Question

In 500-750 words, distinguish the differences between the terms fair market value and fair value. Provide examples real world references of each term to substantiate your understanding of the concepts. Also, develop a table that summarizes the strengths and weaknesses of the four approaches to the valuation of private equity.

Answer 1

Fair Market Value :

The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge or relevant facts. It also involves direct and indirect Value the buyer will get from purchasing business.

Fair Value :

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.

Difference between fair value and Fair market value :

1.On the basis of valuation uses :

a.) uses of valuation of Fair Value :

• Shareholder and partner disputes
• Buy/Sell agreements amongst shareholders to deal with internal transfers of shares

  

uses of valuation of Fair Market Value :

• Estate, gift and inheritance transactions
• IRS filings and other transfers that are IRS controlled
• Sales of an entity at an auction or on the open market

b.) Fair market Value valuation includes discount for marketability accounts for the cost in time and money to get the business to market.

c.) The discount for lack of control accounts for minority interest impacting the amount of control the seller has over the business. When a minority interest exists, there is often lack of control over matters like salaries, distributions or entity sale.

Valuation approaches

Valuation approach	Main Methods involved	Strength	Weakness
1. Market Valuation approach	1. Public Company Comparables 2. Precedent Transactions	It is straightforward and involves simple calculations. It uses data that is real and public. It is not dependent on subjective forecasts	It is difficult to identify transactions or companies that are comparable. There is usually a lack of a sufficient number of comparable companies or transactions in case of new business segment. It is less flexible compared to other methods. The method raises questions on how much data is available and how good the data is.
2.Cost method		Simple and logical Consider factors like cost to build or cost to replace. Best suitable for capital intensive project valuation.	Very casual approach of valuation, do not consider market risk factors. Ignores current and future earning power of company.
3.Discounted cash flow method (Intrensic value approach)	Capitalization of earning method	Can value companies having uneven growth or where earning history is missing. uses elements that are generally valued by investors before investing.	High degree of estimation involved. Due to high degree of estimation professional debates may arise.