BUSINESS VALUATION

MA 3103
 BUSINESS VALUATION
 Business valuation – is a process and a set of procedures used to estimate the economic value of an owner’s
interest in a business.
 Intrinsic value – is a concept that refers to a security’s perceived value on the basis of future earnings or other
attributes of the entity that are not related to a security’s market value.
 Market value – is the price an asset fetches in the market and is commonly used to refer to market
capitalization.
 Market capitalization – refers to the total peso market value of a company’s outstanding shares of stock. It is
calculated by multiplying the share price by the number of shares outstanding.
 Share (stock) price – the price at which a stock sells in the market.
 Reasons for performing a business valuation:
 1. Litigation. In a court case where there is an issue with the value of the business, you may need to provide
proof of your company’s value based on its actual worth.
 2. Exit strategy planning. In instances where there is a plan to sell a business, it is wise to come up with a base
value for the company and then come up with a strategy to enhance the company’s profitability so as to increase
its value as an exit strategy.
 3. Buying a business. The real business value is what the buyers are willing to pay. A good business valuation
will look at market conditions, potential income, and other similar concerns to ensure that the investment you
are making is viable.
 4. Selling a business. When you want to sell your business or company, you need to make certain that you get
what it is worth and the asking price should be attractive to prospective purchasers.
 5. Strategic planning. Having a current valuation of the business will give you good information that will help
you make better business decisions.
 6. Funding. An objective valuation is usually needed when you need to negotiate with banks or any other
potential investors for funding. Providing documentation of company’s worth enhances your credibility to the
lenders.
 7. Selling a share in business. For business owners, proper business valuation enables you to know the worth of
your share and be ready when you want to sell your share and that you get a good value of your share.
 8. Business combinations. Control of another company may be achieved by either acquiring the assets of the
target company or acquiring a controlling interest (usually over 50%) in the target company’s voting common
stock. It is important that identifiable assets and liabilities must be valuated based on quoted market value,
where an active market for the items exist. Where there is no active market, independent appraisals,
discounted cash flow analysis, and other type of analysis are used to estimate fair values.
 Different valuation models:
 a. Dividend discount model. Stock price is calculated based on the probable dividends that will be paid and they
will be discounted at the expected yearly rate. It is a way of valuing a company based on the theory that a stock is
worth the discounted sum of all of its future dividends payments. In other words, this model is used to evaluate
stocks based on the net present value of future dividends.
 b. Discounted cash flow model. Is an intrinsic method used to estimate the present value of an investment based
on its expected future cash flows. It establishes a rate of return or discount rate by looking at dividends, earnings,
operating cash flow or free cash flow that is then used to establish the value of the business outside of other
business considerations.
 c. Residual income model. Is an equity valuation method that is based on the idea that the value of a company’s
stock equals the present value of future residual incomes discounted at the appropriate cost of equity. The cost of
equity is essentially the required rate of return asked by the investors as compensation for opportunity cost and
corresponding level of risk. (residual income = net income – (equity capital x cost of equity)
 Required rate of return – is the minimum rate of return on a common stock that a stockholder considers
acceptable.
 d. Asset-based model. Is a form of valuation in business that focuses on the value of company’s assets or the fair
market value of its total assets after deducting liabilities. Assets are evaluated, and the fair market value is
obtained. This new value is quoted and used in the asset-based approach.
 Dividend Discount Model  Answer:
 Equity value = Present value of expected  Year Dividend PV factor PV of
future dividends. dividend
 = D1__ + D2__ + D3__ + PV of dividends  (a) (b) (a x b)
 (1+Re)1 (1+ Re)2 (1+Re)3 beyond 3 years  1 P40.0 M 0.9091 P36.4 M
 Illustration:  2 50.0 0.8264 41.3
 At the beginning of year 1, the company raises  3 60.0 0.7513 45.1
P60 million of equity and uses the proceeds to
buy a fixed asset. Operating profits before  Equity value P122.8 M
depreciation (all received in cash) and dividends  If a firm has a constant dividend growth rate
for the company to be P40 million in year 1, P50
(Gd), its value would simplify to the following
million in year 2 and P60 million in year 3, at
formula:
which point the company terminates (having a
terminal value of zero). The firm pays no taxes.  Equity value = D1__
 Required: If the cost of equity capital for this  (Re – Gd)
firm is 10%, what is the value of the firm’s equity?
