Value a private firm using methods based on income
The idea
Income approaches include the free cash flow method, which discounts forecast cash flows plus a terminal value. The capitalised cash flow method suits mature companies with stable growth: value = FCF1 ÷ (r − g). The excess earnings method values intangible assets. Under excess earnings, estimate normalised earnings, subtract the required returns on working capital and fixed assets, capitalise the residual earnings to value intangibles, and add that to the values of working capital and fixed assets. The capitalisation rate is the discount rate minus growth, and it is applied to next year's cash flow. The traps are dividing by the discount rate instead of the capitalisation rate and capitalising the current year's flow without growing it.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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- Contrast the key features of private and public companies that matter for valuation
- Set out why private businesses are valued and what financial analysts should concentrate on
- Explain the difficulties of estimating cash flow for private firms and the adjustments needed to arrive at normalised earnings
- Explain what has to be adjusted when setting the discount rate for a private firm
- Contrast the models for estimating the return required on private company equity, such as the build-up approach, the CAPM and the expanded CAPM
- Explain and assess how control and marketability discounts and premiums change the value of a private company
- Explain the asset-based, market and income ways of valuing a private firm and what bears on choosing each one
- Value a private firm using methods based on the market and set out the pros and cons of each method