Abnormal earnings valuation model, Financial Management

Assignment Help:

Abnormal Earnings Valuation Model

Abnormal Earnings Valuation Model is a method to analyse the value of the firm. The value of the firm can be the sum of three components - the original invested capital, the normal rate of return and the abnormal return on invested capital. The equity value of the firm is given as

 

BV0 + S AEt/(1+r)t

where BVt = Book value of equity at beginning of year t

 r = Cost of equity capital

AEt = Expected value of abnormal earnings in year t

       = Projected earnings in yr t -(r * BV of equity at beginning of year t)

            This model is basically a rearrangement of the DCF model. It combines "current value" on the balance sheet with the present value of future "abnormal earnings". It has a few advantages over DCF, the first being its simplicity due to the forecasting of the accounting variables. The terminal value represents only a stream of abnormal earnings beyond the forecast horizon as compared to the forecast of cash flows in the DCF model.

 

This method does have some shortcomings. It is dependent on the initial book value, BV0. Also, the book value fails to account for certain assets that do not generate cash flows. Things like patents, trademarks etc are not accounted for and they may cause the abnormal earnings to persist. Also, the option to back out of a project/business is not included.


Related Discussions:- Abnormal earnings valuation model

Evaluate consolidated income statement, The consolidated income statement...

The consolidated income statement for AB Group for the year ended 30 June 2010: (all amounts in the workings are in $000, unless stated otherwise)

Amount of the total liabilities, A firm has net working capital of -$800. L...

A firm has net working capital of -$800. Long-term debt is $15,400, total assets are $24,800 and fixed assets are $19,100. What is the amount of the total liabilities.

Share price, what course a decrease and increase in share price

what course a decrease and increase in share price

Operating cycle, Define operating cycle and long and short operating cycle?...

Define operating cycle and long and short operating cycle? Use of operating cycle? Can someone give me assistance on these questions??

maximization of a company''s share, a. The primary financial objective of ...

a. The primary financial objective of a company is the maximization of the wealth of shareholders ...per corporate finance theory.    Though, this objective is usually replaced by

What is the advantages of IFRS 8, What is the advantages of IFRS 8 A...

What is the advantages of IFRS 8 Advantages Allows users to view internal management's approach and highlights what's important from management's point of view.

Illustrate report on cash flow budget, Q. Illustrate report on cash flow bu...

Q. Illustrate report on cash flow budget? The cash flows The principal reason why certain statistics were not included in the cash flows is that they are incremental cash

Factors considered in assigning a credit rating, Credit rating agenci...

Credit rating agencies carry out credit rating. Companies appoint these agencies to assign credit rating for their corporate issues. The rating agencies may condu

What are the types of inventory cost, What are the types of Inventory cost?...

What are the types of Inventory cost? Explain the elements of inventory cost also. Types: 1. Ordering cost    2. Holding cost Elements: 1. Unit cost  2. Reordering

Financial and economics evaluation, An offer given by charitable trust to d...

An offer given by charitable trust to develop and build a facility on a 10000 sqmt of plot in a prime locality of pune where 5000 sqmt of area will be used by the trust for housing

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd