Liquidation Based

Valuation
Ms. Retchie Jasper Dangeros-Lorenzo, CPA, MBA
• Liquidation Value
• Situations to consider Liquidation
OUTLINE
Value
• Types of Liquidation
• Calculating Liquidation Value
LIQUIDATION BASED VALUATION

For most companies, the value generated by assets working together and by
human capital applied to managing those assets makes estimated going-
concern value greater than liquidation value.

However, if there will be circumstances that occur which doubts the going-
concern ability of a business, using going-concern value may not be
appropriate anymore as the future cash flows will not be realizable anymore.

An alternative approach is the use of liquidation value.

LIQUIDATION VALUATION

According to the CFA Institutes, liquidation value refers to the value of a

company if it were dissolved and its assets are sold individually. Liquidation
value represents the net amount that can be gathered if the business is shut
down and its assets are sold piecemeal.

In some texts, liquidation value is also known as net asset value.

LIQUIDATION VALUATION

For example, for the case of hotel closes, the assets it owns like beds, chairs,
furniture, and kitchen equipment can be sold as part of a package or separately.
These assets are priced based on the value it can fetch if buyers buy these
assets separately. If these assets will be sold separately, there is no guarantee
that they can generate future cash flows anymore as it once did when it was used
in the hotel.

Hence, the value is significantly reduced to its liquidation value.

LIQUIDATION VALUATION

Once a business closes, synergies generated by assets working together or by

applying managerial skill to these assets are lost which reduces firm value. In
addition, liquidation value may continue to erode based on the time frame
available for liquidating assets.

For example, perishable inventories should be sold immediately or else it cannot

be sold anymore if it gets spoiled. Business cannot afford to wait for potential
buyers that are willing to pay higher price. The most appropriate choice is to sell
it at a discount to recover some money from it instead of throwing it away without
recovering any money. Business can wait longer period to sell other assets like
building or machineries unless there are other constraints that will require them to
be disposed in a short time.
LIQUIDATION VALUATION

Circumstances clearly dictates whether it will be appropriate to use liquidation

value or goin-concern value in a valuation exercise. If a business is profitable or
has sustainable growth prospects, these will normally show future cash flows
which will result in firm value that is higher that if the assets are just separately in
a liquidation.

However, if liquidation value becomes higher compared against going-concern

value, this may signal that a significant business event transpired which makes
the liquidation value more appropriate in valuation exercise.
LIQUIDATION VALUATION

Liquidation value is the base price of the floor price for any firm valuation
exercise.

Liquidation value should not be used to value profitable or growing companies as

this approach does not consider growth prospects of the business. Liquidation
prices can be difficult to obtain as these are not readily available. Instead,
liquidation value should be used for dying or losing companies where liquidation
is imminent to check whether profits can still be realized upon sale of the assets
owned.
LIQUIDATION VALUATION

A unique callout for liquidation value is if the firm is operating under a

proprietorship or a partnership model. In these two forms of organization, profits
and cash flows are highly dependent on the skills, knowledge, ability of network
of the owner or partners.

As a result, liquidation value should consider valuing separately the goodwill

attributed to these partner-specific qualities as this may not reflect the true value
of the assets which will be sold of transferred. In this scenario where liquidation is
the motive, goodwill will reduce liquidation value.
SITUATIONS TO CONSIDER LIQUIDATION VALUE

1) BUSINESS FAILUES

Business failure is the most common reason why businesses close or liquidate.
Early symptoms of business failure are low or negative returns. Companies which
consistently report operating losses will eventually impact and reduce firm value.
If the firm only earns return at a rate lower than its cost of capital, this might
signal business failure. When left unresolved, this may lead to insolvency or even
bankruptcy.
SITUATIONS TO CONSIDER LIQUIDATION VALUE

1) BUSINESS FAILUES

Insolvency happens when a company cannot pay liabilities as they come due.
Insolvent firms have asset balance which is still greater than liabilities but is
having liquidity problems as a result of depleted cash. Bankruptcy is the most
serious type of business failure as this happens when liabilities become greater
than asset balance. As a result, shareholders' equity becomes negative balance.
This signifies that the firm cannot settle all its liabilities unless the assets can be
sold at a higher price than its book value (which is not often the case).
SITUATIONS TO CONSIDER LIQUIDATION VALUE

1) BUSINESS FAILUES

Business failures can be driven by different internal factors:

• mismanagement
• poor financial evaluation and decisions
• failure to execute strategic plans
• inadequate cash flow planning
• failure to manage working capital
SITUATIONS TO CONSIDER LIQUIDATION VALUE

