Valuation approaches and methods, explained

• Foundations 1 of 4 · Terms

• Foundations 2 of 4 · Basis of value

An approach is a broad way of reaching value: market, income or cost. A method is a specific technique within an approach, such as DCF within the income approach. A model is the quantitative tool, usually a spreadsheet, that carries out the method.

The basis of value (market value, fair value, investment value, equitable value) and the premise (highest and best use, current use, orderly or forced liquidation) define the question. Approaches and methods are chosen to answer it, not the other way round.

• Foundations 3 of 4 · Selection

• Foundations 4 of 4 · Reconciliation

Choose with evidence

One conclusion, explained

IVS 103 asks the valuer to consider all relevant approaches and select those that fit the asset, the basis of value, the purpose and the data available. One approach can be enough when it is clearly reliable; otherwise use more than one.

When approaches give different indications, analyse why, judge the reliability of each input, then weight the indications into a single conclusion. Never simply average them, and record the reasoning in the workfile and report.

• Part 1 · Approach 1

• Part 1 · Approach 2

Value by comparison with identical or similar assets for which price information is available, such as transactions, listings or quoted prices. It rests on the principle of substitution: a buyer pays no more than the price of an equally useful substitute.

Value by converting expected future cash flows or income into a single present value. It rests on the principle of anticipation: an asset is worth what its expected economic benefits are worth today, given their timing and risk.

• Part 1 · Approach 3

• Part 1 · Selection

Cost approach

Which approach, when

Value by the cost a buyer would incur to obtain an asset of equal utility, by purchase or construction, less deductions for physical deterioration and every relevant form of obsolescence.

Market for assets with good transaction or price evidence; income for assets valued for the cash they generate; cost for specialised assets that rarely sell. Most assignments use one primary approach with another as a cross-check.

■ Part 1 · Approaches in depth

Market and income approaches in depth

Each column follows the same order: principle, when to use it, when to give it less weight, typical methods, key inputs and the main risk to manage.

Market approach

Income approach

Principle: observable prices for identical or comparable assets, adjusted for differences, show what market participants would pay for the subject at the valuation date.

Principle: the value of an asset equals the present value of the economic benefits it is expected to generate over its life, reflecting their timing and risk.

Use it when: the subject or similar assets trade on an active market, or there are frequent, recent and verifiable transactions in substantially similar assets.

Use it when: income-producing ability is the critical element a participant would consider, or reliable forecasts exist while relevant market evidence is scarce.

Give it less weight when: transactions are few, old or distressed; comparables differ materially; prices are not public; or the market is volatile or distorted at the valuation date.

Give it less weight when: the asset produces no separately identifiable income, forecasts are speculative, or the discount rate cannot be supported by market evidence.

Typical methods: comparable transactions (sales comparison), guideline public company (trading multiples), matrix pricing for debt instruments, and prior transactions in the subject itself.

Typical methods: discounted cash flow, direct capitalisation, dividend discount, the residual and profits methods, option pricing, and the intangible methods (MPEEM, relief-from-royalty, with-and-without, greenfield).

Key inputs: verified prices and terms, a unit of comparison such as price per m² or EV/EBITDA, and adjustments for time, location, size, growth, risk, control and liquidity.

Key inputs: the cash flow forecast and its type, the explicit forecast period, the discount or capitalisation rate, terminal value and, where relevant, tax effects.

Main risk: weak comparability hidden behind precise-looking adjustments. Many or large adjustments signal that the comparable may not be comparable at all.

Consistency rule: cash flows and rates must match: nominal with nominal, pre-tax with pre-tax, firm cash flows with WACC, equity cash flows with cost of equity.

Main risk: optimistic forecasts or a terminal value that dominates the result. Test forecasts against history, industry evidence and what participants actually expect.

■ Part 1 · Approaches in depth

Cost approach, and choosing between approaches

The cost approach completes the three. The right column sets out the sequence a valuer follows to select, apply and weight approaches in one assignment.

Cost approach

Selecting and weighting

Principle: a participant pays no more for an asset than the cost of obtaining one of equal utility, by purchase or construction, unless undue time, inconvenience or risk is involved.

1. Define the question: the asset, the interest valued, the basis and premise of value and the valuation date drive every later choice.

Use it when: an asset of the same utility could be recreated without legal restriction, the asset is specialised and rarely sold, or it was created recently.

2. Consider all three: record why each approach is used or rejected, given the nature of the asset, the data available and how participants actually price it.

Give it less weight when: the asset produces identifiable income, market evidence exists, or the asset cannot readily be recreated, as with most brands and customer relationships.

3. Choose primary and secondary: the most reliable approach becomes primary; others serve as cross-checks where they add independent evidence.

Typical methods: replacement cost, reproduction cost and the summation method; depreciated replacement cost for specialised property; the adjusted net asset method for businesses.

4. Apply consistently: use the same assumptions about the asset, its condition and the market across approaches so the indications can be compared.

Key inputs: current costs of materials and labour, professional fees, finance costs, developer’s profit or entrepreneurial incentive, then all forms of depreciation.

