Question

"Market-Based Evaluation Method"

Examine the usefulness and validity of the market-based valuation method.

• Explain how this method can yield the most accurate results.
• Discuss the challenges associated with using the market-based valuation method. How might analysts address those challenges?
• Evaluate the impact of information availability on market efficiency in today’s economy. Indicate whether it has a positive or negative impact on most companies. Explain your rationale.

Answer 1

Ans. The market approach is a valuation method which is used to determine the appraisal value of a business, intangible asset, business ownership interest  by considering the market prices of comparable assets or businesses that have been sold recently or those that are still available. Price-related indicators like sales, book values, and price to earnings are usually utilized. Regardless of the asset under valuation, the market approach looks at the prices of comparable assets and makes proper adjustments for different quantities, qualities, or sizes. For instance, when you want to determine the value of a share of stock, you should look at the recent selling price of shares of stock that are similar. Since ownership shares of a company are usually identical, the recent selling price of the shares will provide a good estimation of their fair value.

The following are the challenges in this approach:

1) The method raises questions on how much data is available and how good the data is.

2) 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.

3) This method is less flexible compared to other methods.

For the market approach to be successful, it is critical to ensure that all companies being used for comparison are similar to the subject company or that premiums and discounts are applied for divergent features. Moreover, the market approach can only work effectively if the number of other similar businesses to compare with is adequate. For this reason, it is difficult to assign a value to a sole proprietorship purely on the basis of market value.