What is a contributory asset charge and how is it calculated?

Full Explanation

In the Multi-Period Excess Earnings Method (MPEEM), the asset being valued does not generate cash flows in isolation — it relies on other assets like working capital, fixed assets, assembled workforce, and other intangibles. Contributory asset charges represent the fair return on (and sometimes of) these supporting assets, deducted from total cash flows to isolate the earnings attributable to the primary intangible. For each contributory asset, the charge is calculated as: fair value of the asset multiplied by its required rate of return. For wasting assets (like assembled workforce or technology), a return of capital component is also included to reflect the need to replace the asset over time. For example, if tangible fixed assets worth £5M require an 8% return, the annual contributory asset charge is £400K. If assembled workforce worth £2M requires a 12% return plus 10% return of capital, the charge is £440K annually. The sum of all contributory asset charges is deducted from the projected cash flows before discounting to arrive at the value of the subject intangible. Getting contributory asset charges right is essential because understating them inflates the value of the primary intangible, while overstating them suppresses it. Auditors closely scrutinise the rates and assets included in the contributory asset charge schedule.

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