Business Valuation

Business Valuation. Business Valuation. Background

Frank Johnson is 55 years of age. Twenty years ago, Frank and his brother, John, founded Johnson Adhesives, Inc. (the Company). The Johnson family has always owned the business. Frank and John own 55% and 35%, of the common stock in the Company, respectively. A cousin owns the remaining 10% interest; he also works for the Company.

Johnson Adhesives manufacturers adhesives and sealants and has annual revenues of approximately $50 million. It has six manufacturing locations throughout the U.S. Frank and John are both active in daily management and in making all major decisions. Frank has a MBA degree. John has never attended college. They both have extensive experience with the Company’s products and in all aspects of the operations.

Frank and his wife, Susan, have been married for 25 years and are in the process of getting a divorce. Susan’s divorce attorney hired your boss, Maria, on behalf of his client to be an expert in the matrimonial litigation between Frank and Susan. Maria is a CPA specializing in forensic accounting and valuation.

Frank made a financial offer to Susan in an attempt to quickly settle the divorce. Frank hired Valuations R Us to value his 55% equity interest in Johnson Adhesives. That firm has completed its work and issued a report. The value of Frank’s shares—as estimated by Valuations R Us—was used by Frank in making the settlement offer. Frank’s shares are a marital asset under state law and, accordingly, the value of the shares is a component of the total marital net worth. In addition, Frank and Susan live in a state that uses fair market value as the standard of value in divorce matters. Further, the divorce law in their state says that fair market value is the same definition as used by the Internal Revenue Service for tax purposes.

Susan has told her attorney that the Company was writing off personal expenses of Frank and John (to lower taxable income and, therefore, income taxes) and both received large bonuses from the business. Susan was able to provide her attorney with the following information about the Company:[1]

Personal expenses such as vacations, meals and entertainment, country club dues, and personal automobile expenses of $500,000 per year.
The operating expenses of a private jet of $1 million per year and the jet is used for personal trips 50% of the jet’s usage.
The compensation paid to Frank and John was $750,000 per year each.
In 2007, the Company paid $1 million to settle a lawsuit brought by a former employee for an injury suffered while on the job.
Susan’s divorce attorney hired Maria to evaluate the valuation and sent a copy of valuation report prepared by Valuations R Us to your boss. Maria is a CPA specializing in forensic accounting and valuation.

Maria has also learned the following. Johnson Adhesives previously filed an election with the U.S. Internal Revenue Service to be treated as an S-Corporation. Accordingly, the corporation does not pay income taxes. Rather, the Company’s income is allocated among the shareholders who then report their portion of the business’s income on their personal income tax returns and pay taxes. In addition, Frank and John are both in good health and expect to work for at least another 10 years.

Your boss, Maria, has asked you to review the valuation of Frank’s stock as of December 31, 2009. Maria has provided you (1) the report of Valuations R Us plus Excel file containing Exhibit 2 to their report, (2) selected data from Stocks, Bonds, Bills, and Inflation – 2009 Yearbook, Valuation Edition published by Morningstar (formerly published by Ibbotson Associates), and (3) a report on the industry. In addition, she has provided you the following additional information:

•&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ; The Company’s net income is the same as its net cash flow.

•&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ; The “beta” of a large public company (BigCo) that submitted an offer to buy Johnson Adhesives one year ago is 1.1.

•&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ;&νβσπ; The median price multiples of five public companies that are most comparable to Johnson Adhesives are:


Market value of invested capital to sales


Market value of invested capital to EBITDA


Market value of invested capital to EBIT


Market value of equity to pre-tax income


Because of the circumstances, you do not have an opportunity to interview Frank Johnson or anyone else in management. You only can tell what Valuations R Us did by reading their report as you do not have an opportunity to talk with them about their report.

Your assignment:

You are a staff member at Maria’s firm. Maria asked you to critique the Valuations R Us’ report and analysis and provide an overall assessment on Valuation r Us’ conclusion as to the value of Johnson adhesives (you are not expected to provide your own valuation). Prepare a memorandum to your boss that summarizes your findings. Managers are often short on time. Accordingly, prepare your memorandum so it is concise and focuses on only the most important issues. The memorandum should be 4 – 6 pages in length and double-spaced.

As you write your memo, keep in mind that it should be persuasive. When you set up the memo, you should present the material in a deductive, persuasive format. The following will help you in format the memo assignment.

The Persuasive Structure

Within your Introduction, state the question to be resolved in the case – the key issues. You may also provide limited background material. The purpose of the background material is to provide the setting for the analysis. It is not to provide all of the facts that are pertinent to the analysis – remember who your audience is.

Following the introduction, provide your Recommendation. Be sure to present your position, and the main reasons supporting that position. These two elements make up your purpose statement and overview of your rationale. For example, your overall position might be “The valuation ignores ‘A’ and incorrectly incorporates ‘B’” or “The valuation is overstated.” This statement is your ­overall position. You then need to support it with specific reasons WHY. Each reason why is an assertion or major support. As such, each assertion and the alternatives that you considered must be discussed in more detail within your rationale. This setup establishes the paper’s unity and provides cohesion.

The Rationale provides support for the assertions contained in your overall position and discusses the alternatives. Each of the sections addressing an assertion needs to contain the argument statement that supports the overall position. In other words, be deductive. State the particular reason why you believe in your overall position and then present the facts, examples, quotes, logic to support it. Discussion of alternatives follows and includes basis for why the alternative is not recommended. The rationale ends with a concluding paragraph summarizing your overall position and the key supports (the assertions / arguments).

q The memo deliverable for this assignment should begin something like:

Date: November 15, 2006
To: Recipient’s Name

From: Your Name

Subject: Subject of memo

q A specific format for the content of the memo is not prescribed as the format varies based on the situation being analyzed. The above Persuasive Structure provides general guidelines of how to structure your memo and you are strongly encouraged to use these guidelines when completing your assignment

q Memos do not require an additional salutation (that is, “Dear Mrs. Name”) or a complimentary closing (“Sincerely yours,”) at the end.

q The memo must be individually written.

q The memo should be double-spaced, with one inch margins all the way around and a normal (12 point) font size.

q Write your memo to the audience indicated in the assignment.

q Include professional literature cites to support your arguments in the valuation report. Include cites from professional literature, academic journals, and practitioner journals, as necessary. Be careful with Internet citations.

q Use direct quotes sparingly–you are to write the memo as opposed to cutting and pasting together others’ ideas.


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Business Valuation

Business Valuation

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