 Corporate Valuation Model  Illustration: Free cash flow
 Corporate valuation model – a valuation model used as an
alternative to the discounted dividend model to determine a  A company has EBIT of P30 million,
firm’s value, especially one with no history of dividend, or the
value of a division of a larger firm. This corporate model first
depreciation of P5 million, and a 40% tax
calculates the firm’s free cash flows, then finds their present rate. It needs to spend P10 million on new
values to determine the firm’s value.
fixed assets and P15 million to increase its
 MV of company = PV of expected future free cash flows
currents assets, and it expects its payable
 = FCF1__ + FCF2___ + FCF3__ + PV of FCF
to increase by P2 million and its accruals
 (1+WACC)1 (1+WACC)2 (1+WACC)3 beyond 3 yrs
to increase by P3 million.
 Free cash flows (FCF) – the amount of cash that could be  Required: What is its free cash flow?
withdrawn from a firm without harming its ability to operate
and to produce future cash flows.  FCF = [P30 M (1-40%) + P5 M]- [P10 M +
 Net Operating Profit after Taxes (NOPAT) or After tax (P15 M - P5 M)]
operating income – the profit a company would generate if it
had no debt and held only operating assets. It is calculated by
multiplying EBIT by (1-T)
 = P23 M - P20 M
 FCF = [EBIT (1 - T) + Depreciation] – (Capital  = P3 million
 expenditures + Increase in net working capital)
 DISCOUNTED ABNORMAL EARNINGS VALUATION METHOD
 If all transactions that affect equity, other than capital transactions, flows through the income statement, the
expected book value of equity for existing shareholders at the end of year 1(BVE1), is simply the book value at
the beginning of the year (BVEo) plus expected net income or loss in year 1 (NI1) less expected dividends paid in
year 1((Dividend1). This relation can be rewritten as follows:
 Dividend1 = Net income1 + BVE0 – BVE1
 By substituting this identity for dividends into the dividend discount formula and rearranging the terms, equity
value can be rewritten as follows:
 Equity value = Book value of equity + PV of expected future earnings
 Abnormal earnings are calculated as net income adjusted for a capital charge. The capital charge is computed
as the discount rate multiplied by the beginning book value of equity (BVE0). Abnormal earnings therefore,
adjust net income to reflect the fact that accountants do not recognized any opportunity cost for equity funds
used. Thus, the discounted abnormal earnings valuation formula is:
 Equity value = BVEo + NI1 – (Re x BVEo) + NI2 – (Re x BVE1) + NI3 – (Re x BVE2) + PV of abnormal
 (1 + Re) (1 + Re)2 (1 + Re)3 earnings beyond
 3 years
 Equity values can also be estimated by valuing the firm’s assets and then deducting its net debt. Under the
earning-based approach, this implies that the value of the asset is:
 Asset value = BVAo + NOPAT1 – (WACC x BVAo) + NOPAT2 – (WACC x BVA1)
 (1 + WACC) (1 + WACC)2
 + NOPAT3 – (WACC x BVA2) + PV of abnormal NOPAT
 (1 + WACC)3 beyond 3 years
 Book value of assets (BVA) is the book value of the firm’s assets; NOPAT is net operating profit (before
interest) after tax; and WACC is the firm’s weighted average cost of debt and equity. From this asset value,
the analyst can deduct the market value of net debt to generate an estimate of the value of equity.