1) BUSINESS FAILUES

The external factors that would attribute to business failure may the form of, but
not limited to the following:
• severe economic down-turn
• dynamic consumer preferences
• material adverse governmental action or regulation
• occurrence of natural disasters or calamities
• occurence of pandemic or general health hazards
SITUATIONS TO CONSIDER LIQUIDATION VALUE

1) BUSINESS FAILUES

Liquidation value can be used for businesses which are closing, are closed, are in
bankruptcy, are in industries that are irreversible trouble, or going concern firms
that isn't putting its assets to good use and may be better off closing down and
selling the assets. For distressed companies, the liquidation value conveys
relevant information as it typically the lower bound of the valuation range.
SITUATIONS TO CONSIDER LIQUIDATION VALUE

2) CORPORATE OR PROJECT END OF LIFE

Most companies only have finite number of years to operate as state in their
Articles of Incorporation. This is also similar in the case of projects like joint
ventures with finite life. Once the date arrives and life is not extended, due
process takes place to end the life of the corporation and start the liquidation
process. Non-extension of corporate life may stem from collective decision of
shareholders to stop the operation and realize value from liquidating the company
instead. If corporate end of life is already certain, it is more appropriate to
compute terminal value using liquidation value.
SITUATIONS TO CONSIDER LIQUIDATION VALUE

3) DEPLETION OF SCARCE RESOURCES

In some industries like mining and oil, availability of scarce resources significantly
influences firm value. Oftentimes, there are also industries that are highly
regulated by the government. Government regulation often requires that
companies seek approval from the government prior to commencement of
operations. Once the contract with the government expires or scarce resource
become fully depleted and no new site is prepared to support operation, this
might signal potential liquidation and valuation should be based on liquidation
value.
GENERAL PRINCIPLES ON LIQUIDATION VALUE

Liquidation value is the most conservative valuation approach among all as it

considers the realizable value of the asset if it is sold now based on current
conditions. This captures any markdowns (or markups) that potential buyers
negotiate to buy the assets.
GENERAL PRINCIPLES ON LIQUIDATION VALUE

GENERAL CONCEPTS CONSIDERED IN LIQUIDATION:

• If the liquidation value is above income approach valuation (based on going-
concern principle) and liquidation comes into consideration, liquidation value
should be used.
• If the nature of the business implies limited lifetime (e.g. a 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.
GENERAL PRINCIPLES ON LIQUIDATION VALUE

GENERAL CONCEPTS CONSIDERED IN LIQUIDATION:

• Non-operating assets should be valued by liquidation method as the market
value is reduced by costs of sale 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.
• Liquidation valuation must be used if the business continuity is dependent on
current management that will not stay.
GENERAL PRINCIPLES ON LIQUIDATION VALUE

Liquidation value method can also be used as benchmark in making investment

decisions. When a company is profitable with good industry outlook, the
liquidation will typically be lower than the prevailing market price of the share.
Share price often reflects growth prospects of the company which is a
consideration that liquidatin value does not have.
GENERAL PRINCIPLES ON LIQUIDATION VALUE

For firms that are experiencing decline or industry is consistently declining,

prevailing share prices might be lower than liquidation value. If this happens, the
rational decision for the business is to permanently close the business and
liquidate its assets. Some corporate investors tend to look for companies whose
shares exhibit this characteristic. Because liquidation value is higher than market
price of share, these corporate investors but the share at prevailing market price
and sell the company at the higher liquidation value. This results in risk-free
arbitrage profit for these corporate investors.
GENERAL PRINCIPLES ON LIQUIDATION VALUE

However, if the company can be readily liquidated any time, market price per
share should never be below book value per share if all reported assets in the
balance sheet is accurate.
TYPES OF LIQUIDATION

Determining the type of liquidation that will occur is important because it will
affect the costs connected with liquidation of the property, including commissins
for those facilitating the liquidation (lawyers, accountants, auditors) and taxes at
the end of the transaction. These necessary expenses affect the final value of the
business.
TYPES OF LIQUIDATION

Assets are sold strategically over an orderly period to attract and generate the
most money for the assets is known as an orderly liquidation.

This liquidation process will expose assets for sale on the open market, with a
reasonable time allowed to find a purchaser, both buyer and seller having
knowledge of the uses and purposes to which the asset is adapted and for which
it is capable of being used, the seller being compelled to sell and the buyer being
willing, but not compelled, to buy.
TYPES OF LIQUIDATION

Liquidation process, at which the asset or assets are sold as quickly as possible,
such as at an auction. This is known as forced liquidation.

