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CS Professional · Corporate Restructuring, Valuation and Insolvency · Overview of Business Valuation

A valuer is assessing Ravi Steel Ltd, whose industry is cyclical and currently at a peak of demand. The valuer plans to capitalise this year's peak profit at the usual multiple. What is the main concern with this approach?

The approach may overstate value because peak-year profit is not maintainable throughout the industry cycle. Valuers should use normalised or average earnings to reflect sustainable earning capacity, particularly for cyclical businesses.

  1. AIt ignores asset values, which are always irrelevant
  2. BIt may overstate value, because peak earnings are not maintainable over the cycleCorrect
  3. CIt will understate value, because peak profit is too low
  4. DIt is correct, because latest profit is always the best base

Explanation

Earnings-based valuation needs maintainable, normalised earnings. In a cyclical industry, using peak profit overstates the sustainable level, so the valuer should average or normalise across the cycle. Peak profit is high, not low.

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