RoyaltyStat Blog

Valuation of Intangibles - Not Hard to Measure

Posted by Ednaldo Silva on Mar 4, 2016 6:30:11 AM

The valuation of self-developed intangibles does not produce any special analytical problem compared to the valuation of tangible assets. The key issue is to separate and distinguish in the company's general ledger the stream of income and expenses attributed to the identifiable assets. E.g., it’s recognized that R&D expenses (XRD in Capital IQ Compustat’s mnemonics, or investment) produces technology intangibles, such as patents, know-how, and trade secrets. Likewise, it's recognized that advertising and promotion expenses (XAD) produces marketing intangibles, such as trademarks (branding) and customer list. In short, it’s recognized that:

     (a)  XRD → Technology intangibles; an

     (b)  XAD → Marketing intangibles.

In economics it's conceived that these intangibles generate persistent extra or abnormal profits if they lead to significant market share. It’s the existence of significant market share that leads to excess profits, and not the existence of intangibles per se. See Dennis Mueller, “The Persistence of Profits above the Norm,” Economica, Vol. 44, No. 176 (Nov., 1977). Stable URL: http://www.jstor.org/stable/2553570 

After the initial capital stock (K0 = I0/(g + δ)) is calculated based on the initial investment and the expected growth rate of the revenue (income) attributed to the identifiable (tangible or intangible) assets, this start-up amount can be accumulated by the periodic investment flows attributed to the identifiable asset (e.g., annual CAPEX, advertising or R&D expenditures) using the perpetual inventory model (PIM): 

          Kt = It + (1 – δ) Kt-1

where the coefficient δ is the depreciation (tangible assets) or amortization (intangibles assets) rate. See Charles Hulten, "The Measurement of Capital," in Ernst Berndt & Jack Triplett (eds.), Fifty Years of Economic Measurement (University of Chicago Press, 1990), and Measuring CapitalOECD Manual (2nd. Edition, 2001), Chapter 6 (Perpetual Inventory Method), located at URL http://www.oecd.org/std/productivity-stats/43734711.pdf 

Any capital expenditure (CAPEX or investment flow) that can be subject to a separate and distinct accounting treatment in a company’s general ledger can be converted into an identifiable capital stock at a given time, composed of either tangible or intangible assets. The value of intangibles is not hard-to-measure using PIM, and it's more reliable than using present value based on forecasted "net profits" over a long period. See http://www.oecd-ilibrary.org/docserver/download/2314291e.pdf?expires=1461510938&id=id&accname=guest&checksum=DC57E26A9191077449D95D37827FF24D

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Ednaldo Silva (Ph.D.) is founder and managing director at RoyaltyStat. He helped draft the US transfer pricing regulations and developed the comparable profits method called TNNM by the OECD. He can be contacted at: [email protected]

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Topics: Valuation of Intangibles