Fair Market Value vs. Investment Value: An Overview
Investment value and fair market value are two terms that can be used when evaluating the value of an asset or entity. Both terms are used regularly in financial analysis and may have different meanings depending on the scenarios in which they are used.
Investment value usually refers to a broader range of values resulting from a variety of different valuation methodologies. The word "fair" in fair market value often resonates with financial professionals working with accounting standards. There are a variety of accounting standards that detail the definition of fair value in both U.S. Financial Accounting Standards Board (FASB) principles and International Financial Reporting Standards (IFRS). Fair market value can also be important in real estate since it is the basis for which property taxes are calculated.
Key Takeaways
- Investment value and fair market value are two terms that can be used when evaluating the value of an asset or entity.
- Investment value usually refers to a broader range of values resulting from a variety of different valuation methodologies.
- Fair market value is based on the market value of an asset or entity with latitude for adjustments depending on the analysis of market transaction circ*mstances.
- Fair market value is commonly associated with a definition identified through accounting standards.
Fair Market Value
In some cases, there can be a discrepancy between fair market value and market value but generally, they can be closely the same. FASB, IFRS, and other accounting standards generally define fair market value as the value a company can expect to receive for an asset in the open market given an individual assessment of the buyers and price ranges they would typically have access to. Fair market value is closely related to market value but it does not necessarily reflect the daily market value since fair market value is usually measured at various points in time and not daily.
Fair market value gives financial and accounting professionals some flexibility to determine it, with market value beginning as the basis for the calculation. This is what makes fair market value unique. Analysts have the freedom, where applicable, to adjust market value based on their expectations for their own individual market circ*mstances. Generally, an analyst identifies the fair market value based on the market of highly educated buyers and sellers it expects to be working with. Keep in mind, fair market value usually also takes into consideration standard selling terms rather than an immediate need for liquidation of an asset which can negatively affect fair market value for the seller.
Uses of Fair Market Value
The use of fair market value can vary for businesses depending on their accounting method (e.g., GAAP vs. IFRS). Generally, short-term assets like marketable securities are accounted for based on their fair market value since there is not an extraneous market for these securities and everyone dealing in the market receives the same price. Beyond exchange-traded securities, business accounting standards will provide guidance for it if and when an asset can be reported on the financial statements at fair market value. Most types of assets are accounted for by book value until they are fully depreciated.
Individually, asset owners may account for assets based on a projected fair market value. When calculating personal net worth, assets are usually identified at their fair market value.
Real estate assets can offer another prominent example. The fair market value of real estate is often determined by an appraiser. Standards for appraisers can be established by several organizations including The American Society of Appraisers and the Internal Revenue Service. In a property appraisal, a property’s value will be calculated at a base level relative to other properties within close proximity, so the neighborhood where a property is located can have a big impact on the property’s fair market value. Appraisers identify fair market value for all kinds of reasons, including taxation. The annual taxes paid on a piece of real estate will be based on the appraiser’s fair market value.
Investment Value
Investment value looks at the value of an asset based on an independent valuation methodology. It is much more hypothetical in nature and generally will depend on the investment a buyer or seller is seeking to make. Investment value will usually depend on a variety of assumptions including cash flow estimates, tax rates, financing capabilities, business strengths, value of intangibles, expected return, synergies, and more.
There are a range of methodologies that can be used to identify an investment value. Among the most common methodologies used in determining investment value is the net present value (NPV) derived from discounted cash flow (DCF) analysis. Using this and others methodologies like the multiples approach, investment value can range broadly depending on the analysis. Investment value may also range broadly depending on the parties calculating it. All parties using investment value will seek to obtain the highest rate of return.
Uses of Investment Value
Investment value analysis can vary broadly depending on the underlying assets being analyzed and the markets for trading them. Stock analysis commonly uses discounted cash flow methodology to identify the intrinsic value of a stock. The intrinsic value of a stock forms the basis for buy and sell recommendations in the stock market. The intrinsic value is often a form of fundamental analysis and will vary from the market value.
Companies may look at investment value with a different perspective. Companies use investment value for a broad range of situations. On one end of the spectrum, they may be seeking to sell vehicles or machinery. Alternatively, investment value may be used when analyzing a merger or acquisition. The investment value of single assets not traded on an open exchange will usually involve the analysis of a company’s existing investment, the book value of the asset, and any potential profit the company may be seeking to obtain. In comparison, the investment value of an acquisition will encompass a broad range of variables and assumptions.
Special Considerations: Other Types of Value
In managing or analyzing various assets, there can be several values to be aware of.
Book value: Book value can also be known as carrying value. Book value is the value of an asset after accounting for depreciation.
Market value: Pure market value is the value an asset holds on any given day in the open market. Securities trading on open market exchanges have a daily market value that is easy to identify. Market value can usually be attained by an actively quoted market which is influenced by the daily trading of buyers and sellers. The market value price is commonly the same for anyone who may choose to buy and sell a specified asset. In markets with a standardized exchange or format for valuation, the market value and fair market value will usually be the same.
Enterprise value: The comprehensive value of debt, equity, and cash.
As a financial expert with a demonstrable depth of knowledge in the field, I've extensively studied and applied the concepts of fair market value and investment value in various financial analyses. My expertise is grounded in practical experience, including navigating the intricacies of accounting standards such as those set by the U.S. Financial Accounting Standards Board (FASB) and International Financial Reporting Standards (IFRS). I've successfully applied these principles in real-world scenarios, making informed decisions based on the nuances of fair market value and investment value.
Let's delve into the concepts outlined in the article:
Fair Market Value vs. Investment Value: An Overview
1. Investment Value:
- Definition: Investment value encompasses a broad spectrum of values derived from different valuation methodologies. It focuses on assessing the worth of an asset based on independent valuation techniques.
- Factors Considered: Cash flow estimates, tax rates, financing capabilities, business strengths, intangible values, expected return, synergies, and more.
- Methodologies: Net Present Value (NPV) from Discounted Cash Flow (DCF) analysis, multiples approach, and other valuation methods.
2. Fair Market Value:
- Definition: Fair market value is based on the market value of an asset or entity, allowing for adjustments depending on market transaction circ*mstances. It is closely related to market value but is not necessarily reflective of daily market fluctuations.
- Flexibility: Analysts have the freedom to adjust market value based on their expectations for specific market circ*mstances, considering highly educated buyers and sellers.
- Uses: Commonly associated with accounting standards (FASB, IFRS), crucial in real estate for property tax calculations.
3. Uses of Fair Market Value:
- Accounting Methods: Varies for businesses based on accounting methods (GAAP vs. IFRS). Short-term assets like marketable securities are often accounted for at fair market value.
- Real Estate: Determined by appraisers based on factors like neighborhood impact. Annual property taxes are calculated based on the appraiser's fair market value.
4. Uses of Investment Value:
- Stock Analysis: Commonly employs discounted cash flow methodology to determine the intrinsic value of a stock, forming the basis for buy and sell recommendations.
- Companies: Used for diverse situations such as selling assets, analyzing mergers or acquisitions. Involves assessing existing investments, book value, and potential profits.
5. Special Considerations: Other Types of Value:
- Book Value: Also known as carrying value, it accounts for depreciation.
- Market Value: The value an asset holds on any given day in the open market, usually influenced by daily trading. In standardized exchanges, market value and fair market value are usually the same.
- Enterprise Value: The comprehensive value of debt, equity, and cash.
In conclusion, my expertise in financial analysis allows me to navigate the complexities of fair market value and investment value, ensuring a comprehensive understanding and practical application of these concepts in various financial scenarios.
