Capitalization Of Earnings


DEFINITION of 'Capitalization Of Earnings'

A method of determining the value of an organization by calculating the net present value (NPV) of expected future profits or cash flows. The capitalization of earnings estimate is done by taking the entity's future earnings and dividing them by the capitalization rate (cap rate). This will take into account the risk that earnings will stop or be lower than the estimate.

Capitalization Of Earnings

d = discount rate
g = growth rate

BREAKING DOWN 'Capitalization Of Earnings'

This is an income-valuation approach that determines the value of a business by looking at the current benefit of realizing a cash flow now, rather than in the future. The capitalization of earnings is particularly useful when the future earnings can be predicted easily and accurately.

For example, if a company had a business that made $1.2 million last year and that was expected to grow at a 4% rate (plus a 3.25% inflation rate), the annual rate of return needed by a purchaser given the level of risk would be 26%. Expected value using the capitalization of earnings method would be $6.4 million, calculated as:

-$1,200,000/ (0.26 - (.04+.0325))
-$6.4 million

  1. Capitalization Rate

    The rate of return on a real estate investment property based ...
  2. Discounted Cash Flow (DCF)

    Discounted cash flow (DCF) is a valuation method used to estimate ...
  3. Cash Flow

    The net amount of cash and cash-equivalents moving into and out ...
  4. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present ...
  5. Asset Valuation

    A method of assessing the worth of a company, real property, ...
  6. EBITA

    Earnings before interest, taxes and amortization. To calculate ...
Related Articles
  1. Fundamental Analysis

    Discounted Cash Flow Analysis

    Find out how analysts determine the fair value of a company with this step-by-step tutorial and learn how to evaluate an investment's attractiveness for yourself.
  2. Investing

    Using DCF In Biotech Valuation

    Valuing firms in this sector can seem like a black art, but there is a systematic way to pin a price on potential.
  3. Fundamental Analysis

    Top 3 Pitfalls Of Discounted Cash Flow Analysis

    The DCF method can be difficult to apply to real-life valuations. Find out where it comes up short.
  4. Markets

    Intangible Assets Provide Real Value To Stocks

    Intangible assets don't appear on balance sheets, but they're crucial to judging a company's value.
  5. Markets

    Understanding Economic Value Added

    Discover the simplicity of this important valuation metric. We reveal its underlying ideas and examine each of its components.
  6. Economics

    Explaining Appreciation

    Appreciation refers to an increase over time in the value of an investment or asset.
  7. Economics

    Calculating Long-Term Debt to Total Assets Ratio

    A company’s long-term debt to total assets ratio shows the percentage of its assets that are financed with long-term debt.
  8. Economics

    Calculating Days Working Capital

    A company’s days working capital ratio shows how many days it takes to convert working capital into revenue.
  9. Term

    What Is Financial Performance?

    Financial performance measures a firm’s ability to generate profits through the use of its assets.
  10. Economics

    5 Ways to Create Residual Income

    Here are 5 ways through which you can create residual streams of income.
  1. Which is a better measure for capital budgeting, IRR or NPV?

    In capital budgeting, there are a number of different approaches that can be used to evaluate any given project, and each ... Read Full Answer >>
  2. How do I read and analyze an income statement?

    The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >>
  3. How do dividends affect the balance sheet?

    Dividends paid in cash affect a company's balance sheet by decreasing the company's cash account on the asset side and decreasing ... Read Full Answer >>
  4. Who actually declares a dividend?

    It is a company's board of directors who actually declares a dividend. The declaration date is the first of four important ... Read Full Answer >>
  5. Are dividends considered an expense?

    Cash or stock dividends distributed to shareholders are not considered an expense on a company's income statement. Stock ... Read Full Answer >>
  6. Do dividends go on the balance sheet?

    The only account recorded on the balance sheet, when dividends are declared and before they are paid out to a company's shareholders, ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Ex Works (EXW)

    An international trade term requiring the seller to make goods ready for pickup at his or her own place of business. All ...
  2. Letter of Intent - LOI

    A document outlining the terms of an agreement before it is finalized. LOIs are usually not legally binding in their entirety. ...
  3. Purchasing Power

    The value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. Purchasing ...
  4. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  5. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  6. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!