Capitalized Excess Earnings Method

Posted in Finance, Accounting and Economics Terms, Total Reads: 1780
Advertisements

Definition: Capitalized Excess Earnings Method

Capitalized Excess Earnings method is a financial valuation method that computes value of a business by summation of net tangible assets and the capitalized value of excess earnings, which can be attributed to intangibles like reputation.

 

Procedure:

  • Find out net tangible assets of a business (can be obtained by financial statements).
  • Determine the earnings attributable to those assets by multiplying the value with the reasonable rate of return.
  • Compute ‘excess earnings’ as difference between actual business earnings and that by net assets. This difference can be attributed to non tangible assets like goodwill.
  • Capitalize the value computed using an appropriate capitalization rate, to determine fair market value of the intangibles.

Example:

Shivraj Enterprises has net tangible assets worth Rs. 5,000,000. Rate of return on tangible assets is 10%, and rate of return on intangibles is 20%. Income before taxes is Rs. 800,000 for that year.

According to procedure mentioned above,

Tangible assets = 5,000,000

Earnings attributable = 5,000,000 * 10%

= 500,000

Excess earnings = Total earnings – earnings attributable to tangibles

= 750,000 – 500,000

= Rs. 250,000

Capitalized value = 250,000 / 20%

= Rs. 1,250,000

Advertisements



Looking for Similar Definitions & Concepts, Search Business Concepts