Business Valuation Methods
I. Adjusted Book Value
Take the Book Value of net worth
- (minus) assets not acquired
+ liabilities not assumed
+ fair market value of assets acquired
+ any net worth adjustments
= Adjusted Book Value
II. Gross Revenue Multiplier
Example:
Last Year’s Sales x Multiplier
III. Capitalized Adjusted Earnings
First Step: Adjust Historical Earnings
Last year
Net Profit 50.0
+ Officer’s salary + 70.0
+ Discretionary expenses + 30.0
- New Owner salary - 60.0
Adjusted Profit 90.0
Second Step: Get the adjusted profits for 5 years, then do a Weighted
Average of the Adjusted Earnings
Year |
Earnings |
Weight |
Adjusted |
2000 |
$ 50 |
1 |
$ 50 |
2001 |
$ 30 |
2 |
$ 60 |
2002 |
$ 70 |
3 |
$ 210 |
2003 |
$ 60 |
4 |
$ 240 |
2004 |
$ 90 |
5 |
$ 450 |
|
|
Divided by 15 =
Average of $ 67
(rounded) |
| Third Step: Calculate a Discount Rate |
|
| |
Example |
| Determine the T-Bill Rate |
5.0% |
Determine the Offset Risk Rate 12.0%
-- Establish rate of return based on risk factors
-- Establish rate of return based on general economy |
12.0% |
| Determine Offset Illiquidity Rate |
3.0% |
Fourth Step: Take the weighted average of the Adjusted Earnings
and divide by the Discount Rate
Example: $ 67/.20 = $ 335
IV. Discounted Future Earnings
First Step: Adjust Historical Earnings
Last year
Net Profit 50.0
+ Officer’s salary + 70.0
+ Discretionary expenses + 30.0
- New Owner salary - 60.0
Adjusted Profit 90.0
Second Step: Get the adjusted profits for 5 years, then do a Weighted Average of the Adjusted Earnings
Year |
Earnings |
Weight |
Adjusted |
2000 |
$ 50 |
1 |
$ 50 |
2001 |
$ 30 |
2 |
$ 60 |
2002 |
$ 70 |
3 |
$ 210 |
2003 |
$ 60 |
4 |
$ 240 |
2004 |
$ 90 |
5 |
$ 450 |
|
|
Divided by 15 =
Average of $ 67
(rounded) |
| Third Step: Calculate a Discount Rate |
| |
Example |
| Determine the T-Bill Rate |
7.0% |
Determine the Offset Risk Rate 12.0%
-- Establish rate of return based on risk factors
-- Establish rate of return based on general economy |
12.0% |
| Determine Offset Illiquidity Rate |
6.0% |
Total the Rates: |
25.0 |
Fourth Step: Estimate growth, both real and inflationary (for this example, we are estimating a 5% growth rate.
Fifth Step: Multiply the estimated earnings for each year by the estimated growth rate until estimated earnings for the next ten years are determined.
Sixth Step: Multiply the adjusted, weighted earnings by the estimated growth (1 plus the growth rate) to determine the estimated earnings for the first year.
Seventh Step: Using the net present value table, multiply the estimated earnings for
each year by the factor for the discount rate for each respective year to determine the
discounted value of future earnings.
Eighth Step: Total the discounted earnings.
Ninth Step: Determine the residual value by subtracting the growth rate from the
discount rate and dividing the difference into the discounted earnings for year ten.
Tenth Step: Add the residual value to the total discounted earnings.
Year |
Previous Yr. Earnings |
Growth
(1 + 5%) |
Adjusted Earnings |
Factor (25%) |
Net Present Value |
1 |
67.0 |
1.05 |
70.4 |
0.80000 |
56.3 |
2 |
70.4 |
1.05 |
73.9 |
0.64000 |
47.3 |
3 |
73.9 |
1.05 |
77.6 |
0.51200 |
39.7 |
4 |
77.6 |
1.05 |
81.5 |
0.40960 |
33.4 |
5 |
81.5 |
1.05 |
85.6 |
0.32768 |
28.0 |
6 |
85.6 |
1.05 |
89.9 |
0.26214 |
23.6 |
7 |
89.9 |
1.05 |
94.4 |
0.20972 |
19.8 |
8 |
94.4 |
1.05 |
99.1 |
0.16777 |
16.6 |
9 |
99.1 |
1.05 |
104.1 |
0.13422 |
14.0 |
10 |
104.1 |
1.05 |
109.3 |
0.10737 |
11.7 |
|
|
|
Net Total |
290.4 |
|
|
|
Residual |
58.5 |
|
|
|
Total |
348.9 |
V. Cash Flow Method
First Step: Identify available cash for debt service via rule of thumb,
Sources/uses, or any other acceptable method.
Last year
Net Profit 10.0
+ Depreciation 5.0
------------------------------------
Adjusted Profit 15.0
Second Step: Choose a reasonable maturity and market interest rate
for the financing requested.
| |
Years |
| Fixed Asset Purchases |
10 |
| Working Capital |
7 |
| Average Maturity |
8.5 |
| Interest Rate |
12% |
Third Step: Reverse-compute the amount of total funds that the cash flow
can support given the maturity and interest rate chosen (using
an amortization table or calculator).
Cash flow of $15,000 annually at 12% for 8.5 years is annual debt service for the
total amount of $79,696.69 (computed on an annual payment basis) or
$77,295.78 (computed on a monthly payment basis).
Cash flow valuation establishes a range of $77,000 to $80,000.
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Why A Valuation?
