Business Valuation

CHAPTER 9Income Approach and Methods

PYRAMID STEP 9 Convert benefit streams to value.

There are two primary methods under the income approach: the discounted cash flow (DCF) method and the capitalized cash flow (CCF) method. Each of these methods requires the analyst to look back to Chapter 6 (benefit stream analysis) to understand the correct level of cash flow necessary for use in the method. In addition, the analyst should refer to Chapter 7 (cost of capital) to select the appropriate cost of capital model that is consistent with the selected benefit stream. Matching the correct level of cash flow to the correct cost of capital is crucial in applying the methods under the income approach.

Learning Objectives

By the end of this chapter, readers should be able to:

• Explain the income approach to business valuation, its fundamental principle of converting anticipated economic benefits into a single, present value, and its forward-looking nature.
• Define “economic income” as it is used in business valuation.
• Explain the origin and assumptions of the Gordon growth model and its impact on current income approach methodology.
• Differentiate between the CCF method and the DCF method, including when each is appropriate based on company characteristics and available data.
• Apply the CCF method, describe the assumptions necessary to apply this method, including consistent growth and ...