Surplus Earnings Valuation Model
The Surplus Earnings Valuation Model is a method of estimating the value of a company based on its expected cash flows or earnings. The model is typically used in situations where companies are likely to be acquired, such as mergers and acquisitions. In these cases, the fair market value of the business must be estimated in order to facilitate the sale transaction.
The Surplus Earnings Valuation Model is based on the principle that the value of a business is equal to the discounted value of its future earnings. The total expected future cash flows of the business are determined, then discounted over a period of time to reflect their present value, which is then added to the market value of the company’s assets. In order to achieve an accurate value, a company’s cash flows must be estimated accurately and the suitable rate of discount chosen for the calculation.
The surplus earnings valuation model is based on the discounted cash flow (DCF) method, a widely used form of economic valuation of a business. The DCF method considers a stream of future cash flows and discounts them by a suitable rate to obtain a present value. With the Surplus Earnings Valuation Model, the expected future cash flows of the company are used instead of the actual observed cash flows of the company.
The discounted cash flow method can be used to calculate the value of a business in two different ways. The first is the discounted cash flow to equity (DCFE) method, which is based on the principle that the value of a business is equal to the discounted value of its future equity earnings. The second is the discounted cash flow to firm (DCFF) method, which values the company based on the present value of its future earnings before interest and tax.
The decision on which method to use depends on the potential buyer’s individual financial situation and the company’s structure. For example, if the buyer is looking to acquire the whole company and its assets, then the DCFF method is the appropriate one to use. On the other hand, if the buyer is only looking to acquire the portion of the company owned by its shareholders, then the DCFE would be more appropriate.
In the Surplus Earnings Valuation Model, the company’s expected future earnings are discounted using a suitable rate to calculate the present value of the business. The estimated present value is then adjusted for any non-operating elements of the business and any special considerations, such as taxes, to arrive at a final value estimate.
The Surplus Earnings Valuation Model is a commonly used tool for valuing a company for purposes of a sale transaction. It helps to estimate a fair value for the company by taking into account its expected future cash flows and subtracting the cost of the company’s existing liabilities. The model can also be used to provide a more accurate estimate of a company’s worth than alternative methods such as market-based multiples.
