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

Two firms in the same industry earn identical profits. Firm A has a growth rate of 12% per annum with a strong brand; Firm B is growing at 2% in a saturating segment. Other factors being equal, which is the likely valuation outcome under an earnings-based approach?

Firm A is likely valued higher. Valuation reflects expected future earnings, and a higher growth rate with a strong brand supports a higher multiple or higher projected cash flows, even when current profits are identical to those of the slower-growing firm.

  1. AFirm B is valued higher because it is more mature
  2. BBoth are valued equally since profits are identical
  3. CFirm A is valued higher because higher expected growth supports a higher multiple or higher projected cash flowsCorrect
  4. DFirm A is valued lower because growth requires investment

Explanation

Earnings-based valuation capitalises expected future earnings. Higher growth prospects and brand strength support higher projected cash flows and a higher multiple. Equal current profit does not mean equal value, so equal valuation is wrong.

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