Valuation of Jimmy Gilby Ownership Holding in Gearbox Manufacturing Using Excess Earnings Valuation Method
The excess earnings valuation method presumes a company's earnings are created by assets. To the extent a company's earnings are greater than might be expected to be earned on its tangible assets, the company is presumed to have "excess earnings" created by intangible assets (or "goodwill"). The valuation methodology is to identify and value tangible assets and to collectively value intangible assets by capitalizing excess earnings.
|Net Cash Flow||$||159,000|
|Tangible Assets for Establishing Expected Earnings||$||232,000|
|Expected Rate of Return on Tangible Assets||29.7%|
|Expected Earnings based on Tangible Assets||68,904|
|Excess Earnings Capitalization Rate||35.0%|
|Capitalized Excess Earnings (Estimated Intangible Assets Value)||257,417|
|Value of Company's Tangible Assets||232,000|
|Value of Company's Liabilities||189,000|
|Value of Tangible Assets Net of Liabilities||43,000|
|Indication of Company's Equity Value||300,417|
|Jimmy Gilby Ownership Holding Percentage||70.00%|
|Indicated Value of Ownership Holding||210,292|
Assumptions & Notes
Fair Market Value Standard of Value. "Standard of value" as it is generally defined for business valuation purposes, is the fundamental way in which the value of a business or ownership holding will be established, based on the purpose of the valuation. For the subject valuation, the standard of value being employed is "fair market value", which as defined in the International Glossary of Business Valuation Terms, is "the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts."
Net Cash Flow. For purposes of establishing the company's excess earnings, earnings were defined as "net cash flow". The value used in the method is the one year extension of a straight line trend based on 5 historical years rounded to the nearest $1,000.
Tangible Assets for Establishing Expected Earnings. Operating assets as of the valuation date were identified and valued based on fair market values.
Expected Rate of Return on Tangible Assets. This value is a weighted average rate of return determined by the value of the company's assets in asset classes and rates of return associated with the asset classes. This is addressed separately in this report.
Excess Earnings. This is the extent to which the company's net cash flow exceeds the computed net cash flow based on the expected rates of return.
Excess Earnings Capitalization Rate. The excess earnings capitalization rate is an expected rate of return taking into account the investment risks associated with the company's ability to create ongoing excess earnings.
Capitalized Excess Earnings (Indication of Intangible Assets Value). Although computed by capitalizing excess earnings, the underlying asset is the company's description 1.
Value of Company's Tangible Assets. The value here is the fair market value of the company's tangible assets consistent with the value of the assets used for establishing excess earnings.
Value of Company's Liabilities. This is the value of the company's liabilities as recorded on its balance sheet.
For purposes of establishing the earnings value to be used in the method, I computed a trend line based on 5 years of historical earnings. I then compared the trend line to historical earnings and concluded a projection of the trend line for one year was a reasonable estimate of earnings for establishing the company's excess earnings.
|Hist. Earnings||Pro-forma||$ Diff.|
|Projected Earnings Value||-||159,300||-|
|1st Prior Year||149,000||142,700||-6,300|
|2nd Prior Year||137,000||134,400||-2,600|
|3rd Prior Year||126,000||126,100||100|
|4th Prior Year||115,000||117,800||2,800|
|Cumulative Difference Between Pro-forma & Historical Earnings||0|
|Cumulative Difference As a Percent||0.0%|
|Cumulative Absolute Difference Between Pro-forma & Historical Earnings||17,800|
|Cumulative Absolute Difference as a Percent||2.6%|
|Coefficient of Determination||0.88|
Earnings Analysis Notes
Projected Earnings Value. Earnings for this valuation method should be earnings expected to be earned in the year following the valuation date. The projected earnings value displayed here was established based on a 5 year linear regression analysis. The value displayed represents the extension of the trend-line for one year.