5. Explain differences: when indications diverge, look for inconsistent inputs, weak comparables or optimistic forecasts before deciding on weights.

Main risk: treating cost as value. Cost is a ceiling on value only when depreciation, including functional and economic obsolescence, is measured in full.

6. Weight and conclude: weight each indication by the relevance and reliability of its inputs and state a single conclusion of value.

7. Document: report the approaches and methods used, key inputs and assumptions and the reasons for weighting, as IVS 106 requires.

• Part 2 · Methods map

• Part 2 · Methods map

Comparable transactions, guideline public company, matrix pricing, prior transactions in the subject, and rules of thumb used only as a cross-check.

Discounted cash flow, direct capitalisation, dividend discount, residual method, profits method, and option pricing models for contingent claims.

• Part 2 · Methods map

• Part 2 · Methods map

Cost approach methods

Intangible asset methods

Replacement cost, reproduction cost, summation and depreciated replacement cost, with depreciation for physical, functional and economic obsolescence.

Multi-period excess earnings, relief-from-royalty, with-and-without, greenfield and distributor methods, plus cost to recreate for workforce and software.

■ Part 2 · Market approach methods

Market approach methods, step by step

Two core methods. Comparable transactions works for real estate, plant and whole businesses; guideline public company works for businesses and shares. Other market methods close the right column.

Comparable transactions

Guideline public company

1. Identify comparables: transactions in identical or similar assets, close in time to the valuation date, at arm’s length and with known price and terms.

1. Select peers: listed companies with similar industry, products, markets, size, growth and risk; explain why any candidate is excluded.

2. Verify the data: confirm price, date, conditions of sale, financing, rights transferred and any non-market elements such as related-party terms.

2. Normalise financials: adjust the subject and peers for non-recurring items, accounting differences and owner-specific costs.

3. Choose the unit of comparison: price per m², per room or per unit for property; EV/EBITDA, EV/revenue or price/earnings for businesses.

3. Calculate multiples: enterprise value multiples (EV/EBITDA, EV/EBIT, EV/revenue) or equity multiples (P/E, P/B), on the same period for all.

4. Adjust for differences: market conditions and time first, then location, physical characteristics, size, growth, profitability, risk, and control or marketability.

4. Position the subject: select a multiple within the peer range by comparing growth, margins and risk, not simply by taking the median.

5. Reconcile the adjusted range: give most weight to the comparables that need the fewest and smallest adjustments, rather than averaging the whole range.

5. Apply and bridge: apply the multiple to the subject’s metric, then move from enterprise to equity value through net debt and non-operating assets.

6. Apply and conclude: apply the selected unit value or multiple to the subject, then adjust for non-operating assets, debt and the level of value.

6. Level of value: quoted prices reflect minority, marketable interests; consider a control premium or a discount for lack of marketability where relevant.

7. Other market methods: matrix pricing values debt from similar quoted instruments; prior transactions in the subject and rules of thumb serve mainly as cross-checks.

■ Part 2 · Income approach methods

Discounted cash flow, step by step

DCF is the most widely used income method for businesses, real estate, intangibles and projects. The left column gives the sequence; the right column explains the inputs that decide the result.

DCF steps

DCF inputs

1. Choose the cash flow type: free cash flow to the firm (FCFF) or to equity (FCFE), nominal or real, pre-tax or post-tax, consistent with the basis of value.

Forecast quality: reflect participant expectations, test against history and industry data, and exclude synergies a typical buyer would not obtain.

2. Build the forecast: revenue, margins, capital expenditure and working capital over an explicit period long enough to reach a stable state, often 5 to 10 years.

Expected or conditional: use probability-weighted cash flows, or a single scenario with a rate that reflects the extra risk, but never adjust for the same risk twice.

3. Estimate the discount rate: WACC for FCFF and cost of equity for FCFE, built from market evidence and reflecting risks not already in the cash flows.

Cost of equity: commonly the capital asset pricing model (risk-free rate plus beta times equity risk premium), with size or country premiums only where evidence supports them.

4. Calculate terminal value: capitalise a normalised final year with the Gordon growth model, or apply an exit multiple, at the end of the explicit period.

Cost of debt and weights: a market-based cost of debt after tax, weighted at a target market-value capital structure for the industry.

5. Discount to present value: apply mid-year or end-year timing consistently and add the present value of the explicit period and of terminal value.

Terminal growth: long-run growth should not exceed nominal growth of the economy; terminal value is often more than half of total value, so test it hard.

6. Bridge and test: move from enterprise to equity value, run sensitivities on growth, margins and rate, and cross-check implied multiples against the market.

Rates for intangibles: riskier assets such as technology or customer relationships need returns above WACC; contributory assets such as working capital need less.

Reconciliation: the implied internal rate of return, the WACC and the weighted average return on assets should reconcile within a reasonable margin.

■ Part 2 · Income approach methods

Other income methods and intangible asset methods

Beyond DCF, these methods capitalise stable income, value development land by residual, price contingent claims, and isolate the cash flows of individual intangible assets.

