Certified Valuation Analyst (CVA) Practice Exam

How is the value of the business calculated using the excess earnings/reasonable rate return method in Geri Co?

1. Using future projections only

2. By taking the adjusted net assets and adding earnings

3. By subtracting expenses from pretax earnings

4. Using an initial value and income approach

The correct answer is: Using an initial value and income approach

The excess earnings/reasonable rate return method evaluates business value by first determining an initial valuation based on the business's net assets and then adjusting that valuation by considering the company's earnings performance above a reasonable return on those net assets. This method combines elements of both asset and income approaches to value. Initially, the business's adjusted net assets provide a baseline for the valuation. Then, by incorporating earnings, specifically the excess earnings which exceed a reasonable return rate on the net assets, the calculation reflects the business's ability to generate income beyond its tangible assets. Therefore, the total value is derived from this approach, which combines both the initial asset valuation and the income produced, capturing a more comprehensive view of the business's worth. The other options do not capture the full methodology involved in this valuation method. For example, focusing solely on future projections does not account for the established asset base, while simply adding adjusted net assets and earnings or subtracting expenses from pretax earnings does not incorporate the nuanced calculation of excess earnings beyond the reasonable return rate, which is central to this method.