What are the 3 approaches to value and when would you use each?

Business valuation professionals typically apply three approaches to valuing a business — the cost, market and income approaches — ultimately relying on one or two depending on the type of case and other factors. It’s vital that attorneys and clients who rely on business valuations understand the basics of each approach.

1. Cost Approach

The cost (or asset-based) approach derives value from the combined fair market value (FMV) of the business’s net assets. This technique usually produces a “control level” value, meaning the value to an owner with the power to sell or liquidate the company’s assets. For that reason, a discount for lack of control (DLOC) may be appropriate when using the cost approach to value a minority interest. This approach is particularly useful when valuing holding companies, asset-intensive companies and distressed entities that aren’t worth more than their net tangible value.

The cost approach includes the book value and adjusted net asset methods. The former calculates value using the data in the company’s books. Its flaws include the failure to account for unrecorded intangibles and its reliance on historical costs, rather than current FMV. The adjusted net asset method converts book values to FMV and accounts for all intangibles and liabilities (recorded and unrecorded).

2. Market Approach

The market approach bases the value of the subject business on sales of comparable businesses or business interests. It’s especially useful when valuing public companies (or private companies large enough to consider going public) because data on comparable public businesses is readily available.

Under this approach, the expert identifies recent, arm’s length transactions involving similar public or private businesses and then develops pricing multiples. Several different methods are available, including the:

Guideline public company method. This technique considers the market price of comparable (or “guideline”) public company stocks. A pricing multiple is developed by dividing the comparable stock’s price by an economic variable (for example, net income or operating cash flow).

Merger and acquisition (M&A) method. Here, the expert calculates pricing multiples based on real-world transactions involving entire comparable companies or operating units that have been sold. These pricing multiples are then applied to the subject company’s economic variables (for example, net income or operating cash flow).

Under the market approach, the level of value that’s derived depends on whether the subject company’s economic variables have been adjusted for discretionary items (such as expenses paid to related parties). If the expert makes discretionary adjustments available to only controlling shareholders, it may preclude the application of a control premium. If not, the preliminary value may contain an implicit DLOC.

3. Income Approach

When reliable market data is hard to find, the business valuation expert may turn to the income approach. This approach converts future expected economic benefits — generally, cash flow — into a present value. Because this approach bases value on the business’s ability to generate future economic benefits, it’s generally best suited for established, profitable businesses.

The capitalization of earnings method capitalizes estimated future economic benefits using an appropriate rate of return. The expert considers adjustments for such items as discretionary expenses (for example, for above- or below-market owner’s compensation), nonrecurring revenue and expenses, unusual tax issues or accounting methods, and differences in capital structure. This method is most appropriate for companies with stable earnings or cash flow.

The discounted cash flow (DCF) method also falls under the income approach. In addition to the factors considered in the capitalization of earnings method, the expert accounts for projected cash flows over a discrete period (say, three or five years) and a terminal value at the end of the discrete period. All future cash flows (including the terminal value) are then discounted to present value using a discount rate instead of a capitalization rate.

As with the market approach, the income approach can generate a control- or minority-level value, depending on whether discretionary adjustments are made to the future economic benefits.

Important Decision

No universal formula exists for all businesses. Therefore, it’s essential for experts to explain why they chose a specific method (or methods) over all the possible options.

Appraisers use three approaches to value in Appraisal Practice when determining the Market Value of a property:

• The Sales Comparison Approach
• The Cost Approach
• The Income Approach

1. The Sales Comparison Approach

The most frequently-used and accepted approach to determining value in real estate appraisal practice is the sales comparison approach. This approach to value bases its opinion of value on what similar properties (otherwise known as “comparables”, or “comps”) in the vicinity have sold for recently. These properties are adjusted for time, acreage, size, amenities, etc. as compared to the property that is being appraised. Understanding which (and to what extent) adjustments are reasonable for a given market area (for a given property) relies on the experience of the appraiser. A property characteristic that is highly valued in one neighborhood may not be valued to the same degree in a different area.

2. The Cost Approach

The second approach to determining the value of a property is the cost approach. This approach seeks to determine how much a property would cost to replace (meaning, rebuild) after subtracting accrued depreciation. Accrued depreciation is the reduction in actual value of property over a period of time as a result of wear and tear or obsolescence. The term reproduction cost is used if an exact replica of the original property is produced. The term replacement cost is used if a property is rebuilt with comparable utility, but using current design and construction methods and materials.

The cost approach is considered to be more reliable when used on newer construction. The methods and results of the cost approach are considered to be less reliable with older construction.

The cost approach appraisal is frequently the only approach that is considered to be reliable when appraising special use properties such as commercial/industrial properties or public properties such as libraries, schools or churches which are not traded on the open market.

3. The Income Approach

The third approach to value is called the income approach. When a property generates income for it’s owner, that income, or potential for income, helps to substantiate, calculate or identify the market value of the property. Apartment buildings and duplexes are examples of income-producing properties. Appraisers use the income derived from the property as part of the assessment the market value of the property.

What are the 3 approaches to value?

There are three approaches to determination of property value: the cost approach, the market sales comparison approach, , and the income approach.

Which are the different approaches to determine value?

There are three types of approaches to value and they are sales comparison approach, cost approach and income capitalization approach. The sales comparison approach is the most commonly used approach in real estate appraisal practice for determining the value.

What are the three approaches to value quizlet?

(1) The Sales Comparison Approach, (2) The Cost Approach, (3) The Income Approach. A method for estimating the market value of a property by comparing similar properties to the subject property.

What are the three general approaches used in estimating the value of properties?

There are three internationally accepted methods of measuring the value of property: the cost approach, the sales comparison approach and the income approach. ... .

The cost approach begins by establishing the value of the land on which the building sits, using sales of similar lands..