Company Valuation Under IFRS : Interpreting and Forecasting ...

Company valuation under IFRS
Sadly, for the vast majority of valuation models currently in use in banks,
investment institutions and companies, that is indeed it. Of course they are
adjusted to permit companies to be financed both with debt and with equity (a
point to which we shall return later) and they accommodate accounts which
include goodwill, provisions and other items (often badly – that is another point
to which we shall return). But in principle, this is how most of them work, and it
is dangerously simplistic.
Let us return to Constant company and change the rate of growth in the terminal
value calculation. The resulting effect on value is illustrated in Exhibit 1.5.
Exhibit 1.5: Value versus growth
Value Versus Growth
5,264
4,764
4,264
3,764
3,264
2,764
2,264
1,764
1,264
3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 7.0%
TV growth rate
Well, that is impressive! Tiny changes in growth rate are having an increasingly
enormous effect on our value. (The first 1,264 of value is coming from the 25
years of forecast dividend, so the columns are illustrating merely the impact of
changes in the assumed growth rate after 25 years!) But is this realistic? To
answer the question, let us think back to the components of the Gordon Growth
model: dividend, growth rate, and discount rate. What we are doing is changing
the growth rate and leaving the other two unchanged. Is this plausible? Can we
grow at different speeds and still distribute exactly the same amount of dividend?
Surely not. If we want to grow faster then we need to retain more of our profits
within the company, and reinvest them to grow the business. An extreme case is
what happens if we distribute all of our profit, and do not grow at all. So what
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