Capitalized Excess Earnings Method

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.
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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

Hence, this concludes the definition of Capitalized Excess Earnings Method along with its overview.

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