Valuing a business using the income approach may seem straightforward: Estimate future earnings and apply a risk-based discount rate to calculate present value. In practice, however, it’s far more complex. Small missteps can significantly distort results, leading to values that don’t hold up in planning, negotiations or litigation. Here are three common pitfalls that experienced valuation professionals know how to avoid. Mismatching earnings and discount rates The subject company’s “earnings” can take many forms. Examples include earnings before tax, cash flow available to equity investors, and cash flow available to equity and debt investors. Likewise, discount rates can take many forms. Examples include the cost of equity or the weighted average cost of capital (WACC). The WACC blends the cost of equity with the cost...
