CHAPTER 3: LIQUIDATION BASED VALUATION

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 value 
According to the CFA Institute, 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. 
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, their value is
significantly reduced to its liquidation value. 
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. Businesses 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. Businesses can wait longer period to sell other
assets like building or machineries unless they are other constraints that will require them to be disposed in a
shorter time. 
Circumstances clearly dictates whether it will be appropriate to use liquidation value or going 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 than if the assets are just separately like 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 value is the base price or 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 of login companies where liquidation is imminent to check whether
profits can still be realized upon sale of the assets owned.
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 or 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 or transferred. In this scenario where liquidation is the motive, goodwill will reduce liquidation
value. 
Situations to Consider Liquidation Value 
The below list shows circumstances wherein liquidation value will be more appropriate in valuation
exercises: 
 Business Failures 
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. 
CHAPTER 3: LIQUIDATION BASED VALUATION
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). 
Business failures can be driven by different internal factors such as mismanagement, poor financial
evaluation and decisions, failure to execute strategic plans, inadequate cash flow planning or failure to
manage working capital. These external factors that would attribute to business failure may take the form of,
but not limited to the following: 
o severe economic down-turn 
o dynamic consumer preferences 
o material adverse governmental action or regulation
o occurrence of natural disasters or calamities 
o occurrence of pandemic or general health hazards 
Liquidation value can be used for businesses which are closing, are closed, are in bankruptcy, are in
industries that are in 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 is typically the lower bound of the valuation range. 
 Corporate or Project End of Life 
Most corporations only have finite number of years to operate as stated 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. 
 Depletion of scarce resources 
In some industries like mining and oil, availability of scarce resources significantly influences firm
value. Oftentimes, these 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 concepts considered in Iiquidation value are as follows: 
 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 casts) should also be factored in ang deducted to arrive at the liquidation
value. 
 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. 
CHAPTER 3: LIQUIDATION BASED VALUATION
 Liquidation valuation must be used if the business continuity is dependent on current management that will
not stay. 
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 liquidation value does not have. 
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 buy the shares at prevailing market price and sell the company at the higher liquidation value. This
results in risk-free arbitrage profit for these corporate investors. 
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 commissions 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. 
Assets are sold strategically over an orderly period to attract and generate the most money for the assets
is known to be 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. 
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. 
Liquidation value can be 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 quantitative
(e.g. current share price, going concern DCF) and qualitative metrics to justify business decisions to be made. 
Present Value of Sale of Asset Php xxx, xxx
Less: Present Value of Cost for termination and settlement for Liabilities (xxx, xxx) 
Less: Present Value of Tax Charges for the Transactions and Other Liquidation Costs (xxx, xxx)
Liquidation Value Php Xxx, xxx
Calculation for liquidation value at closure date is somewhat like the book Value calculation, except the
value assumes a forced or orderly liquidation 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. 
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. 
CHAPTER 3: LIQUIDATION BASED VALUATION
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 a DCF calculation in order to compute firm value in
case there are years that the firm will still be operational prior to liquidation. 
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)
Assets
Cash  100,000
Accounts Receivable (A/R) - Net  800,000
Inventories   3,500,000
Prepaid Expenses 100,000
Property, Plant and Equipment (PPE) — Net  4,500,000
Total Assets  9,000,000
Notes Payable Other Liabilities Total Liabilities 
Liabilities
Notes Payable 1,200,000
Other Liabilities 800,000
Total liabilities 2,000,000
Pavement Company is undergoing financial problems and management would like to assess liquidation
value as part of their strategy formulation. If assets will be sold/realized, they will only realize amount based on
below table. 
To computed for the adjusted value of the assets, the current book values should be multiplied by the
assumed realizable value if they are liquidated. Next, the liabilities should be deducted from the asset adjusted
value to arrive at the liquidation value (or net asset value)
Asset Valued At Asset in Php Book Valued Asset Adjusted
Value At Value
Cash 100% Cash 100,000 100% 100,000
A/R – net 85% A/R – net 800,000 85% 680,000
Inventories 60% Inventories 3,500,000 60% 2,100,000
Prepaid Expenses 25% Prepaid 100,000 25% 25,000
Expenses
PPE – net 60% PPE – net 4,500,000 60% 2,700,000
Total Assets 9,000,000 5,605,000
Asset Adjusted Value Php 5,605,000
Less: Total liabilities to be settled 2,000,000
Liquidation Value — Pavement Company Php 3,605,000
Number of Outstanding Shares 250,000
Liquidation Value per Share Php 14.42 
CHAPTER 3: LIQUIDATION BASED VALUATION
Illustrative Example 2
Golda Company, which is a company specifically created for a joint venture agreement to extract gold,
will end 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 Php10,000,000 for closure ang 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 for Php 30,000,000 ang 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 Golda Company will terminate its life after 3 years, it is more appropriate to use liquidation value
as terminal value input to the DCF modal. 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. 
Present Value (PV) of Cash Inflows during Years in Operation 
PV of Annual Net Cash Flow = Net Cash Flow x PV Factor 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 + Php2,479,339 + Php 2,253,944
PV of Cash Inflows during Years in Operation = Php 7,460,556
Since corporate life ends by Year 3, terminal value will be based on the liquidation value by end of Year 3. 
Present Value of Sale of Asset (Php30,000,000 x 0.7513) Php 22,539,000
Less: Present Value of Cost for termination and settlement for Liabilities 
(Php 10,000,000 x 0.7513) 7,513,000
Less: Present Value of Tax Charges for the Transactions
and Other Liquidation Costs (Php4,000,000 x 0.7513) 3,005,200
Liquidation Value Php 12,020,800 
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 Golda Company = Php 19,481,593
Illustrative Example 3 
Droid Company’s balance sheet revealed total assets of Php3 million, total liabilities of Php1 million,
and 100,000 shares of outstanding ordinary shares. Upon checking with potential buyers, the assets of Droid can
be sold for Php1.8 million if sold today. Additional Php300,000 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. 
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 = Php500,000
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