CHAPTER 2

ASSET-BASED
VALUATION
Mr. De Guzman
ASSET-BASED VALUATION
• Asset has been defined by the industry as transactions that would
yield future economic benefits as a result of past transactions. Hence,
the value of investment opportunities is highly dependent on the
value that the asset will generate from now until the future.
• In practice, valuation is a sensitive and confidential activity in their
portfolio management. Valuation should be kept confidential to allow
the company to negotiate a better position for them to acquire an
opportunity.
ASSET-BASED VALUATION
• Green field investments are investments that started from scratch.
• Value shall be based on pure estimates.
• Brown field investments are those already in the going concern state,
as most businesses are in the optimistic perspective that they will
grow in the future.
• Opportunities that can be either partially or fully operational.
• Considered as going concern business opportunities (GCBO)
ASSET-BASED VALUATION
• Going Concern Business Opportunities (GCBOs)
• These are the businesses that has a long term to infinite operational
period. The risk indicators of GCBOs are identified easily and can be
quantified accordingly.
• The Committee of Sponsoring Organization of the Treadway
Commission (COSO) suggests that risk management principles must
be observed in doing businesses and determining its value.
ASSET-BASED VALUATION
Sound Enterprise-wide Risk Management allows the company to:
• Increase the opportunities;
• Facilitates the management and identification of the risk factors that
affect the business;
• Identify or create cost-efficient opportunities;
• Manages the performance variability;
• Improve management and distribution of resources across the
enterprise;
• Make the business more resilient to abrupt changes.
ASSET-BASED VALUATION
• Since the entire company is driven by its asset base, the value of the
company can be best attributed to the value of assets.
• In asset-based valuation, familiarity with the generally accepted
accounting principles is a key attribute for an analyst to enable them
to establish the value.
• Among the popular method used to determine the value using assets
as its bases are: (1) book value method; (2) replacement value
method; (3) reproduction value method; and (4) liquidation value
method.
BOOK VALUE METHOD
• Book value can be defined as the value recorded in the accounting
records of the company.
• Book value is highly dependent on the value of the assets as declared
in the audited financial statements, particularly the balance sheet or
the statement of financial position.
• IAS no.1 requires that the statement of financial position to
summarize the total value of its assets, liabilities and equity of a firm.
BOOK VALUE METHOD
• Assets are required to be categorized into current and non- current.
• Liabilities is also categorized as current and non-current.
• Book value method – the value of the enterprise is based on the
book value of the assets less non-equity claims against it.
• Formula:
BOOK VALUE METHOD

• Illustration: Golden Crown Corp. in the year 2021 presented their

statement of financial position with the following balances: Current
Assets – P500 Million; Non-current Assets – P1 billion; Current
Liabilities – P200 Million; Non-current Liabilities - P700 Million and
the Outstanding shares is 1 Million.
BOOK VALUE METHOD
REPLACEMENT VALUE METHOD
• Replacement cost – the cost of similar assets that have the nearest
equivalent value as of the valuation date.(National Association of
Valuators and Analysts)
• Replacement value method the value of the individual assets shall be
adjusted to reflect the relative value or cost equivalent to replace that
asset
REPLACEMENT VALUE METHOD
• Factors that can affect the replacement value of an asset:
• Age of the asset – enable thevaluator to determine the costs
related in order to upkeep a similarly aged asset and whether assets
with similar engineering design are still available in the market.
• Size of the asset – is important for fixed assets particularly real
property where assets of the similar size will be compared.
• Competitive advantage assets which have distinct characteristics are
hard to replace However, the characteristics and capabilities of the
distinct asset might be found in similar, separate assets
REPLACEMENT VALUE METHOD
• Formula:
𝑵𝒆𝒕 𝑩𝒐𝒐𝒌 𝑽𝒂𝒍𝒖𝒆 ± 𝒓𝒆𝒑𝒍𝒂𝒄𝒆𝒎𝒆𝒏𝒕 𝒂𝒅𝒋𝒖𝒔𝒕𝒎𝒆𝒏𝒕
𝑹𝒆𝒑𝒍𝒂𝒄𝒆𝒎𝒆𝒏𝒕 𝑽𝒂𝒍𝒖𝒆 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆 =
𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑶𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝑺𝒉𝒂𝒓𝒆𝒔

