Agenda - Council - 08/24/1982 - Laserfiche WebLink

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YHE WEEK Iix) REVti'~,'v-~. ~ - 2- J~:i,,S0, lg82 I I special financial accounting. Similarly, buyers must adjust many corporate accounts to reflect expenses realistically and, more importantly, to give a clear picture of real earning power. Com- panies frequently overstate interest expenses, executive salaries, owners' perquisites, and deprecia- tion expenses to hold down taxes. I I I I Determine the Market Value of Fixed Assets. This is generally a straightforward job for a profes- sional commercial real estate appraiser, A separate appraisal of fixed assets is necessary because their value, which is usually subject to lower risk than intangible assets, tends to exceed that of intangible assets. Agree on the Capitalization Rate. The parties must reach a consensus (as appropriate to the company and assets being evaluated) on the interest rate, so that the annual cost of owning the tangible assets eT the business can be calculated. To reach a realistic agreement, first determine an under- lying lending rate, which is usually 3 to 4 percentage points above inflation. Then calculate a penalty on the selling price equal to the extra cost of interest for a period of time (usually 1 to 3 years), based on the assumption that prevailing rates will decline. I I Figure the Cost of Ownership. Given a good estimate of the fixed assets of a business and a defens- ible definition of the cost of money, determining the annual cost of owning the tangible assets is straightforward. Even if the prevailing rates are unstable, you can still make and state assump- tions. Such a method leads to an estimate of the dollar cost of owning the {angible asset portion of the business at temporarily higher rates for a specified period. I I I I Calculate the Earning Power. Determine the stabilized earning power of the company after deducting the annual cost of ownership of tangible assets, which leads to a figure described as excess earn- ing power. Determine the Right Multiple. This is done to estimate the value of the excess earnings. A rating scale helps account for such factors as risk, growth, industry, track record, and desirability. Estimate the Actual Value. The estimated value of the business is the sum of the appraised value of tangible assets plus the value of the excess earnings. Deduct from this sum a penalty for the tem- porary extra cost of money in order to arrive at the estimated actual value. An alternative method is to project the income stream over a period of several years, determine an appropriate discount rate, and arrive at a net present value. Conclusion Don't take the calculated figure as an absolute statement of value. It is a beginning point for buyer and seller to check one another's assumptions, focusing the discussion on numerical judgments rather than on negotiating tactics. The actual selling price is often modified to reflect an entire package of money, securities, contract fees, perquisites and intangible benefits. I I I This technique is not appropriate for all acquisition situations-including start*ups, high technology companies, and professional service or information companies.'No method can eliminate the need for the large number of individual judgments necessary to arrive at an opinion of value. Both parties must clearly state and debate the underlying assumptions. By focusing on objective rather than emotional factors, buyers and sellers are better able to put together an acquisition package that accomplishes both of their goals.