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

Two Pune firms, Alpha Auto Parts and Beta Auto Parts, report identical profits of Rs 10 crore. Alpha's profits are growing steadily at 12% a year, while Beta's are flat. Other things equal, how will a valuer treat them under an earnings-based approach?

Alpha will be valued higher. Valuation looks at future earning capacity, and steady 12% growth justifies a higher multiple or higher discounted cash flows than Beta's flat profits, even though current profits are the same.

  1. ASame value, since current profit is identical
  2. BBeta higher, because flat earnings are more reliable
  3. CAlpha higher, because growth prospects justify a higher multipleCorrect
  4. DAlpha lower, because growth requires reinvestment of profit

Explanation

Growth prospects are a key value driver. With the same current earnings, the firm with higher expected growth warrants a higher capitalisation multiple, or a higher present value of future cash flows. Treating them equally ignores expected future performance.

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