A Fair Value Discount Factor (Deflator) Applied to the Valuation of Earnouts

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American Society of Appraisers Business Valuation Review™
Winter 2011 Volume 30, Issue 4 pp. 115-120
Ron-zeev Elkounovitch

Summary

In this article, I propose an approach to determine the appropriate discount factors to value an earnout. I start with an example and provide a set of discount factors to value the earnout. I then show that the proposed discount factors meet certain conditions required to ensure that the valuation of the earnout is market consistent. Since the discount factors derived here are scenario specific, the same set of discount factors can be used to value any earnout structure based on the same performance metric and time period. The approach I present is by no means original, only an application of techniques used in other areas of valuations (in particular, in the valuation of insurance liabilities). To be consistent with the actuarial literature, I term the scenario-specific discount factors “stochastic deflators.”
A Fair Value Discount Factor (Deflator) Applied to the Valuation of Earnouts
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