 The earnings-based formulation (also known as the residual income model) has intuitive appeal. It implies
that if a firm can earn only a normal rate of return on its book value, then investors should be willing to pay
no more than the book value for the shares. Investors should pay more or less than book value if are above
or below this normal level. The deviation of firm’s market value from book value depends on its ability to
generate abnormal earnings. The formulation also implies that a firm’s equity value reflects the cost of its
existing net assets (i.e. its book equity) plus the net present value of future growth options (represented by
cumulative abnormal earnings)
 Illustration:
 Assume the cost of company’s equity capital is 10% and it depreciates its fixed assets using the
straight line method, its beginning book equity, earnings, abnormal earnings and valuation are shown
as follows:
 Beginning Book Abnormal PV of Abnormal
 Year Value of Equity Net income Re x BVE Earnings PV Factor Earnings
 (a) (b) (c) (d)(b – c) (e) (d) x (e)
 1 P60 M P20 M P6.0 M P14 M 0.9091 P 12.7 M
 2 40 30 4.0 26 0.8264 21.5
 3 20 40 2.0 38 0.7513 28.6
 Cumulative PV of abnormal earnings in years 1- 3 P 62.8 M
 Add: Beginning book value of equity 60.0 M
 Equity value P122.8 M
 Residual Income Model
 How to calculate a company’s value using the residual income valuation model?
 The first step required to determine the intrinsic value of a company’s stock using residual income valuation is
to calculate the future residual income of a company.
 Residual income = Net income – Equity charge
 Equity charge = Equity capital x Cost of equity
 After the calculation of residual incomes, the intrinsic value of a stock can be determined as the sum of the
current book value of the company’s equity and the present value of the future residual incomes
discounted at the relevant cost of equity. The valuation formula for the residual income model can be
expressed in the following way:
 Vo = BVo + RI1__ + RI2__ + RI3__ + PV of residual income
 (1 + r)1 (1 + r)2 (1 + r)3 beyond 3 years
 Where: BVo – Current book value of the company’s equity
 RIt – Residual income of the company at a time period t
r - Cost of equity
 Discounted Cash Flow Model
 The value of an asset or investment is the present value of the net payoffs that the asset generates. The discounted cash
flow valuation model clearly reflects this basic principle of finance. The model defines the value of a firm’s business
assets as the present value of the cash flows generated by those assets (cash from operations, or CFO) minus the
investment made in new operating assets. It is derived from the dividend discount model, and is based on the insight that
dividends can be forecast as free cash flows, that is:
 Dividends = Operating cash flow – Capital outlays + Net cash flows from debt owners
 Operating cash flows to equity holders are simply net income plus depreciation minus changes in working capital
accrual. Capital outlays are capital expenditures less asset sales. Finally, net cash flow from debt owners are issues of
net debt less retirement less the after-tax cost of interest. By rearranging these terms, the free cash flows to equity can
be written as follows:
 Dividends = Free cash flows to equity = Net income - ^BVA + ^BVND
 Where: ^BVA is the change in book value of operating net assets (including changes in working capital plus capital
expenditures less depreciation expense), and ^BVND is the change in book value of net debt (interest bearing debt less
excess cash)
 The discount dividend model can therefore be written as the present value of free cash flows to equity. Under this
formulation, firm value is estimated as follows:
 Equity value = PV of free cash flows to equity claim holders
 = NI1 - ^BVA1 + ^BVND2 + NI2 - ^BVA2 + ^BVND2 + NI3 - ^BVA3 + ^BVND3
 (1 + Re) (1 + Re)2 (1 + Re)3
 + PV of free cash flows to equity beyond 3 years
 Alternatively, the free cash flow formulation can be structured by estimating the value of claims to net debt and equity
and then deducting the market value of net debt. This approach is widely used in practice because it does not require
explicit forecasts in changes of debt balances. The value of debt plus equity is then:
 Debt plus equity value = PV of free cash flows to net debt and equity claim holders
 = NOPAT1 - ^BVA1 + NOPAT2 - ^BVA2 + NOPAT3 - ^BVA3 + PV of free cash flows to debt
 ( 1 + WACC) (1 + WACC)2 (1 + WACC)3 and equity beyond 3 years

 Valuation under the discounted cash flow method involves the following steps:
 1. Forecast free cash flows available to equity holders, or to debt and equity holders, over a finite forecast horizon – usually
5 to 10 years.