• Illustration: Following through the given information for Golden

Crown Corp., suppose that 50% of the non- current assets has an
estimated replacement value of 150% of its recorded net book value
while the remaining half has a estimated replacement value of 75%
of their recorded net book value. With the given information, the
equity value is adjusted:
REPLACEMENT VALUE METHOD
1. Calculate the replacement value of the affected items.
REPLACEMENT VALUE METHOD
1. Calculate the replacement value of the affected items.
REPLACEMENT VALUE METHOD
1. Calculate the replacement value of the affected items.
REPLACEMENT VALUE METHOD
2. Add back the unadjusted components

3. Apply the Replacement Value Formula

REPRODUCTION VALUE METHOD
• Reproduction value is an estimate of cost of reproducing, creating,
developing or manufacturing a similar asset.
• Reproduction value method requires reproduction cost analysis
which is internally done by companies especially if the assets are
internally developed.
• this method is useful in calculating the value of new start- up
businesses, ventures that use specialized equipment or assets, firms
that are heavily dependent on intangible assets and those with
limited market information.
REPRODUCTION VALUE METHOD
• Steps in determining the equity value using the reproduction value
method are as follows:
• Conduct reproduction costs analysis on all assets
• Adjust the book valuesto reproduction costs values (similar
as replacement value)
• Apply the replacementvalue formula using the figures calculated
in the preceding step
REPRODUCTION VALUE METHOD
• Illustration: Using the information of Golden Crown Corp., supposed
that it was noted that the 80% of the total non-current assets are
cheaper by 10% of the book value when reproduced. 20% of the total
non-current assets are comprised of goodwill which upon testing was
proven to be valued correctly.
REPRODUCTION VALUE METHOD
1. Conduct reproduction cost analysis to all assets
80% of the Total Non-current Assets if reproduced is equal to 90% of
its value

