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However, in other situations, an active market for the equity shares will not be available. The effect of income taxes should be considered when an intangible assets fair value is estimated as part of a business combination, an asset acquisition, or an impairment analysis. One of the primary purposes of performing the BEV analysis is to evaluate the cash flows that will be used to measure the fair value of assets acquired and liabilities assumed. (See. For example, the selling price of an asset that is sold in liquidation is not a useful indication of fair value. The fair value of the PHEI in a company that remains publicly traded should generally be based on the observable quoted market price without adjustment. The WACC tells you the overall return a company pays its investors. Calculate the NCIs proportionate share of the BEV and apply a minority interest discount. Provide an example of the consequences of inaccurately estimating WACC. In year five, net cash flow growth trended down to 3.7%, which is fairly consistent with the expected long-term growth rate of 3%. Understanding the difference between these rates provides valuable information about the economics of the transaction and the motivation behind the transaction. 2. PFI should consider tax deductible amortization and depreciation to correctly allow for the computation of after tax cash flows. The usefulness of these approaches is diminished by the requirement to limit the term of the reacquired right to the remaining contractual term. Premiums and discounts are applied to the entitys WACC or IRR to reflect the relative risk associated with the particular tangible and intangible asset categories that comprise the group of assets expected to generate the projected cash flows. The cash flows used to support the consideration transferred (adjusted as necessary to reflect market participant assumptions) should be reconcilable to the cash flows used to measure the fair value of the assets acquired. To appropriately apply this method, it is critical to develop a hypothetical royalty rate that reflects comparable comprehensive rights of use for comparable intangible assets. PwC. \begin{aligned} &WACC= \frac{E}{E+D}\cdot r+\frac{D}{E+D}\cdot q\cdot (1-t)\\ &\textbf{where:}\\ &E = \text{Equity}\\ &D = \text{Debt}\\ &r = \text{Cost of equity}\\ &q = \text{Cost of debt}\\ &t = \text{Corporate tax rate}\\ \end{aligned} The fair value of certain tangible assets (e.g., buildings, machinery, and equipment) is typically established using the market approach because there is usually available market data for sales and rentals of buildings, machinery, and equipment. In the rare instances in which a reporting entity is valuing buildings, machinery, or equipment for which there is no market or cash flow data, the depreciated replacement cost approach may be appropriate to measure fair value. The next step is to adjust the original cost for changes in price levels between the assets original in-service date and the date of the valuation to obtain its replacement cost new. Replacement cost new represents the indicated value of current labor and materials necessary to construct or acquire an asset of similar utility to the asset being measured. The discount rates selected for intangible assets in conjunction with the rates selected for other assets, including goodwill, results in a WARA of 12.1%, which approximates the comparable entity WACC and IRR of 11.5% and 12%, respectively. One of Company As product lines (Line 1) has significant new components for which there is little historical claims data as well as other components for which historical claims data is available. The WACC for comparable companies is 11.5%. These include the profit split method (in which the profits of the business are allocated to the various business functions), the return on assets method (in which returns on other assets are subtracted from the profits of the business), and the comparable profits method (in which the profitability measures of entities or business units that carry out activities similar to that provided by the intangible asset are considered). The MEEM, which is an income approach, is generally used only to measure the fair value of the primary intangible asset. Click here to extend your session to continue reading our licensed content, if not, you will be automatically logged off. Therefore, identifying market participants, developing market participant assumptions, and determining the appropriate valuation basis are critical components in developing the initial fair value measurement for defensive assets. Although goodwill is not explicitly valued by discounting residual cash flows, its implied discount rate should be reasonable, considering the facts and circumstances surrounding the transaction and the risks normally associated with realizing earnings high enough to justify investment in goodwill. Comparable utility implies similar economic satisfaction, but does not necessarily require that the substitute asset be an exact duplicate of the asset being measured. If a project's IRR is equal to its WACC, then, under all reasonable conditions, the project's NPV must be This problem has been solved! The concern with reliance on the value from the perspective of the asset holder is that assets and liabilities typically transact in different markets and therefore may have different values. Other intangible assets, such as technology-related and customer relationship intangible assets are generally assigned higher discount rates, because the projected level of future earnings is deemed to have greater risk and variability. The value of a reacquired right should generally be measured using a valuation technique consistent with an income approach. In the following$500 zero coupon bond example, there are three possible outcomes, representing different expectations of cash flow amounts. The acquirer also needs to select a discount rate to apply to the probability-weighted expected warranty claims for each year and discount them to calculate a present value. Company ABC manufactures clothing in the United States and produces shirts under a highly recognized brand name.