Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

CASE STUDY

We describe here an actual study that we carried out to use the Longstaff model for valuing illiquid common stock.5 The case is about estimating the value of shares of Elite Financial Corporation for estate tax purposes. The shares were part of the estate of Mary Hellmann, who died on September 27, 1998. The estate owned 396,000 shares of Elite Financial common stock. The market cap of Elite Financial in September 1998 was approximately $52 million. The shares were traded on the NASDAQ. The closing price on Friday, September 25, was $15.1875, which was also the opening price on Monday, September 28. The total value of the shares at this price was slightly more than $6 million. The median and mean daily reported trading volumes were, respectively, 1,900 shares and 4,113 shares, however, so a block of 396,000 shares was not readily marketable at the then current price.6 Moreover, the shares were unregistered and, therefore, subject to selling limits under SEC Rule 144 (see Note 1). A realistic estimate of the value of the shares at the time of Ms. Hellmann’s death must recognize that the stock was illiquid.

Maximum Discount for Illiquidity

The number of shares that could be sold in any three-month period was limited to the greater of either 1 percent of the 3.6 million shares outstanding—36,000 shares—or the average weekly trading volume preceding the week of the sale. The average weekly trading volume in Elite Financial from January 1 through September 25, 1998, was 20,555 ...