Liquidation is done immediately especially if creditors have sued or a bankruptcy

is filed. Assets are sold in the market at the soonest time possible which result in
lower prices because of the rush sale. This ultimately drives down liquidation
value.
CALCULATING LIQUIDATION VALUE

The liquidation value considers the present value of the sums that can be
obtained through the disposal (i.e. sale) of the assets of the firm in the most
appropriate way, net of the sums set aside for the closure costs, repayment of the
debts and settlement of all liabilities, and net of the tax charges related to the
transaction and the costs of the process of liquidation itself,
CALCULATING LIQUIDATION VALUE

Liquidation value can further computed on a per share basis by dividing total
liquidation value by outstanding ordinary shares. Liquidation value per share
should be considered together with other quantities (e.g. current share price,
going concern DCF) and qualitative metrics to justify business decisions to be
made.
CALCULATING LIQUIDATION VALUE

Present Value of Sale of Asset Php xxx.xx

Less: Present Value of Cost for Termination
and settlement for Liabilities ( xxx.xx)
Less: Present Value of Tax Charges for the
Transactions and Other Liquidation Costs ( xxx.xx)
Liquidation Value Php xxx.xx
CALCULATING LIQUIDATION VALUE

Calculation for liquidation value at closure date is somewhat like the book value
calculation, except the value assumes a forced or orderly liquidation of assets
instead of book value. Book value should not be used as liquidation value.
Liquidation value can be obtained based on the potential sales price of the assets
being sold instead of relying on the costs recorded in the books. Liquidation value
is far more realistic as compared to the book value method. Even if these assets
generate lower than expected return in the present business, liquidation value
should be based on the potential earning capacity of the individual asset when
sold to the buying party instead of the original capital invested in the assets.
CALCULATING LIQUIDATION VALUE

In practice, the liabilities of the business are deducted from the liquidation value
of the assets at closure to determine the liquidation value of the business. The
overall value of a business that uses this method should be lower than going-
concern value.
CALCULATING LIQUIDATION VALUE

In computing for the present value of a business or property on a liquidation

basis, the estimated net proceeds should be discounted at a rate that reflects the
risk involved back to the date of the original valuation. This is important to ensure
that all assumptions are aligned. Liquidation value can be used as basis for
terminal cash flow (instead of going concern terminal cash flow) in Discounted
Cash Flow calculation in order to compute firm value in case there are years that
the firm will still be operational prior to liquidation.
CALCULATING LIQUIDATION VALUE

Special consideration should be emphasized for intangible assets like patents

and internally developed software programs which are often unsaleable. When
takeover occurs, it is usual that goodwill is recognized as part of the transaction.
Monetary equivalent specific for intangible assets cannot be reliably and
separately measured. Instead, intangible assets are offset against shareholder's
equity to come up with a conservative liquidation value.

Estimation of liquidation values will be more complex if assets cannot be easily

identified or separated; hence, individual valuation may be impractical.
Illustrative Example 1:

Pavement Company reported below balances based on its accounting books records. Pavement Company has 250,000
outstanding shares.

PAVEMENT COMPANY
December 31, 2019
(in ‘000 Philippine Pesos) Pavement Company is undergoing financial
problems and management would like to
ASSETS
assess liquidation value as part of their
Cash 100,000
strategy formulation. If assets will be
Accounts Receivable (A/R) – Net 800,000
Inventories 3,500,000 sold/realized, they will only realize amount
Prepaid Expenses 100,000 based on table.
Property, Plant, and Equipment – Net 4,500,000
Total Assets 9,000,000

LIABILITIES
Notes Payable 1,200,000
Other Liabilities 800,000
Total Liabilities 2,000,000
Asset Valued At:
Cash 100%

A/R – Net 85%

Inventories 60%
Prepaid 25%
Expenses
PPE – Net 60%
ILLUSTRATIVE EXAMPLE 2

Golda company, which is a company specifically created for a joint venture agreement
to extract gold, will ends its corporate life in 3 years. Net Cash Flow expected during the
years it still operate is at Php 3,000,000 per year. At the end of its life, Golda estimates
to incur Php 10,000,000 for closure and rehabilitation costs for its mining site and other
costs related to the liquidation process. Cost of capital is set at 10%. Remaining assets
by end of the corporate life will be bought by another company Php 30,000,000 and
remaining debt of Php 4,000,000 will be fully paid off by then. If the valuation happens
now, compute for the value of Golda Company.

