If an entity would like to sell (or buy) an intangible asset, it needs to determine how to price/value this asset. There are three generally accepted methods available:
Market Based Approach: This approach uses market data to determine an appropriate price. This is used when there is market data available for comparable assets.
Replacement Cost Approach: This approach can be used when it is possible to determine how much it costs to replace the asset.
Incremental Cash Flow Approach: In order to use this approach, we project the incremental cash flows generated by the asset and then discount this at the appropriate rate. The discount rate used is either the minimum rate of return that the entity would like to see from their investment or the entity’s weighted average cost of capital (WACC). It is up to the entity to determine which discount rate they would like to apply. There is great debate within the financial/statistics community regarding which discount rate is better to use for cash flows. We will not delve into this topic, but in general, it is better to use the entity’s required rate of return. For accounting case studies, if a rate of return is specified - use this rate. If nothing is specified - use the entity’s WACC. Summing/adding up the discounted cash flows from the total number of years the entity expects to use the intangible asset, will provide a valuation based on Incremental Cash Flows.
Excess Earnings Approach: With the Excess Earnings Approach, the sales and costs for the entire project/operation are projected into the future. The “excess” amount attributable to the intangible is then deducted from the projection. These “excess earnings” are then discounted and added together, to determine a value for the intangible asset. As with the Incremental Cash Flow approach, the discount rate used is either the desired rate of return or the WACC.
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