buy.

2. Forced liquidation – is a liquidation process at which the assets

are sold as quickly as possible such as an auction. This happens
when creditors have sued the company or bankruptcy is filed,
hence liquidation value decreases as it resulted to lower prices
because of rush sale.

Activities/Assessments:
Answer the problem:
At year end, Lysle Company balance sheet showed total assets of Php50
Million, total liabilities of Php30 Million and 500,000 ordinary shares outstanding.
If Lysle could sell its assets for Php40 Million, Lysle liquidation value per share
of ordinary share is?
References:
- Valuation Concepts and Methods by M. V. Lascano, H. C. Baron, A. T. L. Cachero