Valuation Methods A business may be sold a) at a value as a going concern (capitalized value) or b) on the value of the assets within it (asset value) Normally, valuation methods are: Liquidating (asset) value Going concern (capitalized) value Market value of the common shares Book value Replacement cost less depreciation Liquidating Value Sometimes, a business is worth more dead than alive because some of the assets have higher and better uses outside than within the existing business. The best example of this could be a gas station located on a prime piece of real estate in a high rise section of a city where the land would be valued for a skyscraper.
83 Often, it may be better to buy the assets only and leave the debts and other liabilities to the old firm. The Going Concern Value a) It is best to liken a „going concern‟ value to what you would pay for a money machine. You will be willing to pay more for a machine which has a low risk of failure and the ability to earn a good profit. In your research of the business, you have to determine how good are the chances of the business continuing to operate as it is (before you touch it) for a long period into the future and to set a price based on the profits you can see it continuing to earn well into the future (the capitalized value). If you can see where improvements can easily be made or tax incentives taken which will give you greater profits, you may be willing to pay a premium for the venture. The ability for a business to continue earning its normal profits could be considered the goodwill factor of the business, which is often the difference between the value of the assets listed on the balance sheet of the business and the purchase price. b) The opposite of goodwill is badwill . It is possible that a business is listed for sale because it is deteriorating. It is often very difficult to win back customers and it may be best to start afresh, rather than to buy the existing business. c) Great differences in perceived capitalized value are possible between the buyer and seller, based on the amount of risk that a person sees in the probability of the business continuing. In smaller business situations, it seems a relatively common norm to use a capitalization value of 5 times earnings. These norms are often given as capitalization percentage rates and are interpreted as a reflection of the risk found in the venture. For example, 5 times earnings is a risk of 20% and 2.5 times earnings reflects a risk factor of 40%. Consider the following example: If a fad venture, such as a beauty parlour or health club, is for sale, showing a net income of K3,000,000, the capitalization would be:
84 Price = Income / Risk = K3,000,000 / 0.40 = K7,500,000 In this case, the owner may be asking K7,500,000 for the venture based on its proven ability to earn an income.
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