Fair value basics Example 1 – asset or liability attributes

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Fair value basics

Example 1 – asset or liability attributes

The Big Land Acquisition Company (BLAC) has a piece of agricultural machinery that is 10 years old.  The machinery is located in Illinois and BLAC intends to sell the machinery in its principal market, which includes the state of Ohio.  The machinery has not been utilized for several years and, therefore, BLAC needs to get it reconditioned, which will cost $100,000.  The equipment will also need to be transported across the three states at a cost of $10,000.  Lastly, BLAC will incur sales commissions of $30,000 in order to sell the asset.  BLAC has determined that the exit price for this asset is $400,000 (after reconditioning) based on comparable sales of identical machines in principal markets.

►    What attributes for the machinery should be identified for determining the fair value of the machinery?

►    What is the fair value amount of this asset that should be reflected in the financial statements of BLAC?

Fair value basics

Example 2 – highest and best use

The Valuation Premise Company (VPC) acquires land in a business combination.  The land is currently being developed for industrial use as a site for a manufacturing facility.  Nearby sites were recently developed for residential high-rise condominiums.

Based on recent zoning and other changes that will facilitate development for residential high-rise condominiums, VPC determines that the acquired land currently used as a site for a manufacturing facility could be developed as a site for residential use.

The fair value of the land used in the manufacturing operation, which presumes that the land would continue to be used as currently developed for industrial use, is determined to be $8 million.  The fair value of the land as a vacant site for residential use, considering the demolition and other costs necessary to convert the land to a vacant site, is determined to be $11 million.

  • What would be the fair value of the land?

Fair value basics

Example 3 – principal or most advantageous market

Car Company has 100 leased cars (same make, model and mileage) that it needs to measure at fair value for impairment purposes.  Assume Car Company has access to three markets for the leased cars or similar assets which include the dealer market, the retail market and the spare parts market.  Management’s intent is to sell to the dealer market.

Volumes and prices in the respective markets are shown in the table below:

Market Price Entity-specific volume Total market volume
Dealer $30,000 60% 15%
Retail $25,000 25% 75%
Spare parts $20,000 15% 10%
  • Which market, principal or most advantageous, should Car Company use to measure fair value?

Fair value basics

Example 4 – active and inactive markets

In 2008, Big Mortgage Investing Company (BMIC) purchased a $10 million tranche of a residential mortgage-backed security yielding 7%.  At that time, there was an active market in mortgage-backed securities and fair values were readily determinable from purchase and sales transactions facilitated by a number of large New York investment banks.

As of December 31, 2010, the market facilitated by the large New York investment banks decreased in volume by 85%, with very few transactions in the recent months.  However, at this same time, two mid-size broker/dealers located in Denver and Seattle were facilitating mortgage-backed security sales transactions in an orderly manner with volumes comparable to the that of the large New York investment banks with many recent, orderly transactions and recent published prices.

  • Since this asset is carried at fair value in the financial statements at the measurement date of December 31, 2010, how may BMIC go about determining fair value relative to activity in the markets?

Fair value basics

Example 5 – orderly transactions

A financially troubled mortgage bank located in Iowa was recently acquired by Insurance Corporation.  One of the bank’s assets was a loan on a condominium project located in South Florida that was being carried at $50 million.  The condominium project, although completed from a construction standpoint, still was 90% vacant and was in an inactive sales mode for the last 60 days.  A few days after Insurance Corporation took control of the bank, it sold the loan for the condominium to a real estate development company located in Miami, Fla., for $15 million in cash.  Insurance Corporation was trying to liquidate assets of the bank in a quick manner in order to satisfy the demands of the depositors.  The normal period in which a company would sell a condominium project in totality would be approximately one year.

  • What considerations would you have in determining whether this transaction was conducted in an orderly manner in which to determine fair value?