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

Deseasonalizing a time series, Deseasonalizing a Time Series The Ratio...

Deseasonalizing a Time Series The Ratio to Average Method allows us to identify the component of the seasonal variation in time series data and the indices themselves help us

Long-term debt finance, The approaches that Blin could accept regarding the...

The approaches that Blin could accept regarding the relative proportions of long- and short-term finance to meet its working capital needs have been described as moderate, conserva

Corporate debt, which critically examines the benefits and risks to a compa...

which critically examines the benefits and risks to a company, of incorporating corporate debt into a portfolio of equity and debt.

Define measures that propose to prevent the recurrence, In an integrated wo...

In an integrated world financial market, a financial crisis in a country can be rapidly transmitted to other countries, causing a global crisis. What kind of measures would you pro

Lease, Lease A lease is a contractual arrangement allowing one party th...

Lease A lease is a contractual arrangement allowing one party the use of some exact assets for a specific times period in exchange for a payment it is same as a rental arrangem

Use npv method to show your calculations, Xcell engineering is planning to ...

Xcell engineering is planning to construct a futsal stadium which has 5 courts to be rented out at any point of time. Its initial cost of investment is RM$280,000. It is expected t

Create a report that fully explains both directors views, The Directors of ...

The Directors of Rohan Plc are discussing the importance of the dividend policy on the market value of their firm. The Chairman considers that the dividend is important and does a

Illustrating a straddle, Options Traded on Legal and General August 14  200...

Options Traded on Legal and General August 14  2009 Share   Price         Exercise      Price    Calls       Puts                                 Sep        Dec        Mar

Definition of financial management, DEFINITION OF FINANCIAL MANAGEMENT ...

DEFINITION OF FINANCIAL MANAGEMENT Financial Management is a stream concerned with the generation and allotment of scarce resources (generally funds) to the most proficient use

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