Page 56 - Bankruptcy and Reorganization Services

 Other Considerations. Listed here are some other factors to consider when evaluating the dis-
counted cash flow model under the income approach.

— Management Projections. If the projections used to perform the valuation have been pro-
vided by management, it is important for the valuation analyst to assess the reasonable-
ness of the projections. Improvements in operating performance based on cost-cutting
measures, operational restructuring, or improvements in technology should be supported
with documentation of analysis, and the expenditures required for the improvements
should also be incorporated into the forecast. In addition, when management projections
are used, management’s ability to forecast should be assessed by comparing prior fore-
casts with actual performance. The practitioner’s confidence in management’s ability to
forecast can also impact the discount rate selected, which is discussed later in this section.

— Control Versus Minority Value. If the projections reflect a continuation of present firm
operations and policies, the model may produce a control or minority interest value. If the
projections represent changes that only a controlling owner could make (for instance,
changes in the capital structure or exclusion of discretionary items), the value will repre-
sent control. In addition, a control valuation may remove discretionary expenses that are
not necessary or are unrelated to the business. The difference between control value and
minority value will be greatest when the firm has an irrational capital structure or is not
operating at an optimal level.

— Restructuring Cash Flows. In an out-of-court negotiation, there will be an agreement re-
garding the payout of the different classes of creditors. In a Chapter 11 filing, there will
be a plan of reorganization, to be confirmed in the bankruptcy court. When each of these
"plans" goes into effect, certain creditors (trade creditors) may receive an actual cash dis-
tribution. These cash outflows and other deal-closing or emergence costs need to be con-
sidered.

— Net Operating Loss Carryforwards. If the firm possesses NOLs, these may be applied to
income to offset taxes as long as the statutory period for using the NOLs has not expired
and no change of ownership, as defined in IRC Section 382, has occurred or is expected.
fn 17 To the extent that the firm is forecasted to generate negative earnings in future peri-
ods, NOLs should be accumulated and applied to the subsequent years when income gen-
erated is positive. To the extent that NOLs are remaining at the end of the projection pe-
riod and management can support the position that they will be realized in the future, the
present value of the tax benefits from the tax shield remaining should be added to the
value separately derived for the business. It is worth noting, however, that if this position
is unsupportable, a valuation allowance or complete write-off of the NOL and related
benefit may be necessary.

It is preferable to estimate the benefit of NOL utilization through a stand-alone DCF cal-
culation that is separate from the projections used for the income approach. There are
several reasons for this:

fn 17 A discussion of the statutory requirements relating to the utilization of NOLs is contained in chapter 14 of this practice aid.

54 © 2020 Association of International Certified Professional Accountants