Page 47 - FINAL CFA II SLIDES JUNE 2019 DAY 8

LOS 33.f: Calculate the value of a READING 33: PRIVATE COMPANYVALUATION
private company using free cash flow,
capitalized cash flow, and/or excess
earnings methods. MODULE 33.2: INCOME-BASED VALUATION

The Excess Earnings Method (EEM)
Firm value = (Normalised) earnings less earnings required to provide the required rate of return on working capital + fixed assets +
PV of intangible assets

• (PV of intangible assets = PV of the (growing) stream of excess earnings using the CCM growing CCM perpetuity formula).

Used infrequently but applicable to small firms when their intangible assets are significant. However, the required return for working
capital and fixed assets is subject to estimation error.

EXAMPLE: Given the following figures, calculate the value of the firm using the EEM.

Step 1: Calculate the required return for working capital and fixed assets.

• working capital: $300,000 × 6% = $18,000
• fixed assets: $1,000,000 × 10% = $100,000

Step 2: Calculate the excess earnings.
excess earnings = $130,000 − $18,000 − $100,000 = $12,000

Step 3: Value the intangible assets.
value of intangible assets = ($12,000 × 1.05) / (0.14 − 0.05) = $140,000

Step 4: Sum the asset values.
firm value = $300,000 + $1,000,000 + $140,000 = $1,440,000