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Adjustment for Illiquidity
As previously discussed, when shares of a public firm are sold, the seller will usually receive the
proceeds in just a few days. These sorts of investments are liquid and can be quickly converted to cash
because they are mostly traded in active markets. But Acme‟s shares—like those of most private
firms—are relatively illiquid. In most cases, an owner of these sorts of shares cannot quickly sell
them. It may take months—if not longer—to sell these types of investments. Since people prefer to
own assets that are liquid over assets that are not, research shows that people will pay more for liquid
assets. Conversely, people pay less for illiquid assets.
Victoria believes that she needs to make a valuation adjustment to consider Acme‟s illiquidity since
she used valuation methods that have not already considered illiquidity. Recall that Victoria used rates
of returns from publicly traded securities in developing Acme‟s cost of equity for the income