Capitalization Of Earnings
- Capitalization Of Earnings
- A method of determining the value of an organization by calculating the net present value (NPV) of expected future profits or cash flows. The capitalization of earnings estimate is done by taking the entity's future earnings and dividing them by the capitalization rate (cap rate). This will take into account the risk that earnings will stop or be lower than the estimate.
Where:
d = discount rate
g = growth rate
This is an income-valuation approach that determines the value of a business by looking at the current benefit of realizing a cash flow now, rather than in the future. The capitalization of earnings is particularly useful when the future earnings can be predicted easily and accurately.
For example, if a company had a business that made $1.2 million last year and that was expected to grow at a 4% rate (plus a 3.25% inflation rate), the annual rate of return needed by a purchaser given the level of risk would be 26%. Expected value using the capitalization of earnings method would be $6.4 million, calculated as:
-$1,200,000/ (0.26 - (.04+.0325))
-$1,200,000/0.1875
-$6.4 million
Investment dictionary.
Academic.
2012.
Look at other dictionaries:
capitalization — cap·i·tal·i·za·tion /ˌka pət əl ə zā shən, əl ī / n 1: the act or process of capitalizing capitalization of earnings 2: a sum resulting from a process of capitalizing; esp: paid in capital at capital ina … Law dictionary
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Capitalization rate — (or cap rate ) is a measure of the ratio between the net operating income produced by an asset (usually real estate) and its capital cost (the original price paid to buy the asset) or alternatively its current market value. The rate is calculated … Wikipedia
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capitalization ratios — Also called financial leverage ratios, these ratios compare debt to total capitalization and thus reflect the extent to which a corporation is trading on its equity. Capitalization ratios can be interpreted only in the context of the stability of … Financial and business terms
Market capitalization — (often market cap) is a measurement of the value of the ownership interest that shareholders hold in a business enterprise. It is equal to the share price times the number of shares outstanding (shares that have been authorized, issued, and… … Wikipedia
retained earnings — An account on the balance sheet which represents the accumulated earnings of a corporation less any dividend distributions (including capitalization through stock dividends). It is usually a credit balance and a component of stockholder s equity … Black's law dictionary
