The theory underlying the asset-based approach is that the value of a business is equal to the sum of the value of the business's assets. This is the principle of substitution: no rational investor will pay more for the business assets than the cost of procuring assets of similar economic utility. The approach estimates the intrinsic value of a common share from the estimated value of assets of a corporation minus the estimated value of its liabilities and preferred shares.
Pursuant to accounting conventions, most assets are reported on the books of the subject company at their acquisition value, net of depreciation where applicable. These values must be adjusted to fair market value wherever possible.
The value of a company's intangible assets, such as goodwill, is generally impossible to determine apart from the company's overall enterprise value. For this reason, the asset-based approach is not the most probative method of determining the value of going business concerns. In these cases, the asset-based approach yields a result that is probably less than the fair market value of the business.
The result from an asset-based valuation model may be used as a "sanity check" when compared to other models of valuation.
|johntan1979: To do the "sanity check", you might need one yourself considering all the work you need to do for this method.|
|farhan92: or after registering to take the CFA exams....|
|asmaaab: Very well said !! lol|