True Value

The Upside

When it comes to worth, you may as well start at the beginning: dollar value. You'd think that would be simple, but it's not. There are dozens of ways to calculate value, some better than others, depending on the circumstances. For example, you can price an asset based on its historical cost, less depreciation-but this may have no relation to economic reality or fair market value. Using replacement value is relevant only if you can replace, license or recreate the item in question.

Earning potential is a more sophisticated approach, often used to value an entire enterprise. Professional appraisers have numerous for-mulas to compute earning potential, such as multiplying projected annual profits or sales (after-tax earnings or dividends) by an accepted industry multiplier called a "cap rate," or discounting some estimate of future cash flows. As you may imagine, tech-nical problems abound, and the numbers you get depend on your assumptions, your accountant and the cap rate you choose.

Assessing the long-term potential of your deal is another factor to consider-and it's more about being in the right place at the right time than about specific numbers. When the strategic advantage of an entire product line, service or market is in question, long-term potential is a critical factor. To get it right, you need to be part analyst, part visionary.

Subjective value, which focuses on what personally turns you on about a deal, should also be considered. Will you work with good friends? Visit your favorite city more often? Fulfill some lifelong dream? Clearly, this consideration "ain't about the money."

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This article was originally published in the January 2001 print edition of Entrepreneur with the headline: True Value.

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