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Replacement Cost

Previously, I’ve covered two important valuation methods: i) discounted cash flow (DCF) and ii) comparables (Comps). To conclude my valuation series, the third tool Alderman & Company utilizes to build a complete valuation is Replacement Cost.

Would you buy a company if you could build it for a fraction of the cost?

The Replacement Cost valuation method addresses whether a potential buyer should acquire their target, or if they would benefit from building the target company from the ground up. Replacement Cost simply totals how much it would cost a potential buyer to replace and build the company on an arm’s length basis. This includes two main components, tangible and intangible assets, which most importantly include a subjective assessment of time to market and time to capture market share.

Tangible assets, items like inventory and property, are totaled at what it would cost to replace those items in a similar condition and at the present-day value. Intangible assets are items like patents, copyrights, proprietary technology, goodwill, and most importantly an assessment of the cost to acquire customers and capture market share. The value of these items are often very subjective.

When conducting a valuation in the middle market of the aerospace and defense industry, Alderman & Company has always used three methods collectively: DCF, Comps, and Replacement Cost. If the replacement cost is considerably lower than the other methods, and the time to market and time to capture market share are potentially not too far into the future, then it’s an indication that buyers may opt to build your company from the ground up rather than pay a premium to acquire your company.

While the buyers in the middle market of aerospace and defense don’t often rely on replacement cost for an accurate gauge of value, it’s an important criterion that many buyers will review when considering their level of interest in buying a business.

Have a great day everyone.

Ryan Kirby
Vice President