Capitalization of earnings,
Definition of Capitalization of earnings:
Capitalization of earnings is a method of determining the value of an organization by calculating the worth of its anticipated profits based on current earnings and expected future performance. This method is accomplished by finding the net present value (NPV) of expected future profits or cash flows, and dividing them by the capitalization rate (cap rate). This is an income-valuation approach that determines the value of a business by looking at the current cash flow, the annual rate of return, and the expected value of the business.
An estimate of earnings. It finds future earnings by dividing the future earning by the capitalization rate. This method considers the risk of earnings that cease or are lower than estimated. For example, a 1 million dollar business is expected to grow by 5 percent (plus 2 percent inflation) the annual rate of return is 25 percent. The earnings estimate is 5.5 million.
Calculating the capitalization of earnings helps investors determine the potential risks and return of purchasing a company. However, the results of this calculation must be understood in light of the limitations of this method. It requires research and data about the business, which in turn, depending on the nature of the business, may require generalizations and assumptions along the way. The more structured the business is, and the more rigor applied to its accounting practices, the less impact any assumptions and generalizations my have.
How to use Capitalization of earnings in a sentence?
- The formula is Net Present Value (NPV) divided by Capitalization rate.
- Capitalization of Earnings is a method of establishing the value of a company.
- To properly apply the formula requires a strong understanding of the business being reviewed.
Meaning of Capitalization of earnings & Capitalization of earnings Definition