Capitalization of Earnings
 Method of determining organization value based on current earnings and expected performance.
 Formula: Capitalized Earnings = Net Operating Income
Capitalization rate
Illustration: Parent Co. agreed to acquire Subsidiary Co. based on the capitalization of the last 3 years profits at an
earnings yield of 25%.
Net Operating Profits
Year 1
7,500,000
Year 2
8,900,000
Year 3
8,200,000
Cost/ Asset Approach
 Derives value from Fair Market Value (FMV) of the business’ net assets.
 Techniques used: 1. FMV of comparable assets
2. Expert appraisal
3. Price indexed-based inflation adjustments
 It is important to identify unrecorded intangible assets (i.e. goodwill) and unrecorded liabilities, leases
(operating & financing), and other off-balance sheet & contingent liabilities
Adjustments per independent appraisers:
Illustration:
Current Assets
Non-Current Assets
Total Assets
2,500,000
12,750,000
15,250,000
Current Liabilities
Non-Current Liabilities
Shareholders’ Equity
Total Liabilities and Equity
2,200,000
6,000,000
7,050,000
15,250,000
a. Inventories costing 500,000 should be written down to
450,000
b. Accounts receivable is overvalued by 30,000
c. Equipment should have 500,000 additional depreciation
d. Land costing 5,000,000 has current market value of
6,000,000
e. Unrecorded trade payables amounted to 40,000
f. Long term loan payable is undervalued by 100,000
Required: Adjusted FMV of CA, NCA, CL, NCL, and Net Assets