• Since the remaining 20% or P200 million is Goodwill and already in

its proper value, it will not be adjusted.
REPRODUCTION VALUE METHOD
2. Adjust the book value to reproduction costs
• 80% of the Total Non-current Assets if reproduced is equal to 90% of
its value
REPRODUCTION VALUE METHOD
3. Apply the replacement value formula using the figures calculated in
the preceding step
LIQUIDATION VALUE METHOD
• Liquidation value refers to the value of a company if it were dissolved
and its assets are sold individually. (CFA Institute)
• 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
• Liquidation value method is an equity valuation approach that
considers the salvage value as the value of the asset. This assumes
that the reasonable value for the company to be purchased is the
amount which investors will realize in the end of its life or the value
of the business when it is terminated.
LIQUIDATION VALUE METHOD
• Once the business closes, synergies generated by assets working
together or by applying managerial skill to these assets are lost which
reduces firm value.
• In addition, liquidation value may continue to erode based on the
time frame available for liquidating assets.
• For example, perishable inventories should be sold immediately or
else it cannot be sold anymore.
LIQUIDATION VALUE METHOD
• Circumstances clearly dictates whether it will be appropriate to use
liquidation value or going concern value in valuation exercise. If a
business is profitable or has sustainable growth prospects, these will
normally show future cash flows which will result in firm value that is
higher than if the assets are just separately like in a liquidation.
• However, if liquidation value becomes higher compared against going
concern value, this may signal that a significant business event
transpired which makes the liquidation value more appropriate in
valuation exercise.
LIQUIDATION VALUE
• Liquidation value is the base price or the floor price for any firm
valuation exercise.
• Liquidation value should not be used to value profitable companies
as this approach does not consider growth prospects of the business.
• Liquidation prices can be difficult to obtain as these are not readily
available.
• Instead, liquidation value should be used for dying or losing
companies where liquidation is imminent to check whether profits
can still be realized upon sale of the assets owned.
SITUATIONS TO CONSIDER
LIQUIDATION VALUE
• a. Business Failures – low or negative returns are signs of business
failures that is why it is the common or usual reason why a certain
business closes or liquidates.
• Types of Business Failures
• Insolvency, when a company cannot pay liabilities as they become
due.
• Bankruptcy, when liabilities become greater than an asset balance.
SITUATIONS TO CONSIDER
LIQUIDATION VALUE
• Factors causing Business Failures
• Internal Factors – can come from mismanagement, poor financial
evaluation and decisions, failure to execute strategic plans,
inadequate cash flow planning or failure to manage working capital.
• External Factors – are severe economic downturn, occurrence of
natural calamities or pandemic, changing customer preferences, and
adverse governmental regulations.
SITUATIONS TO CONSIDER
LIQUIDATION VALUE
• b. Corporate/Project End of Life – normally, corporations have stated
their finite life in their Articles of Incorporation. If there will be no
extension on the corporate life, the terminal value may be computed
using liquidation value.
• c. Depletion of Scarce Resources – this is most applicable to mining
and oil where availability of scarce resources influences the value of
the firm. Liquidation happens in this business when the permits or
contracts with the government expire and the operation will no
longer be allowed to execute.
GENERAL PRINCIPLES ON
LIQUIDATION VALUE
• Liquidation value is the most conservative approach among all as it is
considers the realizable value of the asset if it is sold now based on
current conditions. This captures any markdowns (or markups) that
potential buyers negotiate to buy the assets.
GENERAL PRINCIPLES ON
LIQUIDATION VALUE
• General Concepts considered in liquidation value
If the liquidation value is above income approach valuation (based on
going concern principle) and liquidation comes into consideration,
liquidation value should be used.
If the nature of the business implies limited lifetime (e.g. 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
• General Concepts considered in liquidation value
Non-operating assets should be valued by liquidation method as the
market value reduced by costs of sales 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.
Liquidation value must be used if the business continuity is dependent
on current management that will not stay.
TYPES OF LIQUIDATION
• Orderly liquidation – assets are sold strategically over an orderly
period to attract and generate the most money for the assets
• Liquidation process will expose assets for sale on the open market
with a reasonable time allowed to find a purchaser, both the buyer
and seller having knowledge of the uses and purposes to which 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.
TYPES OF LIQUIDATION
• Forced liquidation – assets are sold as quickly as possible, such as at
an auction.
• Liquidation is done immediately especially if creditors have sued or
bankruptcy is filed.
• Assets are sold in the market at the soonest time possible which
result in lower prices because of the rush sale.
• Ultimately drives down the liquidation value.
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
CALCULATING LIQUIDATION VALUE
CALCULATING LIQUIDATION VALUE
• Calculation for liquidation value at closure date is somewhat like the
book value calculation, except the value assumes a forced or orderly
liquidation of assets instead of book value.
• Book value should not be used as liquidation value.
• Liquidation value can be obtained based on the potential sales price
of the assets being sold instead of relying on the costs recorded in
the books.
• Liquidation value is far more realistic as compared to the book value
method
CALCULATING LIQUIDATION VALUE
• Liquidation value should be based on the potential earning capacity
of the individual asset when sold to the buying party instead of the
original capital invested.
• The present value of a business or property on a liquidation basis is
computed as: the estimated net proceeds should be discounted at a
rate reflects the risk involved back to the date of the original
valuation.
• Liquidation value can be used as basis for terminal cash flow in DCF
calculation in order to compute firm value in case there are years that
the firm will still be operational prior to liquidation.
CALCULATING LIQUIDATION VALUE
• Special consideration should be emphasized for intangible assets like
patents and internally developed software programs which are often
unsaleable.
• When takeovers occurs, it is usual that goodwill is recognized as part
of the transactions.
• Monetary equivalent specific for intangible assets cannot be reliably
and separately measured.
• Instead, intangible assets are offset against shareholders’ equity to
come up with conservative liquidation value
ILLUSTRATION 1
• Pearl Company below balances based on its accounting books
records. Pearl company has 250,000 outstanding shares’
• Pearl Company December 31, 2020
ILLUSTRATION 1
•Pearl Company is undergoing financial problems and management
would like to assess liquidation value as part of their strategy
formulation. If assets will be sold/realized, they will only realize amount
based on the table on the next slide.
•To compute for the adjusted value of the assets, the current book
value should be multiplied by the assumed realizable value if they are
liquidated. Next, the liabilities should be deducted from the asset
adjusted value to arrive at the liquidation value (or net asset Value).
ILLUSTRATION 1
ILLUSTRATION 1