Pro-forma Values. The first value appearing in the "pro-forma" column is the projected earnings value based on the extrapolation of historical earnings. Other pro-forma values are regression line values for each of the years used in the regression formula. Side-by-side, historical and pro-forma values display the correlation between the pro-forma values and the company's actual performance.
Annual Differences Column. Annual differences between pro-forma earnings and historical earnings are reflective of how well the linear regression analysis (straight-line trend) reflects the pattern of earnings over the historical period on a year-by-year basis. Small differences suggest the computation is predictive of the company's performance over the historical period and provide mathematical support for the use of the computation for establishing the projected earnings value.
Cumulative Difference Between Pro-forma & Historical Earnings. This is the total difference between pro-forma and historical earnings over the period used to compute the pro-forma earnings. A small difference indicates values in total are substantially in balance and support that the method used to establish pro-forma earnings is accounting for earnings in total. A significant difference reduces the mathematical support for the use of the method for establishing pro-forma earnings.
Cumulative Difference as a Percent. This is the cumulative difference between pro-forma and historical earnings as a percent of historical earnings.
Cumulative Absolute Difference Between Pro-forma & Historical Earnings. This is the cumulative difference between historical and pro-forma earnings without regard to whether differences are positive or negative. It is a strict test of the correlation between values on a year-by-year basis.
Cumulative Absolute Difference as a Percent. This is the absolute difference between cumulative historical and pro-forma earnings expressed as a percent of historical earnings. It is a relative indicator of the extent to which the method used to establish pro-forma earnings is predictive of actual earnings for the historical years. A low percentage here is an indication that the method used to produce the pro-forma earnings results in similar earnings in total and on a year-by-year basis. A low percentage is mathematical support that the method may be appropriate for developing the projected earnings value, absent of compelling evidence to the contrary.
Coefficient of Determination. This statistical measure, also referred to as r2, is an indicator of how well the regression line (or trend-line), upon which the pro-forma values fall, correlates to the historical earnings used to establish the line. 1.0 is perfect correlation and 0.0 is no correlation. As a practical matter, a value above .6 is usually required to assert that the use of the trend-line is appropriate for establishing pro-forma values.
Rates of Return on Tangible Assets
For purposes of establishing an average rate of return on tangible assets, I began with the company's tangible assets at book value. Expected rates of return were then assigned to asset categories and a weighted average rate of return was computed.
|Tangible Assets for Establishing the Expected Rate of Return||232,000|
|Weighted Average Rate of Return||29.7%|
Rates of Return on Tangible Assets - Notes
Tangible Asset Values. Operating assets as of the valuation date were identified and valued based on fair market values.
Rates of Return. The specified rates of return are reflective of the risks of holding the assets within the business, their capacity for producing revenue and income, and the risks associated with holding the specified levels of assets should the assets prove incapable of producing the required level of revenue and income.
Weighted Average Rate of Return. The weighted average rate of return is the specified rates of return times the respective asset values divided by the sum of the asset values.
This report is subject to the following limiting conditions.
The company has unaudited financial statements, and I performed no audit or review activities to ensure the statements are accurate. To the extent values displayed on the statements are inaccurate, assumptions I made may be in error. Material mistatements on the company's financial statements might result in all or portions of this report being inappropriate or in error.
The establishment of values used in analyses were not developed in accordance with established and published forecast and projection procedures. If such procedures were applied, different values might be determined to be appropriate for use. No known inappropriate assumptions are embodied in the report.
Material representations were provided to me by the company's management and I relied on such information as being true. No information known to be untrue is included in the report.
This report has been produced for purposes of the sale of the company and any use of this report for any other purpose is unauthorized. Assumptions made in this report are specific to the purpose of the valuation and the definition of value and not applicable to other valuation purposes and definitions of value.
All information used to prepare this report was received prior to the date of the report. Information becoming known after such date might materially affect my opinion of value but I have no obligation to update this report for such information.
No portion of my fee is contingent on any value expressed in this report.
I am independent with respect to Gearbox Manufacturing and its company's management.