# Discrepancy between CFA Text and Schweser: Private Company Valuation

In valuing private companies using excess earning method, in CFA (EoC Q #15): You calculate the return on intangibles, and then you divide it by (required return - growth rate). In Schweser Notes book 3 page 318, they multiply the return on intangibles by its growth rate, and then you divide it by (r - g). Which one is correct? The Schweser’s approach seems to fit what we’ve learned so far well, but… CFA text is supposed to be the ultimate authority on stuff. What do you guys think?

holy smoke I just realized that in the example on page 655 CFA also multplies the return on intangibles (residual income, it’s also called normalized earnings) x g but in #15 they do NOT multiply by g

EOC #4 also does NOT multiply the “free cash flow to the firm” by g if I see this on the exam I will not multiply by g

I had this yesterday… schweser and the CFA text says to multiply by growth,but the EOC q doesn’t. I can only assume that you must multiply it by growth. After all, it’s always given on the question.

please note EOC #4 has an erratum, and they multiply by 1+g there in the erratum.

where is the errata info?

the usual location. you are in year 2 of the program, sir.!

I have it. I knew where to go. But i don’t understand the solution. Even with the the changes, shouldn’t the answer be: 1,000,000 (1.05) - [540,000] = 510,000 510,000 / r-g = 5.1m what am I doing wrong?

you need to do it instead as 1000 - 540 = 460 Intangible = 460 * 1.05/(0.15-0.05) = 4830 Total value = 4830 + 5500 + 1000 = 12330

I see. thanks.

So what’s the conclusion – do we multiply with 1 + g or not? Anybody has any other source that supports one or the other?

I still don’t know because #15 EOC does NOT multiply by g, and there is no errata on that question Perhaps, if we see this on the test, they will say something like “normalized income for the most recent year is…” —> then we multiply by g but if they say “next year’s normalized income is…” then we don’t multiply by g

rayllionaire Wrote: ------------------------------------------------------- > So what’s the conclusion – do we multiply with 1 > + g or not? Anybody has any other source that > supports one or the other? We do multiply Page 655 of Reading 44 Vol 4 EOC #4, as cpk said it is errata, page 677 we do multiply by 1+g

Hi idreesz, as CFA.Rhythm said, we’re referring to question 15 (page 686). There was no errata there and in the answer we don’t multiply by 1+g.

CP, What problem is this?

rayllionaire Wrote: ------------------------------------------------------- > Hi idreesz, as CFA.Rhythm said, we’re referring to > question 15 (page 686). There was no errata there > and in the answer we don’t multiply by 1+g. CFA.Rhythm posted just b4 my post, so I didnt see his. His approach will be the one I would go by. It is still confusing after I opened the book but that is what I will follow since it makes the most sense.

I’m glad you brought this up. I didn’t even notice before. It just doesn’t make sense why #4 has an errata (tells us to multiply by g) #15 (has no errata, the answer tells us not to multiply by g)

Ah. My guess would be that the normalized income in the valuation data exhibit is already an estimate of the future year. As such, you wouldnt need to apply the growth rate. If the question had said, “historical normalized earnings”, or “normalized earnings for the most recent year”…you would need to multiple by 1+g. Maybe

the problem with this conclusion is that the normalized income in the chart MUST be the normalized income for the current year. the reason is because you subtract current year working capital and fixed asset charge from this amount. once you get this excess earnings you need to multiply by 1+g. This is carefully laid out on page 655 of volume 4 (pay attention to steps 2 and 6. in short, i think 15 has to be an error.

I agree.