Lesson 4 – LIQUIDATION BASED VALUATION

Unit 1 – Liquidation Value

Overview:
An alternative approach to Going Concern Based Valuation when
going-concern ability of a business is being question or doubtful is the
Liquidation Based Valuation or use of liquidation value. This chapter will discuss
the concept of this valuation and describe the situations or scenarios to consider
in this valuation.

Learning Objectives:
After successful completion of this lesson, you should be able to:
1. Identify situations that would require liquidation value.
2. Enumerate the principles to apply in liquidation valuation.

Course Materials:

Liquidation value
It is a value of a company if it were dissolved and its assets were sold
individually. It represents the net amount that can be gathered if the business is
shut down and its assets are sold in piecemeal. This is known as Net Asset
Value.

Situations to Consider Liquidation Value

a. Business Failures – low or negative returns are signs of business failures
that is why it is the most common or usual reason why a certain
business closes or liquidates.

Types of Business Failures

i. Insolvency, when a company cannot pay liabilities as they become due.
ii. Bankruptcy, when liabilities become greater than an asset balance.

Factors causing Business Failures

iii. 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.
iv. External Factors – are severe economic downturn,
occurrence of natural calamities or pandemic, changing
customer preferences, and adverse governmental
regulations.

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

1. If the liquidation value is above income approach valuation (based
on going concern principle) and liquidation comes into
consideration, liquidation value should be used.
2. 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.
3. 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.
4. Liquidation value must be used if the business continuity is
dependent on current management that will not stay.