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Capitalized Excess Earnings and Rules of Thumb

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Values goodwill. Used in Professional Practice Valuation, etc. ... Specific to particular industries. May be self fulfilling 'prophesies' ... – PowerPoint PPT presentation

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Title: Capitalized Excess Earnings and Rules of Thumb


1
Capitalized Excess Earnings and Rules of Thumb
  • Galbraith, EBD 481 Fall, 09

2
CAPITALIZED EARNINGS
  • Compute Cap-rate (approximation of Present value
    under two conditions)
  • constant cash flows (constant growth)
  • Nlarge
  • Apply to last periods earnings
  • Often use an average of several past periods,
    weighted to more recent
  • Appropriate for stable firms

3
Formulas for Capitalized Earnings
D1 PV0 --------------
Dr - g
Where g is constant growth
D0(1 g) PV0 --------------
Dr - g
OR
4
CAPITALIZED EXCESS EARNINGS
  • Values goodwill
  • Used in Professional Practice Valuation, etc.
  • Only technique that uses balance sheet plus
    income statement
  • 5-step process
  • compute normal return on assets (ROA)
  • compute normal (expected earnings)
  • compute excess earnings
  • compute value of excess earnings (cap rate)
  • compute value of company (value of excess
    earnings plus net tangible assets)
  • NTA is difference between tangible assets and
    liabilities
  • Note the difference in ROA to compute normal
    return on assets, but NTA to compute value of firm

5
GOODWILL
  • Three basic types of goodwill
  • Institutional Goodwill
  • 15-25 risk
  • Organizational Goodwill
  • 25-35 risk
  • Personal Goodwill
  • 35-75 risk
  • Use weighted average of different classes of
    goodwill
  • ask the principal what influences customers to
    buy from business)

6
Rules of Thumb
  • Ad hoc but commonly used formulas
  • Non theoretical
  • Specific to particular industries
  • May be self fulfilling prophesies
  • http//businessbookpress.com/catalog/b901.htm
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