Question

"Earnings-Based Valuation"

Present an argument explaining the benefits of the earnings-based valuation method.

• Explain how this valuation approach may generate accurate results.
• Evaluate the inherent challenges associated with earnings-based valuation.
• Provide suggestions for how analysts may overcome such challenges.

Answer 1

Earnings based valuation is based on the present value of future cash flows of a business. Future earnings of the business are estimated by making required adjustments to the expected future cash flows. all stakeholders are looking into the earnings of a business. Once future cash flows are calculated then the risk is incorporated through a discounting process, which will give the risk incorporated Present values of the future cash flows. as the risk is incorporated in the discount rate, this will give more accurate results for the users.

The challenges associated with earnings based valuations are the prediction of effective interest rate and calculating the expected future cash flows. In order to arrive at the proper discount rate, the business should consider all the factors affecting the business cash flows whether it is internal or external.