 2. Forecast free cash flows beyond the terminal year beyond the terminal year based on some simplifying assumptions.
 3. Discount free cash flows to equity holders (debt plus equity holders) at the cost of equity (WACC). The discounted
amount represents the estimated value of free cash flows available to equity (debt and equity holders as a group)
 Illustration: Present Value of Free Cash Flows
 The company has no debt, so that the free cash flows to owners are simply the operating profits before
depreciation. Since the company is an all-equity firm, its WACC is the cost of equity (10%) and the present
value free cash flows is shown as follows:
 Change in book Change in book PV of
 Year Net income value of assets value of debt FCF to Equity PV factor FCF
 (a) (b) (c) d) = (a) – (b) +(c) (e) (d) x (e)
 1 P 20 M - P 20 M P0 P 40 M 0.909 P 36.4 M
 2 30 M - 20 0 50 0.826 41.3
 3 40 M - 20 0 60 0.751 45.1
 Equity value P122.8 M
 Free cash flows used in DCF valuations are defined as follows:
 FCF to Debt and Equity = EBIT x (1 – tax rate) + Depreciation and Deferred taxes – Capital
 Expenditures -/+ Increase/Decrease in Working Capital
 FCF to Equity = Net income + Depreciation and Deferred Taxes – Capital Expenditures
 -/+ Increase/Decrease in Working Capital -/+ Increase/Decrease in Debt
 Operating activities – items that occur as part of normal ongoing operations.
 Net income – this is the first operating activity which is the first source of cash.
 Increase in inventories, accounts receivable and marketable securities – are application/uses of cash
(cash outflow).
 Decrease in inventories, accounts receivable and marketable securities – are sources of cash (cash
inflow).
 Increase in accounts payable, accrued wages and taxes – are sources of cash (cash inflow).
 Decrease in accounts payable, accrued wages and taxes – are application/uses of cash (cash outflow).
 Additions to property, plant, and equipment – are application/uses of cash (cash outflow).
 Increase in notes payable, bonds payable (long-term debt) – are sources of cash (cash inflow).
 Decrease in notes payable, bonds payable (long-term debt) – are uses of cash (cash outflow).
 The EVA Approach
 This is an alternative approach based on the concept of Economic Value Added (EVA).
“Economic Value Added (EVA) versus Net Income,” that can be rewritten as follows:
 EVA = (Equity capital)(ROE – Cost of Equity Capital)
 This equation suggests that companies can increase their EVA by investing in projects that
provide shareholders with returns that are above their cost of equity capital, which is the
return they could expect to earn on alternative investments with the same level of risk.
When you purchase stock in a company, you receive more than just the book value of equity,
you also receive a claim on all future value that is created by the firm’s managers (the
present value of all future EVAs). It follows that a company’s market value of equity can be
written as follows:
 Market Value of Equity = Book value + PV of all future EVAs
 We can find the “fundamental” value of the stock,, by simply dividing the preceding the
preceding expression by the number of shares outstanding
 The Connection between ROE and EVA
 EVA is different from traditional accounting profit because EVA reflects the cost of equity as
well as the cost of debt.
