Cost of Capital: Applications and Examples, + Website, 5th Edition

CHAPTER 30

Cost of Capital for Fair Value Reporting of Intangible Assets¹

Gary Roland and Glen Kernick

Introduction

Financial Reporting Context

Market Participants

Asset Group

Cash Flows and Risk

Synergies

Fair Value Balance Sheet

Net Working Capital and Fixed Assets

Identifiable Intangible Assets

Unidentifiable Intangible Assets (i.e., Goodwill)

Intangible Asset Income Approach

Multiperiod Excess Earnings Method

Contributory Assets

Differentiating Risks among Assets

Net Working Capital

Fixed Assets

Intangible Assets

Implied Rate of Return—Unidentifiable Intangible Assets

Rate of Return-based Reconciliation

Value-based Reconciliation of Rates of Return

Liabilities

Summary

Additional Reading

INTRODUCTION

The emphasis on fair value in financial reporting with the goals of improving transparency and providing useful information to investors has solidified the need for supportable and defensible estimates of the cost of capital used in the measurement of assets and liabilities for financial reporting. Although this applies to all types of assets and liabilities, the focus of this chapter is on the development of the cost of capital for intangible assets.

The general lack of observable market data related to rates of return for individual tangible or intangible assets of a business enterprise creates challenges in the development of a supportable cost of capital. As cost of capital relates to tangible assets (net working capital and fixed assets), there are many cases in which discount ...