Asset Adjusted Value P5,605,000

Less: Total liabilities to be settled 2,000,000
Liquidation value - Pearl Company 3,605,000
Number of Outstanding shares 250,000
Liquidation value per share 14.42
ILLUSTRATION 2
• Golden Company, which is a company specifically created for a
venture agreement to extract gold, will end its corporate life in 3
years. Net Cash Flow expected during the years it still operate is at
P3,000,000 per year. At the end of its life. Golden estimates to incur
P10,000,000 for closure and rehabilitation costs for its mining site
and other costs related to the liquidation process. Cost of capital is
set at 10%. Remaining assets by end of the corporate life will be
bought by another company for P30,000,000 and remaining debt of
P4,000,000 will be fully paid off by then. If the valuation happens
now, compute for the value of Golden Company.
ILLUSTRATION 2
•Since Golden Company will terminate its life after 3 years, it is more
appropriate to use liquidation value as terminal value input to the
DCF model. For the three years prior to the closure, Golden Company
will continue to generate positive Net Cash Flow and this will form
part of its value.
ILLUSTRATION 2
Present Value (PV) of Cash Inflows during Years in Operation
Formula: PV factor of 1 = (1 +i)-n
PV Of annual Net Cash flow = Net Cash Flow X PV Factor of 10%
PV of Net Cash Flow (year 1) = P3,000,000 x 0.909091 = P2,727,273
PV of Net Cash Flow (year 2) = P3,000,000 x 0.826446 =
P2,479,338 PV of Net Cash Flow (year 3) = P3,000,000 x 0.751315
= P2,253,945
PV of Cash inflow during Years in Operation = PV of NCF (Year 1) + PV of
NCF (Year 2) + PV of NCF (Year 3)
PV of Cash Inflows during Years in Operation = P2,727,273 + P2,479,338
+ P2,253,945
PV of Cash Inflows during Years in Operations = P7,460,556
CALCULATING LIQUIDATION VALUE
ILLUSTRATION 2
• Since corporate life ends by Year 3, terminal value will be based on
the liquidation value by end of Year 3.
ILLUSTRATION 2
• Cash flows during the remaining operating life and liquidation value
by end of year 3 should be combined to arrive at the value of Golden
Company now.
• Value of Golden Company = PV of Cash Inflows during years in
Operation + Liquidation Value
• Value of Golden Company = P7,460,556 + P12,021,040
• Value of Golden company = P19,481,596
ILLUSTRATION 3
•Diamond Company’s statement of financial position revealed total
assets of P3 million, total liabilities of P1 million, and 100,000 shares of
outstanding ordinary shares. Upon checking with potential buyers, the
assets of Diamond can be sold for P1.8 million if sold today. Additional
P300,000 will also be incurred to cover liquidation expenses. How
much is the liquidation value of Diamond Company per share?
•To compute for the liquidation value in this example, we need to
consider how much the company will receive from the assets if it will
sell today. This money will also be used to pay for the remaining
liabilities and liquidation expenses.
ILLUSTRATION 3
•Liquidation Value = Sale of Assets upon Liquidation – Payment for
Liabilities – Liquidation costs
•Liquidation Value = P1,800,000 – P1,000,000 – P300,000
•Liquidation Value = P500,000
•Liquidation Value per Share = Liquidation Value / Number of
Outstanding Ordinary shares
•Liquidation Value per share = P500,000 / 100,000
•Liquidation Value per share = P5.00 per share