 EVA = EBIT(1 – Tax rate) – [(Total investors’ capital) x (After-tax cost of capital)]
 We could express EVA as net income minus the peso cost of equity:
 EVA = Net Income – (Equity capital x Cost of equity capital)
 The expression could be rewritten as follows:
 EVA = Equity capital x [(Net income / Equity capital) – Cost of equity capital]
 Which can be rewritten as:
 EVA = (Equity capital)(ROE – Cost of equity capital)
 This last expression implies that EVA depends on three factors: rate of return, as reflected in ROE;
risk, which affects the cost of equity; and size, which is measured by the equity employed. The
shareholders’ value therefore, depends on risk, return and capital invested.
 ASSET-BASED MODEL
 Asset-based approach identifies a company’s net assets by subtracting liabilities from assets. The
asset-based valuation is often adjusted to calculate a company’s net assets value based on the
market value of assets and liabilities.
 When to use asset-based valuation
 The asset-based approach is used to value the overall business and is usually performed during the
purchase or sale of the business, or a merger or acquisition.
 Theory of the asset-based approach
 The asset-based approach encompasses a set of methods that value the company by reference to its
balance sheet. In contrast, income approach and market approach valuation methods primarily focus
on the company’s income statement and/or cash flow statements.
 The asset-based approach value-based balance sheet recognizes the current value of:
 1. All of the company’s assets (tangible and intangible); and
 2. All of the company’s liabilities (recorded and contingent)
 Adjusted net asset approach
 Is a principal method used in the asset approach. This method is used to value business on
the basis of the difference between the fair market value of its assets and its liabilities.
Under this method, the assets are adjusted from book value to fair market value, and the
total adjusted assets are then reduced by recorded and recorded liabilities.
 Distinction between asset-based approach and cost approach
 1. The asset-based approach is a generally accepted business valuation approach while the
cost approach is generally accepted property valuation approach.
 2. The objective of the asset-based approach is to estimate a business equity (or total net
assets) value while the objective of the cost approach is to estimate the value of an
individual tangible asset or intangible asset.
 In the asset-based approach, the individual asset categories may be valued using the cost
approach, the market approach or the income approach. In the typical asset-based approach
analysis, the analyst may expect that all of the property valuation approaches will be used.
 Fair Value Measurements – PFRS 13
 Fair value – refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
 The objective of fair value measurement is to estimate the price at which an orderly transaction to sell the asset or to
transfer the liability would take place between the market participants at the measurement date under current
market conditions.
 The asset or liability
 A fair value measurement is for a particular asset or liability. Therefore, when measuring fair value, an entity shall
take into account the characteristics of the asset or liability if market conditions would consider these characteristics
when pricing the asset or liability at the measurement date. Such characteristics include the following:
 1. the condition and location of the asset; and
 2. restrictions, if any, on the sale or use of the asset
 A fair value transaction assumes that the asset or liability is exchanged in an orderly transaction between market
participants to sell the asset or transfer the liability at the measurement date under current market condition. A fair
value measurement assumes that the transaction to sell the asset or transfer the liability takes place either: (a) in
the principal market for the asset or liability; or (b) in the absence of principal market, in the most advantageous
market for the asset or liability.
 Principal market – is the market with the greatest volume and level of activity for the asset or liability.
 Most advantageous market – is the market that maximizes the amount that would be received to sell the asset or
minimizes the amount that would be paid to transfer the liability, after taking into account transaction and
transport cost.
 Transaction cost – are the costs to sell an asset or transfer a liability in the principal or most advantageous market
for the asset or liability that are directly attributable to the disposal of the asset or the transfer of the liability.
 Fair value at initial recognition
 When a asset is acquired or a liability is assumed in an exchange transaction for the asset or liability, the
transaction price is the price paid to acquire the asset or received to assume the liability or the so called entry
price. In contrast, the fair value of the asset or liability is the price that would be received to sell the asset or paid
to transfer the liability, or the exit price.
