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According to the Federal Court of Justice, external liabilities are to be taken into account in the capitalized earnings value method by deducting the interest on borrowed capital attributable to them.
The ruling by the Federal Court of Justice (BGH) on April 13, 2016 (case no. XII ZB 578/14) has significant implications for business valuation using the capitalized earnings method. According to this ruling, when determining the business value using the capitalized earnings value method, the external liabilities encumbering the business must be taken into account by deducting the interest on borrowed capital attributable to them.
According to the BGH ruling, it is not permitted to deduct external liabilities in the amount of their nominal value directly from the calculated enterprise value. Instead, the interest attributable to the external liabilities must be deducted from the total enterprise value. This leads to a more precise and realistic valuation of the company, as the interest burden on Debt influences the financial performance of the company.
In accordance with Section 1376 (4) BGB, the nominal value of the debt liabilities must be deducted from the total enterprise value. If the resulting value is lower than the capitalized earnings value, the lower market value must be used. This regulation ensures that the valuation of the company is fair and in line with the market by taking into account both the interest burden and the actual debt.
The capitalized earnings value method is a common business valuation method in which the company value is calculated on the basis of future earnings. This method takes into account the expected income and expenses of a company and discounts these to the present value. Interest on borrowed capital plays an important role here, as it influences future expenses and therefore reduces the value of the company.
Taking interest on borrowed capital into account when determining the total enterprise value is crucial for an accurate valuation. By deducting the interest charge, the actual financial condition of the company is better reflected. This is particularly important in order to avoid overvaluation, which could occur if only the nominal value of borrowings were taken into account.
The ruling emphasizes that the lower market value must be used if the value after deducting the nominal value of external liabilities is lower than the capitalized earnings value. This ensures that the valuation of the company is based on a realistic and market-oriented value and that both the earning power and the actual indebtedness of the company are taken into account.
The BGH ruling of April 13, 2016 has important implications for business valuation using the discounted earnings method. The requirement to take external liabilities into account by deducting the interest on borrowed capital attributable to them enables a more accurate and realistic valuation. This contributes to transparency and fairness in business valuation and helps to avoid overvaluation. Companies and valuation experts should follow these guidelines to ensure a correct and fair valuation.
The ruling is relevant as it clarifies the practice of business valuation and ensures that the interest charge on Debt is correctly included in the valuation, allowing for a more realistic and fairer valuation.
If the market value is lower than the capitalized earnings value, the lower market value must be used in accordance with the ruling. This ensures that the valuation of the company is based on a realistic and market-oriented value.
With the capitalized earnings value method, the company value is calculated on the basis of future earnings, whereby these expected income and expenses of a company are discounted to the present value.
The consideration of interest on Debt leads to a more accurate valuation, as the interest burden on Debt influences the financial expenses of the company and thus reduces the company value.
Companies should ensure that they account for interest on borrowings, correctly deduct the nominal value of borrowings and consider fair value to ensure a fair and realistic valuation.
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