Chapter 5

Income Approach

Perhaps the most widely recognized approach to valuing an interest in a privately held enterprise is the income approach. As with both the market and asset approaches, several valuation methodologies exist within the income approach to develop an indication of value. This chapter explores the fundamental theory behind the approach and its numerous applications.

This chapter will discuss three methods of the income approach: the capitalized cash flow (CCF) method, the discounted cash flow (DCF) method, and the excess cash flow (ECF) method. These methods are sometimes identified by other names. For example, the capitalized cash flow method has been referred to in other publications as the “single period earnings” method, and the excess cash flow method has traditionally been referred to as the “excess earnings method.” This chapter will also discuss the economic benefit stream of a privately held entity. Valuation analysts use a number of terms, such as economic benefits, economic income, and net income. These terms are used interchangeably throughout this chapter. This text identifies each method as “cash flow” (CF), which is an industry standard. In discussing CF, we will address two types of cash flow: “cash flow to equity” (CF-Eq) and “cash flow to invested capital” (CF-IC).

FUNDAMENTAL THEORY

Equity Interests Are Investments

An equity interest in a privately held enterprise is an investment that can be evaluated in the same basic manner as any other ...

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