Reading 76: Alternative Investments -LOS n～ Q1-3

1.Approaches commonly used in the valuation of closely held companies include all of the following EXCEPT the:

A)   fundamental value approach.

B)   comparables approach.

C)   cost approach.

D)   income approach.

The correct answer was A)

The cost approach, comparables approach, and the income approach are all used in the valuation of closely held companies. The fundamental value approach is a fictitious approach.

2.Regarding closely held companies, the valuation adjustment, due to the lack of a public market for the shares, is called a:

A)   marketability premium.

B)   minority discount.

C)   marketability discount.

D)   control premium.

The correct answer was C)

A minority discount would be applied to shares that represent a non-controlling minority interest in a company. A control premium would be added to reflect a shareholder’s ability to influence corporate policy. Shares of closely held companies are not publicly traded, so the shares should be discounted an appropriate amount to reflect this lack of marketability.

3.Which of the following is a disadvantage to using the comparables approach to valuing investments in closely held companies?

A)   The benchmark value used may be mispriced or difficult to establish.

B)   It is difficult to determine the appropriate discount rate.

C)   Estimates of future income may be inaccurate.

D)   Cost to replace assets may not reflect current value.

The correct answer was A)

A discount rate and an estimate of future income are both variables used in the income approach. The cost to replace a company’s asset is a factor when using the cost approach. The benchmark value used in the comparable may be mispriced or difficult to establish if no comparable companies have been sold recently.