CIMA F3 Syllabus D. Business valuation - Forms of intangible asset and methods of valuation - Notes ^{5 / 15}

Valuation of intangibles

The asset based valuation method specifically excluded most intangible assets from the computation. 

This rendered this method unsuitable for the valuation of most established businesses, particularly those in the service industry.

Historical cost

We are interested in any element of business that may have some value.

Certain intangible assets can be recorded at their historical cost. 

Examples include patents and trademarks being recorded at registration value and franchises being recorded at contract cost. 

However over time these historical values may become poor reflections of the assets' value in use or of their market value.

Intellectual capital

is knowledge which can be used to create value. 

Intellectual capital includes:

• Human resources

  the collective skills, experience and knowledge of employees

• Intellectual assets

  knowledge which is defined and codified such as a drawing, computer program or collection of data

• Intellectual property

  intellectual assets which can be legally protected, such as patents and copyrights

Types of Intangible assets and intellectual capital:

• Patents, trademarks and copyrights

• Franchises and licensing agreements

• Research and development

• Brands

• Technology, management and consulting processes

• Know-how, education, vocational qualification

• Customer loyalty

• Distribution channels

• Management philosophy

Methods of Measurement of intangible assets

1. Market-to-book values

2. Tobin's 'q'

3. Calculated intangible value

1) Market-to-book values

This method represents the value of a firms intellectual capital as the difference being

• the book value of tangible assets and

• the market value of the firm.

• Value of IA = Market Capitalisation - Value of tangible NA

For example, if a company's market value is $10 million and its book value is $8 million, the $2 million difference is taken to represent the value of the firm's intangible (or intellectual) assets.

2) Tobin's 'q'

Tobin's q is the ratio between a physical asset's market value and its replacement value.

The formula for Tobin's Q is: Tobin's Q = Total Market Value of Firm / Total Asset Value of Firm.

3) Calculated intangible values (CIV)

(CIV) is used for calculating the fair market value of a firm's intangible assets. 

CIV =[(Earnings - ROA) x Tax] / WACC

A step-by-step approach would be as follows:

1. Calculate average pre-tax earnings

2. Calculate the return on assets (ROA)

   Industry average return on tangible asset / Company's Tangible assets

3. Adjust it by Tax

4. Divide it by the entity's cost of capital (WACC)

Illustration 1

Cow Co. is using CIV method to value its intangible assets.

Relevant data:
Earnings = 10,000
Industry average return on tangible assets is 15%
Cow Co's tangible assets are $20,000
Corporate income tax is 30%
Cow Co's WACC is 10%

Required

Value Cow Co's intangible assets.

• Solution

  CIV = [(Earnings - ROA) x Tax)] / WACC
  CIV = [(10,000 - 15% x $20,000) x 0.70] / 0.10
  CIV = $49,000