Valuation Glossary

Fair market value is the estimated price at which an asset would be sold between a willing buyer and a willing seller in an open market. It's the value that both parties agree upon when they have all the necessary information and are not under pressure to make the transaction. Fair market value is determined by considering factors like the characteristics of the asset, market conditions, and expert opinions. It's commonly used in business valuation, legal matters, and taxes. The concept assumes a fair and unbiased transaction in a competitive market.

The excess earnings method is a way to estimate the value of a business based on its ability to generate profits that go beyond a reasonable return on its physical assets. It is used when a company has valuable intangible assets like brand recognition or patents that contribute to its earnings. The method involves valuing the physical assets separately, determining a reasonable return on those assets, and then calculating the excess earnings by subtracting the expected return from the actual earnings. This excess earnings value represents the contribution of the intangible assets. Finally, this value is used to estimate the overall value of the business. The method assumes that the excess earnings will continue in the future. It helps provide a more complete picture of a business's worth by considering the value of intangible assets.

Excess earnings are the profits a company makes that go beyond a reasonable return on its tangible assets. These earnings are attributed to intangible assets like brand value or intellectual property. Excess earnings are important in business valuation as they capture the additional value provided by these intangible assets. It helps assess the company's overall worth and potential for future earnings. Determining excess earnings involves separating the impact of tangible and intangible assets on a company's earnings.

The equity risk premium is the extra return that investors expect to receive for investing in stocks compared to safer investments. It represents the compensation for taking on the higher risk associated with stocks. Investors demand this premium as a reward for dealing with the uncertainty and volatility of the stock market. The equity risk premium can change based on economic conditions, investor sentiment, and other factors. It is used to estimate the potential return on stocks and is an important factor in investment decisions.

Equity net cash flows refer to the amount of cash that remains for the owners or shareholders of a business after considering all the cash inflows and outflows. It shows how much cash is available to distribute to the owners. Positive equity net cash flows mean the business generated cash that can be given to shareholders, while negative equity net cash flows mean the business used cash for various purposes. The cash flows can come from operating activities, financing activities (like dividends or equity issuances), or investing activities (such as asset purchases or sales). Equity net cash flows provide insights into the cash returns for the owners of the business.