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Business Valuation Methods print this article

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
 
Totals
15
$ 1,010
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
 
Totals
15
$ 1,010
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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