Company Valuation Under IFRS : Interpreting and Forecasting ...

Company valuation under IFRS
The first page of this model derives projected historical cost accounts for a
company which plans to make an investment of 100 at the end of Year 0, and
whose investments grow at 5 per cent annually thereafter, this merely
representing the inflation rate. So once the company is mature it will not grow
but will merely maintain itself. To keep the spreadsheet manageable, the asset life
is set at three years (it could be ten times that in reality), so by Year 4 we have a
mature company, which should simply be growing in line with inflation.
Each annual investment is permitted by the regulator to generate a stream of cash
which begins at 39.71 per cent of the original investment (we shall explain this
odd figure below), and which grows annually with inflation. So the initial 100
investment in Year 0 generates 39.71 * 1.05 = 41.69 in Year 1, and 5 per cent
more in each subsequent year of its life. It is retired at the end of Year 3. The cash
flow calculations culminate with a calculation of cash flow from operations and
of net cash flow (cash flow from operations minus capital expenditure). By Year
4, the company is mature, and both are growing at 5 per cent annually.
1.4.2 HCA accounts
Now, we need to convert these cash flows into balance sheets and profit and loss
accounts. Starting with gross assets, these grow each year with capital
expenditure, but in Year 3, that year’s expenditure is offset by the retirement of
the investment made in Year 0. So, by Year 4, gross assets are also expanding at
5 per cent annually, as one third of the balance sheet is uplifted by 15 per cent
(three years’ worth of inflation). Net assets in the balance sheet also grow with
capital expenditure, but are reduced by an annual depreciation charge, which is
the opening gross asset figure, divided by the asset life, in this case by three. The
cumulative depreciation charge is the difference between closing gross assets and
closing net assets, and grows each year by the difference between depreciation
and retirements (when an asset is retired it drops out of gross assets and
cumulative depreciation). With a three year asset life, after two years the
proportion of gross assets that have been depreciated is a stable number. There
will always be two partly depreciated assets and one un-depreciated asset in the
balance sheet at the end of each future year.
Profit is simply cash flow from operations minus depreciation, and return on
opening capital is profit divided by opening capital (which, in this model, merely
comprises fixed assets as there is no working capital).
1.4.3 CCA accounts
The second page of Exhibit 6.1 takes the same cash flows and converts them into
current cost account. As with the HCA numbers, we capitalise capital
expenditure. But when we calculate the closing balance sheet figure for gross
fixed assets, we include an adjustment for inflation, to increase the opening
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