Chapter 5: Income Approach to Value

Question 1

What is a principle underlying the income approach?

Answer 1

Future benefits: The income approach measures expected benefits, usually defined as cash flows or net income.

Question 2

When should you use the DCF method?

Answer 2

When the company’s performance is not currently at a normalized level and is expected to be different than historical results.

Question 3

How do the number of periods compare for CCF vs DCF?

Answer 3

CCF uses a single period measure of income, and DCF uses multiple periods.

Question 4

What is the formula for cash flow to total equity?

Answer 4

Normalized net income after tax
\+Non-cash charges
-Incremental working capital to support growth
-Anticipated capital expenditures
\+New debt principal in (borrowings)
-Debt principal out (repayments)

Question 5

What is the formula for net cash flow to invested capital?

Answer 5

Normalized net income after tax
\+ Interest expense (tax-effected)
\+ Non-cash charges
- Incremental working capital
-Anticipated capital expenditures

Question 6

What is the Gordon Growth Model Formula for Direct equity DCF residual (terminal) value?

Answer 6

[(Net cash flow to equity)(1 + g)] / (cost of equity - g)

Question 7

What is the Gordon Growth Model Formula for Invested Capital Terminal Value?

Answer 7

[(Net cash flow to invested capital)(1 + g)] / (WACC - g)

Question 8

When do you have to normalize the income statement?

Answer 8

When you are valuing a control position.

Question 9

When do you perform a valuation using cash flows to equity vs. cash flows to invested capital?

Answer 9

Cash flows to equity = minority basis

Cash flows to invested capital = control basis

Question 10

What is the formula for earnings attributable to net tangible assets?

Answer 10

Earnings attributable to net tangible assets = net tangible asset value * rate of return for net tangible assets

Question 11

What is the formula for earnings attributable to net intangible assets?

Answer 11

Earnings attributable to net intangible assets = Normalized net income - earnings attributable to net tangible assets

Question 12

What is the formula for total enterprise value (using excess earnings method)?

Answer 12

Indicated value of business enterprise = net tangible asset value + indicated value of intangible assets + non-operating assets