Since Gold Company will terminate its life after 3 years, it is more appropriate to use
liquidation value as terminal value input to the DCF model. For the three years prior to
the closure, Golda Company will continue to generate positive Net Cash Flow and this
will form part of its value.
ILLUSTRATIVE EXAMPLE 2

Present Value of Cash Inflows during Years in Operation

PV of Annual Net Cash Flow = Net Cash Flow x PV Factors of 10%

PV of Net Cash Flow (Year 1) = Php 3,000,000 x 0.9091 = Php 2,727, 273
PV of Net Cash Flow (Year 2) = Php 3,000,000 x 0.8264 = Php 2,479,339
PV of Net Cash Flow (Year 3) = Php 3,000,000 x 0.7513 = Php 2,253,944

PV of Cash Inflows during Years in Operation = PV of NCF (Year 1) + PV of NCF (Year

2) + PV of NCF (Year 3)
PV of Cash Inflows during Years in Operation = Php 2,727, 273 + Php 2,479,339 + Php
2,253,944
PV of Cash Inflows during Years in Operation = Php 7,460,556
ILLUSTRATIVE EXAMPLE 2

Since corporate life ends by Year 3, terminal value will be based on the liquidation value
of Year 3

Present Value of Sale of Asset Php 22,539,000

(Php 30,000,000 x 0.7513)
Less: Present Value of Cost for termination and
settlement for liabilities
(Php 10,000,000 x 0.7513) Php 7,513,000
Less: Present Value of Tax Charges for the
Transactions and Other Liquidation Costs
(Php 4,000,000 x 0.7513) Php 3,005,200
Liquidation Value Php 12,020,800
ILLUSTRATIVE EXAMPLE 2

Cash flows during the remaining operating life and liquidation value by end of Year 3
should be combined to arrive at the value of Golda Company now

Value of Golda Company = PV of Cash Inflows during Years in Operation + Liquidation

Value
Value of Golda Company = Php 7,460,556 + Php 12,021,037
Value of Gold Company = Php 19,481,593
ILLUSTRATIVE EXAMPLE 3

Droid Company's balance sheet revealed total assets of Php 3 million, total liabilities of
Php 1 million, and 100,000 shares of outstanding ordinary shares. Upon checking with
potential buyers, the assets of Droid can be sold for Php 1.8 million if sold today.
Additional Php 300,000 will also be incurred to cover liquidation expenses. How much is
the liquidation value of Droid Company per share?

To compute for the liquidation value in this example, we need to consider how much the
company will receive from the assets if it will sell today. This money will also be used to
pay for the remaining liabilities and liquidation expenses.
ILLUSTRATIVE EXAMPLE 3

Liquidation Value = Sale of Assets upon Liquidation - Payment for Liabilities -

Liquidation Costs
Liquidation Value = Php 1,800,000 - Php 1,000,000 - Php 300,000
Liquidation Value = Php 500,000

Liquidation Value per Share = Liquidation Value / Number of Outstanding Ordinary

Shares
Liquidation Value per Share = Php 500,000/100,000 shares
Liquidation Value per Share = Php 5.00 per share
SUMMARY

Liquidation Value refers to the value of a company if it were dissolved and its assets
sold individually. Liquidation value represents the net amount that can be gathered if the
business is shut down and its assets are sold piecemeal. Liquidation value is
considered as the minimum or floor value for any firm valuation exercise. Liquidation
value is the most conservative valuation approach among all as it considers the
realizable value of the asset if it is sold now based on current condiations.
SUMMARY

Liquidation value is appropriate in the cases of business failures, end of life of the
business of project and depletion of scarce resources.

Liquidation value should be used:

• When liquidation value is greater than going concern value
• When business has finite life
• To value non-operating assets
• If business continuity is dependent on current management who will not stay
SUMMARY

The liquidation value considers the present value of the sums that can be obtained
through the disposal (i.e. sale) of the assets of the firm in the most appropriate way, net
of the sums aside from the closure costs, repayment of the debts and settlement of all
liabilities, and net of the tax charges related to the transaction and the costs of the
process of liquidation itself.
SUMMARY

For better appreciation of shareholders, liquidation value can be divided by the number
of outstanding ordinary shares to arrive at the liquidation value per share. Liquidation
value per share should typically always below market price per share in times of
profitable operations. If liquidation value per share exceeds market price, this might
signal significant downturn for the business
REFERENCE

Valuation Concepts and Methodologies by Lascano, Baron, and Cachero (2021 edition)