Business Valuation - Asset Approach

Capitalized Excess Earnings - Asset Approach

WACC-formulaThe first method to the Asset Approach is the Capitalized Excess Earnings method. You calculate the value of the business by first finding the fair market value (FMV) of the net tangible assets, then by finding the value of the goodwill (excess earnings). The total of these two combined gives the value of the enterprise.

Key notes:

  • Note the circular reasoning that could be problematic when finding capitalization rates. You need to know the weighted average cost of capital to use this method. However, since you know the WACC, you could use other methods more accurately.
  • Note the blanket disproportion level of earnings in any asset class or group.
  • Useful when the fair market value of assets comprise the most if not all the value of the company (and business has little or not income).
  • Better methods are available if business has higher income.

Steps to Capitalized Excess Earnings

  1. Determine the FMV of tangible assets.
  2. Determine the business earnings.
  3. Calculate the weighted average cost of capital (WACC) with either CAPM

Asset Accumulation - Asset Approach

The second Asset Approach is the Asset Accumulation method. This is most useful when the value of the assets is greater than the capitalized value of the company. Meaning the value of the parts is greater than the whole. This is usually used for companies where earnings are inadequate to give a value greater than the FMV of assets.

Key notes:

  • Do not use if there are sufficient earnings.
  • Uses the replacement cost / substitution theory.
  • Include off balance sheet asset items such as: intellectual property, key distribution and customer contracts, strategic partnership agreements, etc.
  • Include off balance sheet liabilities: pending legal judgements, tax obligations, environmental compliance, etc.

Steps to Asset Accumulation

  1. Determine tangible asset FMV.
  2. Determine intangible asset FMV including off balance sheet assets.
  3. Determine off balance sheet liabilities.
  4. Add all the assets minus the liabilities.
  5. Final amount is the value of the business.