Company Valuation Under IFRS : Interpreting and Forecasting ...

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Chapter Two – WACC – Forty years on working with for the rest of this book, ignore this option value, as it is relatively small for well capitalised companies. This still begs the question of where the unleveraged cost of equity comes from, and, as we have indicated, there are problems with the CAPM. It remains the most widely used approach, but there are good empirical reasons for replacing Betas with alternative factors reflecting size, leverage and liquidity. And there is a very real risk, even if we discount tax shelters at the unleveraged cost of equity, that we shall add back the value of the tax shelter to the company and not properly subtract the cost associated with default risk, unless we make the assumption that the risk premium that attaches to debt is all related to specific risk, and that the Beta of debt is zero. The two extreme assumptions are either to assume that all of the default risk that attaches to debt is attributable to market risk, which is probably very unrealistic, or to assume that none of it is attributable to market risk, which is probably closer to the truth for most companies. In the case of very risky companies, it will clearly not be true, and a deduction for the specific cost of default needs to be made. 9.1 Practical recommendations The practical and theoretical difficulties with the theory surrounding discount rates (both CAPM and the impact of leverage) have not been fully resolved. Because they are difficult they are often ignored by practitioners, which may be very dangerous. As with the choice of valuation model to use out of the four discussed in Chapter one, we would recommend a pragmatic approach to deciding how to handle discount rates, depending on what the key issue is that is to be addressed. Points to bear in mind are the following: 1. Are the cash flows and the discount rate in the same currency? 2. Does it matter if we use one risk free rate or do we need to model using the yield curve (which would require a time-varying model, whether WACC or APV)? 3. Do we have a group of homogenous enough companies to try to get to an industry asset Beta in which we can have some confidence? 4. Is a significant proportion of what we are valuing attributable to tax shelters, in which case we want to use APV? 5. What are we going to assume about the Beta of debt? 6. Is the company’s balance sheet structure going to change enough for this to be significant to its value, in which case we need to use either APV or timevarying WACC (in both cases being sure to discount the tax shelter at the unleveraged cost of equity, and to adjust the cost of debt for default risk)? 69
Company valuation under IFRS 7. Is the company so risky that there is a significant option component to the value of the equity? Rather than providing a single menu for the selection of discount rates, we should prefer to leave readers equipped to determine which approach to use after answering for themselves the questions above. Our examples in Chapters five and six will include selection of and calculation of appropriate methodologies and discount rates for valuation. 70
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Company valuation IFRS under Interp
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HARRIMAN HOUSE LTD 3A Penns Road Pe
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Contents Index of exhibits About th
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Index of exhibits Chapter One 1.1 C
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Index of exhibits 4.28 Capitalising
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About the authors Nick Antill: Sinc
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Company valuation under IFRS Most q
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Company valuation under IFRS Chapte
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Acknowledgments The authors have be
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Chapter Five Valuing a company Pull
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Chapter Five - Valuing a company Ex
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Chapter Seven An introduction to co
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Chapter Seven - An introduction to
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Chapter Eight Conclusions and conti
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Chapter Eight - Conclusions and con
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Chapter Eight - Conclusions and con
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Further reading Introduction This b
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Further reading Difficult sectors T
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Index A Accrual 14-15, 90, 99, 106,
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Index E Earned premiums 301-303, 32
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Index J Joint venture 354 L Leases
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Index Regulatory capital 274, 281,
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Company Valuation Under IFRS : Interpreting and Forecasting ...

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