How the European Debt Crisis came to be: Excellent Video!

5 Steps to Value Intangible Assets

Let’s assume that Widget Corp., is a small company with stable residual income growth of 3% annually. Upon meeting with the CFO he provides you with the following figures: 

• Current Assets are $5,000,000 and current liabilities are $2,500,000. 

• Book value of fixed assets is $7,000,000, which is $1,000,000 less than fair value. 

• Free cash flow to the firm for the most recent 12 months is $900,000. 

• Required returns on working capital, fixed assets and intangibles are: 3.0%, 6.0% and 10.5%, respectively. 

• Weighted average cost of capital is 11.5%. 

As the analyst, you proceed in using the excess earnings method (EMM) to calculate the value of Widget’s intangible assets. The EEM estimates the earnings remaining after the required return on working capital and fixed assets is calculated and deducted. The EEM then capitalizes the residual earnings to obtain and estimate the value of the intangible assets. Here’s how it works: 

1. Determine the value of working capital and the fair value of fixed assets. Working capital equals: CA – CL = $2,500,000. The fair value of fixed assets is: $8,000,000. 

2. Estimate normalized earnings. Based on the information given, we can use FCFF of $900,000. 

3. Calculate the required returns on working capital and fixed assets from normalized earnings: $900,000 x 3% = $27,000 and $8,000,000 x 6% = $480,000, respectively. 

4. Estimate residual income by subtracting the required returns on working capital and fixed assets from normalized earnings: $900,000 - $27,000 - $480,000 = $393,000. 

5. Value the intangible assets by capitalizing the excess earnings using a growing perpetuity formula. The excess earnings are multiplied by the residual income growth rate to determine normalized earnings for the next period. Then, the next period earnings are capitalized by the required return for intangibles assets less the residual income growth rate. 

Here’s the calculation: 

$393,000(1+0.03) / (11.5% - 3%) = $4,762,235 (value of Intangibles)

Steps to calculate NPV of Venture Capital Investments

6 Steps to Choosing a Career

When it comes time to choosing a career path, many people often find themselves at a fork in the road. With so many options and decisions to make, the emotional side often clouds the realistic expectations of what lies ahead. In this brief tutorial, I will offer an outline that has worked consistently over the years to the benefit of those who’ve used it. I have personally used the formula with great success and today I’m going to share it with all: 

Step 1:

It’s hard to hit a target you can’t see. So, start with a vision of where you want to be in 5 years. What type of lifestyle do you envision living then? Be realistic! This is key because not all careers will allow you to live according to your dreams. Plus, a period of 5 years is measurable and most people can look ahead 5 years. If you can picture where you want to live, the type of car you want to be driving and the lifestyle in general you envision living, then you’re on track to making the following steps a lot easier. But it all starts with where you want to be in 5 years. You will surely arrive somewhere, the question is where?

Step 2:

How much money would it take to live the lifestyle that you’ve envisioned? Only you know that answer. For some it may be $50,000 a year while for others it may be $150,000. Whatever the figure is, write it down and be realistic!

Step 3:

How much could I potentially earn from my chosen profession in 5 years time? If you don’t have a clue then you’re headed for trouble. How can you position yourself in the market to maximize your potential? If you’re going to school to major in minors then you might want to start thinking about making ‘mid-course’ corrections to position yourself for the earnings power needed to command good pay. Remember, wages will make you a living; profits will make you a fortune. 

Step 4:

Find five people in varying capacities within your target profession and ask them a list of well-designed questions to help you gain knowledge about the profession. For example, if you plan to major in law, then realize that under the law umbrella there are many niches that one can specialize in. The same holds true for other professions. You may not be fit for being a trader, but could you do better as an analyst? But, how would you know unless you interviewed someone in practice? Only then will you understand the pros and cons of each niche. This is crucial in helping you chart the best path to take. And, after concluding your interviews, you may decide that not everything that shines is gold. This can save you countless hours in pursuit of a career that’s empty and meaningless.

Step 5: 

Quantify your education cost relative to your potential earnings power. Are you majoring in debt? The money invested in your education can be thought of as its “book value.” Now, to quantify this, you want the calculation to be accurate so you need to account for wages that were foregone during your time at school – assuming you didn’t work during college.

