Page 41 - FINAL CFA II SLIDES JUNE 2019 DAY 8

LOS 33.d: Explain the income, market, and
asset-based approaches to private company READING 33: PRIVATE COMPANYVALUATION
valuation and factors relevant to the selection
of each approach. MODULE 33.1: PRIVATE COMPANY BASICS

1. Income approach: Values a firm as the present value of its expected future income. Such valuation may be based on a
variety of different assumptions and variations.

2. Market approach: Values a firm using the price multiples based on recent sales of comparable assets.

3. Asset-based approach: Values a firm’s assets minus its liabilities.

MODULE 33.2: INCOME-BASED VALUATION
LOS 33.e: Explain cash flow estimation issues related to private companies and adjustments required to estimate
normalized earnings.

Estimating Normalized Earnings
Normalized earnings should exclude nonrecurring and unusual items. In the case of private firms with a concentrated control,
there may be discretionary or tax-motivated expenses that need to be adjusted.

• Private firm expenses may be inflated, therefore, earnings may be artificially low. Artificially low earnings may also be the
result of excessively high owner compensation or of personal expenses charged to the firm. These expenses will also affect
the firm’s tax expense. The adjustments are potentially larger when the owners’ family members have connections to the firm.
Use of company-owned assets (e.g., aircraft, personal residences, company-provided life insurance, loans for
managers/owners) potentially require an adjustment to earnings.
• On the other hand, if a firm is performing poorly, the owners may be receiving compensation below market levels.