PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

268 THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLESExcess return t = after-tax operating income t¡ (hurdle rate £ capital invested t¡1 ):3. Consistent assumptions about the value of the companyafter the explicit forecast period are required. That meansthat for both models, capital required, earnings growthrate, and the hurdle rate must be consistent in computingthe terminal value.4. The hurdle rate for the explicit forecast period must bethe same as the hurdle rate after the explicit forecastperiod. 142.3. Relative or Market Multiple ValuationWhile the value of a company may be derived from the DCFor EVA valuation methodologies, other more simplistic methodsare often used to corroborate or supplement more sophisticatedmodels. In relative valuation, one estimates the value of a companyby looking at how similar companies are priced. Relativevaluation methods are typically based on market-based multiplesof balance sheet or income statement values such as earnings,revenues, or book value.Comparable CompaniesThe first step in the market multiple approach is to identifya peer group for the subject company. To select insurers for thepeer group, it is common to rely on data for publicly traded insurersthat meet certain criteria based on premium volume, mixof business, asset size, statutory or GAAP equity, and regulatoryenvironment. These criteria are intended to assure that thepeer group is reasonably comparable to the subject company.In selecting the criteria, however, it is important to balance pre-14 While it is not uncommon for a higher hurdle rate to apply to earnings at a later dateto account for the uncertainty, it is also common to apply one hurdle rate for all periodsreflecting the expected cost of acquiring capital to perform an acquisition of such anentity, that is, the required rate of return to investors.