This step does not account for the important “non-economic” benefits of an education and focuses only on its economic value. 

To begin, you must first take an estimate of the potential earnings you can receive over your lifetime. Then subtract from that figure an estimate of what you would have earned had you lacked a college education. The difference will give you what’s called an “Excess earnings figure.” The ‘excess earnings figure’ must then be discounted, at an appropriate discount rate, back to graduation day. The result will equal the “Intrinsic economic value of your education.”

There are some people who will find that the ‘book value’ of their education exceeds its “Intrinsic economic value,” which means that you essentially overpaid for your education. On the flip-side, if your ‘intrinsic economic value’ far exceeds its ‘book value,’ then the result would prove that capital was spent wisely.

For example: Assume you enter college right out of high school. After 4 years, at age 22, you are ready to enter the work force. Assuming you love your job, you may end-up working 45 years until age 67. Let’s pretend your weighted average salary over the course of 45 years was $120,000 p/year. That translates to $5.4M in earnings over a lifetime. Now, let’s assume that the average weighed pay for a non-college grad over the same period was $40,000 p/year. The ‘excess earnings’ for a college grad would be $3.6M. Now, if you feel that the cost of your college education should yield you at least a 10% return on investment, then you can use 10% as your discount rate. The result would an “intrinsic economic value” of $49,389. This figure must then be compared to the cost of your education, plus the cost of your lost wages during the time you were in school.

For example: Assume the cost of a Bachelors degree is $35,000 p/year. Let’s say there’s 4 years till graduation. During those same 4 years, you could’ve worked and made an equivalent sum. The combined book value of your education is therefore $280,000 vs. $49,389 in ‘intrinsic economic value.’ 

The formula should be used as a template so you can plug-in your own numbers to customize the results. (The numbers above were used only for illustration purposes). 

Step 6:

Make a decision! The proceeding 5 steps are designed to help you make better career choices. We all know a variety of ways to make a living. What’s even more fascinating is figuring out ways to make a fortune. You have no idea how many people I’ve meet who’ve put the cart before the horse only to later find out that they hated their chosen profession. Sure, there many decisions involved when choosing one’s career. But at the end of the day it’s all about the “NET”. How much can you possibly earn to live a lifestyle consistent with you dreams? I hope the steps I’ve outlined will serve to guide and bring you closer in the direction of your dreams.

Warning: if your financial adviser....

Steps to calculate the NPV of Venture Capital Investments

Let’s pretend you’re approached by a group of tech-savvy guys who have just completed product development, organized their operations, and now need additional capital to begin production and sales. The company’s management is asking you to consider a $4.5 million investment. How would you proceed? How do you determine if the investment merits your time and money? 

When you start putting pencil to paper you estimate that the company will be ready for IPO in 3 years, which would permit you to exit the investment with $31 million. 

Feeling the excitement of this newfound opportunity you begin to estimate the probability of success in each of the next 3 years: 60%, 75% and 90%, respectively. 

If investments with similar risk profiles require a 23% discount rate, how would you calculate the expected net present value of the investment? 

Here are the steps: 
The initial investment is $4.5 million. The probability of success after three years is: (.60)(.75)(.90) = 40.5%. Therefore, the probability of failure is: 1- .405 = 59.5%. 

The NPV of success can therefore be calculated as follows: 

NPVsuccess = Terminal Value/(1+r)t – Initial Investment 

$31 
--------- - $4.5 = $12.16 million 
(1.23)3*  *(raised to 3) 

Keep in mind that if the project fails the $4.5 million is lost. 

The expected overall NPV can then be calculated as follow: 

E(NPV) = [NPVsuccess x P(Success)] + [NPVfailure x P(Failure)] 

= $12.16(.405) - $4.5(.595) = $2.25 million 

This step would then be combined with any due diligence needed to further evaluate the project. The figures used above are only for illustration purposes and should not be relied on for investment decisions. The process and formula can be used to evaluate a variety of projects requiring an NPV decision.

5 Steps to Value Intangible Assets