Other income methods

Intangible asset methods

1. Direct capitalisation: divide one year of stabilised income by a capitalisation rate (discount rate less long-term growth); suited to stable property and mature businesses.

1. Multi-period excess earnings (MPEEM): cash flows of the primary asset less charges for every contributory asset, discounted at an asset-specific rate; used for customer relationships and technology.

2. Dividend discount: values shares as the present value of expected dividends; used for banks, insurers and mature companies with steady payout.

2. Contributory asset charges: fair returns on and of working capital, fixed assets, workforce and other intangibles that help the primary asset earn its income.

3. Residual method: gross development value less construction cost, fees, finance and developer’s profit gives residual land value; highly sensitive to small input changes.

3. Relief-from-royalty: the present value of royalties saved by owning rather than licensing the asset; royalty rates come from comparable licences and profit split analysis.

4. Profits method: for hotels and other trading property, values the property from the fair maintainable operating profit of a reasonably efficient operator.

4. With-and-without: the difference between business cash flows with and without the asset over the time needed to replace it; used for non-compete agreements.

5. Option pricing: Black-Scholes, binomial lattice and Monte Carlo simulation value options, convertibles, contingent consideration and real options.

5. Greenfield: assumes the business starts with only the subject asset and builds everything else; suited to licences and franchises that drive the business.

6. Excess earnings for goodwill: capitalises earnings above a fair return on net tangible assets to value goodwill as a whole; now used mainly as a cross-check.

6. Distributor method: values customer relationships from the margins earned by comparable distributors, separating them from the returns of the wider business.

7. Tax amortisation benefit: where the basis of value allows, add the present value of tax savings from amortising the asset, a common step in fair value work.

■ Part 2 · Cost approach methods

Cost approach methods and depreciation

Cost methods start from what it costs today to replace or reproduce an asset, then deduct every form of depreciation a buyer would recognise. The right column explains how each deduction is measured.

Cost methods

Depreciation and obsolescence

1. Replacement cost: the cost of a modern equivalent asset of the same utility, using current materials and design; the usual starting point because it removes surplus capacity.

1. Physical deterioration: loss of value from wear and age, measured by the age-life ratio (effective age over economic life), observed condition or cost to cure.

2. Reproduction cost: the cost of an exact replica, including obsolete features; used when utility can only be matched by an identical asset, such as heritage buildings.

2. Functional obsolescence: loss from inefficiency compared with a modern equivalent, such as excess capacity, poor layout or higher operating costs.

3. Cost elements: direct costs of materials and labour, indirect costs such as design, permits and finance, and an entrepreneurial profit where participants expect one.

3. Economic obsolescence: loss from factors outside the asset, such as falling demand, regulation or rising input costs; often measured by an income shortfall.

4. Summation method: adds separately valued components, typically land at market value plus the depreciated replacement cost of buildings and improvements.

4. Curable or incurable: a deficiency that costs less to fix than the value it adds is curable and deducted at cost to cure; otherwise measure the value lost.

5. Depreciated replacement cost: replacement cost new less depreciation; widely used for specialised property and public-sector assets that rarely sell.

5. Useful life: distinguish total economic life, physical life and remaining useful life; remaining life drives the depreciation rate.

6. Adjusted net asset method: restates each asset and liability of a business to value; suited to holding and asset-intensive companies or a liquidation premise.

6. Intangibles at cost: workforce, software and some databases are valued at cost to recreate plus an opportunity cost, less obsolescence.

7. Cross-check: test depreciated cost against market evidence or the income the asset can support; a large gap usually signals unmeasured economic obsolescence.

• Pitfall 1 of 4 · Reconciliation

• Pitfall 2 of 4 · Consistency

Averaging a DCF and a market indication that differ widely hides a problem rather than solving it. Find the cause, such as optimistic forecasts, poor comparables or a missed adjustment, and rely on the more reliable method.

A nominal post-tax cash flow to equity needs a nominal post-tax cost of equity; a cash flow to the firm needs WACC. Mixing them, or adding risk to both the forecast and the rate, double counts or misses risk.

• Pitfall 3 of 4 · Cost approach

• Pitfall 4 of 4 · Intangibles

Treating cost as value

Double counting in intangibles

Cost does not necessarily equal value. Without deducting functional and economic obsolescence, or checking that a participant would actually recreate the asset, the cost approach overstates value, especially for specialised or underused assets.

Valuing customer relationships and technology both with MPEEM on the same cash flows, or omitting CACs, counts the same earnings twice. Allocate earnings so each asset receives only its own share, and check the total against the business value.

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Read the official text, then go deeper

This page is Valuvix’s independent summary of valuation approaches and methods, drawing on IVS 103 Valuation Approaches and its appendix (IVS 2025), IVS 210 Intangible Assets and the RICS Red Book. Rely on the official texts for any assignment. Continue with our IVS 2025, RICS Red Book, EVS and USPAP guides in the standards hub.