 Valuation Techniques
 An entity shall use valuation techniques that are appropriate in the circumstances and for which sufficient data are
available to measure fair value. The objective of using a valuation technique is to estimate the price at which an
orderly transaction to sell the asset or to transfer the liability would take place between market participants at the
measurement date under current market conditions. The three widely-used valuation techniques are the: (a)
market approach; (b) cost approach; and (c) income approach
 Market approach
 The market approach uses prices and other relevant information generated by market transactions involving
identical or comparable assets, liabilities, or a group of assets and liabilities such as business.
 Valuation techniques consistent with market approach often use market multiples derived from a set of
comparables. The valuation techniques include matrix pricing. Matrix pricing is a mathematical technique used
principally to value some types of financial instruments, such as debt securities, without relying exclusively on
quoted prices for the specific securities, but relying on the securities’ relationship with other benchmark quoted
securities.
 Cost approach
 The cost approach reflects the amount that would be required currently to replace the service capacity of an
asset, often referred to as current replacement cost. From the perspective of a market participant seller, the
price that would be received for the asset is based on the cost to a market participant buyer to acquire or
construct a substitute asset of comparable utility, adjusted for obsolescence.
 Obsolescence encompasses physical deterioration. Functional or technological obsolescence and economic or
external obsolescence are broader than depreciation for financial accounting purposes.
 In many instances, the current replacement cost method is used to measure the fair value of tangible assets that
are used in combination with other assets or with other assets or liabilities.
 Income Approach
 The income approach converts future amounts like cash flows or income and expense into a single current or
discounted amount. When the income approach is used, the fair value measurement reflects the current
market expectations about those future amounts. The valuation techniques include:
 a. present value techniques;
 b. option pricing models such as model that incorporates present value techniques and reflects both the
time value and intrinsic value techniques; and
 c. multi-period excess earnings method, which is used to measure the fair value of some intangible assets.
 If the transaction price is fair value at initial recognition and a valuation technique that uses unobservable
inputs will be used to measure fair value in subsequent periods, the valuation technique should be
calibrated so that at initial recognition, the result of the valuation technique equals the transaction price.
Valuation techniques used to measure fair value shall be applied consistently. However, a change in
valuation technique is appropriate if the change results in a measurement that is equally or more
representative of fair value. A change in valuation technique is appropriate if a new market develops; new
information becomes available; information previously used is no longer available; valuation technique
improves; or market condition change.
 Valuation technique used to measure fair value shall maximize the use of relevant observation
inputs and minimize the use of unobservable inputs. Markets in which inputs might be observable
for some assets and liabilities (e.g., financial instruments) include the following:
 a. Exchange markets. In an exchange market, closing prices are both readily available and
generally representative of fair value.
 b. Dealer markets. In a dealer market, dealers stand ready to trade (either buy or sell for their
account), thereby creating liquidity using their capital to hold an inventory of the items for which
they make a market. Typically, bid and ask prices are more readily available than closing prices.
 c. Broker markets. In a broker market, brokers attempt to match buyers with sellers but do not
stand ready to trade for their own account. In other words, brokers do not use their own capital
to hold an inventory of the items for which they make a market. Ex: commercial and residential
real estate markets.
 d. Principal-to-principal markets. In a principal-to-principal market, transactions both
origination and resales, are negotiated independently with no intermediaries. Little information
about these transactions may be made available publicly.
 Bid and Ask Prices
 If an asset or a liability measured at fair value has a bid price and an ask price, the price within the bid-ask
spread that is most representative of fair value in the circumstances shall be used to measure fair value. Bid
price represents the price at which the dealer is willing to buy, while ask price represents the price at which
the dealer is willing to sell.
 Liabilities and Equity Instruments Held by other Parties as Assets
 When quoted price for the transfer of an identical or similar liability or entity’s own equity instrument is not
available and the identical item is held by another party as an asset, an entity shall measure the fair value of
the liability or equity instrument from the perspective of a market participant that holds the identical item as an
asset at the measurement data. In such case, an entity shall measure the fair value of the liability or equity
instrument as follows:
 a) using quoted price in an active market for the identical item held by another party as an asset if the price is
available.
 b) If the price is not available, using other observable inputs , such as a quoted price in a market that is not
active for the identical items held by another party as an asset.
 c) if the observable prices of (a) and (b) are not available, using another valuation technique such as: an income
approach, or a market approach.
