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ACCA Strategic Professional · Advanced Financial Management · Valuation and the use of free cash flows

Which statement best describes a key weakness of valuing a company using the net asset (asset-based) method compared with a free cash flow valuation?

The main weakness is that the net asset method ignores future cash generation and unrecorded intangibles such as brands and know-how. It values what the company owns rather than what it earns, whereas free cash flow valuation captures expected cash flows.

  1. AIt ignores the value of future cash generation and internally generated intangibles not on the statement of financial positionCorrect
  2. BIt requires an estimate of the cost of capital that is difficult to obtain
  3. CIt cannot be used for companies that pay no dividends
  4. DIt always produces a value higher than free cash flow valuation

Explanation

Asset-based values reflect assets less liabilities, often at book or break-up values, so earnings power, brands and other unrecognised intangibles are missed. It does not need a cost of capital and does not depend on dividends. It is not always higher.

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