Journal of Finance and Investment Analysis

Business Valuation Based on Assets Replacement Cost

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  • Abstract

    According to the established valuation practice, when valuing businesses (companies, business units and other retail assets) the income and market approaches are generally applied. The use of the cost approach is rather limited and is normally employed when valuing small companies (those that have not reached their breakeven point or those having little historic data) and holding groups. The article suggests modernization of the cost approach, aiming to broaden its scope of use through the integration of some income approach elements. The article provides a description of this valuation technique, which the author calls Assets Replacement Cost Method (ARCM). It relies on the replacement concept, according to which the investor will not pay more for an asset than the total cost necessary to create an asset of equal utility, be it by means of acquisition or construction. This method is based on the cost approach and incorporates some elements of the income approach, which allows optimizing the strengths and weaknesses of both methods. From the authorís point of view, this method can be classified as hybrid, similar to the Economic Value Added (EVA) and Edwards-Bell-Ohlson (EBO) valuation approaches.