 Active market – is a market in which transactions for the asset or liability take place with sufficient
frequency and volume to provide pricing information on an ongoing basis.
 Income approach – is a valuation technique that converts future amount (e.g., cash flows or income
and expenses) into a single current discounted amount. The fair value measurement is determined on
the basis of the value indicated by current market expectations about those future amounts.
 Market approach – is a valuation technique that uses prices and other relevant information
generated by market transactions involving identical or comparable assets, liabilities, or a group of
assets and liabilities, such as business.
 Input – refers to the assumptions that market participants would use when pricing the asset or
liability, including the assumption about risk inherent in a particular valuation technique used to
measure fair value, such as pricing model and the risk inherent in the input to the valuation
technique. Inputs may be observable or non-observable
 Non-performance risk – is the risk that an entity will not fulfill an obligation. It includes, but not
limited to, an entity’s own credit risk. It is assumed to be the same before and after the transfer of
the liability.
 Merger and Acquisitions (PFRS 3)
 Under paragraph 4 of PFRS 3, the required method of accounting for business combination is the
acquisition method. Under the acquisition method, all assets and liabilities are identified and
reported at their fair values the general approach to accounting business combinations is a five
step process: (a) Identify the acquirer; (b) Determine the acquisition date; (c) Calculate the fair
value of the purchase consideration transferred (i.e., the cost of purchase); (d) Recognize and
measure the identifiable assets and liabilities of the business; and (e) Recognize and measure
either goodwill or a gain from a bargain purchase, if either exists in the transaction.
 Calculating the Fair Value of consideration Transferred
 According to IFRS 3, the consideration transferred is measured at fair value at acquisition date
and is calculated as the sum of the acquisition date fair values of:
 1. the assets transferred by the acquirer;
 2. the liabilities incurred by the acquirer to former owners of the acquire; and
 3. the equity interest issued by the acquirer.
 The consideration transferred to the acquirer includes the following items:
 1. Cash or Other Monetary Assets. The fair value is the amount of cash or cash equivalent dispersed.
The amount is usually readily determinable. One problem that may occur arises when the settlement
is deferred to a time after the acquisition date. For deferred payment, the fair value to the acquirer
is the amount the entity would have to borrow to settle the debt immediately (i.e., the present
value of the obligation). Hence, the discount rate used is the entity’s incremental borrowing rate.
 2. Non-monetary Assets. Non-monetary assets are assets such as property, plant and equipment,
investments, licenses and patents. As noted earlier, if active second-hand market exists, fair values
can be obtained by reference to those markets. The items sold in the market may be exactly the
same as the item being exchanged in business combination, and an estimate of fair value for the
specific item may have to be made. Where active markets don not exist, other means of valuation may
be used. In this case , the acquirer is in effect selling the non-monetary asset to the acquire. Thus, it is
earning an income equal to the fair value on the sale of the asset.
 3. Equity instruments. If an acquirer issues its own shares as consideration, it needs to determine the
fair value of those shares at acquisition date. For listed entities, reference is made to the quoted
prices of the shares.
 4. Liabilities Undertaken. The fair values of liabilities are best measured by
the present values of expected future cash outflows. Future losses or other
costs expected to be incurred as a result of the combination are not liabilities
of the acquirer and are therefore not included in the calculation of the fair
value of consideration paid.
 5. Contingent Consideration. The contingent consideration may include the
distribution cash or other assets or the issuance of debt or equity securities.
PFRS 3 defines contingent consideration as an obligation of the acquirer to
transfer additional assets or equity interests to the former owners of an
acquire as part of the exchange for control of the acquire if specified under
future events occur or conditions are met.