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

Sources of long term financing , you are checking a financial analyst''s re...

you are checking a financial analyst''s recommendation. the analyst projects a company''s stock price to be P72 per share in 3 years. the most recent annual dividend was P1.68 per

Calculation of weighted average cost of capital, Calculation of weighted av...

Calculation of weighted average cost of capital (WACC) Market values Market value of equity = 5m × 4.50 = $22.5 million Market value of preference shares = 2.5m × .0762 =

Evaluate of risk-adjusted discount rate, Q. Evaluate of Risk-Adjusted Disco...

Q. Evaluate of Risk-Adjusted Discount Rate? Illustration: - From the following date state which project is preferable: Year Project A Proj

Public finance, suppose perfect competition prevails in the market for hote...

suppose perfect competition prevails in the market for hotel rooms. the current market equilibrium price of a stanar hotel room is 100 per night

Collateralized mortgage obligations (cmos), Collateralized Mo...

Collateralized Mortgage Obligations (CMOs) CMOs retain many of the yield and credit quality advantages of pass-throughs, while eliminating some of the

International financial system, International financial system has always b...

International financial system has always been a debatable and crucial focus of the world discussion and it is mainly due to the repression of the economies especially after the cu

Types of government stocks, Types of Government Stocks Issue of Stock t...

Types of Government Stocks Issue of Stock through AuctionThe RBI, on behalf of the government, issues notification to auction government securities, stating the amount and time

Debt ratio, What is the Debt Ratio? Describe please.

What is the Debt Ratio? Describe please.

Regulatory aspect in employees provident fund organization, Regulatory Aspe...

Regulatory Aspect Employees Provident Fund Organization (EPFO) is under the Ministry of Labor and is a primary organization for retirement income for private employees in India

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