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 Incomplete adjustments to multiples

— The appraiser should consider differences in size, growth, profitability, or risk, as op-
posed to simply applying mean or median multiples without adequate justification or
analysis.

— The multiples may be influenced by certain nonoperating assets and liabilities that have
not been factored out.

 Inconsistent treatment of cash, as well as nonoperating assets and liabilities

— If cash or nonoperating assets and liabilities have been subtracted to calculate the guide-
line multiples, they should be added back to the subject company value after applying the
multiples.

Income Approach

The income approach determines value by estimating the present value of the future benefit stream to be
received by the asset’s owners. Future benefits, such as net cash flow, are estimated and capitalized or
discounted to present value using a capitalization rate or discount rate that is comparable to other similar
investments in the market.

A benefit stream is any measure of income or cash flow that can be converted into value either by capi-
talizing or discounting at appropriate rates. Therefore, more than one type of benefit stream may be
used, such as net income, net cash flow, or pretax income. Most practitioners prefer free cash flow be-
cause it measures the ultimate cash benefit stream that can be realized by the investor, which is realized
through dividends and share price appreciation. Also, discount rates used by many valuation analysts are
often derived from return data that is applicable to cash returns to shareholders. When assessing the val-
ue of invested capital, rate of return data for holders of debt is also considered.

The income approach can be used to estimate the value of equity directly or to estimate the value of in-
vested capital.

Income Approach Methods

Both values of equity and invested capital can be estimated with the following income approach meth-
ods: fn 9

1. Capitalization of future benefits method. In this method the present value of future benefits
(earnings or cash flows) is calculated by dividing a single-period benefits forecast by a capitali-
zation rate. The capitalization rate is based on a discount rate minus an expected future benefits
growth rate.

fn 9 If the income approach is used to determine the value of invested capital of the business, the equity value can then be estimated
by subtracting the value of debt. Note that the premise of value used for the value of debt will depend on the purpose of the valuation.
This is discussed in more detail under the section "Asset (Asset-Based) Approach."

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