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Lukas Loderer
lloderer@deloitte.at
Tel: +43 (0)1 537 00 2888

Since the financial crisis in 2008, there has been great volatility in the markets and hence in forward-looking equity risk premium (ERP) estimates. Stomas Nicholas and Greg Forsythe (both Deloitte US) found in their new paper,  Are You Mispricing the Investment Risk?  that most companies rely on static forecasts to estimate equity risk premiums. Such static forecasts do not properly incorporate the volatility of markets and thus often misprice the costs of investment risks.  A method which addresses this shortcoming, the implied ERP, uses future cash flow expectations and consequently takes into account current investors’ expectations of risk.

The authors describe the advantages of using the implied ERP approach and further illustrate why investors and managers need to review their ERPs on a regular basis (at least quarterly).

More information on their paper: CFO Insights 

Lukas Loderer
lloderer@deloitte.at
Tel: +43 (0)1 537 00 2888

The market risk premium represents the difference between the expected return of the market portfolio and the risk-free rate. In its latest publication, dated January 17th 2012, the Specialist Committee on the valuation of companies of the Chamber of Certified Public Accountants recommends to currently apply a market risk premium of 5.5% for the Austrian market.

In the light of the already enacted change in the Austrian tax system concerning the taxation of capital gains (a flat rate tax of 25% will be imposed on all capital gains, before this amendment long-term capital gains had been tax free) and the accompanying assimilation of the Austrian to the German tax system, the Specialist Committee believes, until further notice, a market risk premium (before personal income tax) of 4.5% to 5.5% (until now: 4.5% to 5.0%) to be appropriate. In conjunction with the currently observable situation on capital markets the Specialist Committee recommends the use of a market risk premium at the upper end of this suggested range.

Apart from this, there are also a number of other sources which estimate market risk premiums. One very popular is Prof. Damodaran’s website. At the moment, he estimates the market risk premium for mature equity markets, e.g. Austria, at 6.0%. He splits the market risk premium in two separate factors: (1) a risk premium for a mature equity market (estimated from US historical data) and (2) a country risk premium which adjusts the market risk premium for a greater default risk as compared to a mature equity market. The default risk is estimated on the basis of Moody’s country ratings. Since Austria still enjoys highest credibility (according to Moody’s – Standard & Poor’s has already downgraded Austria), his estimate for the market risk premium for Austria equals that of a mature equity market.

As a final remark, we want to stress that especially in the light of the current economic situation, one should keep in mind the need for consistency of all valuation parameters – therefore also the market risk premium needs to be ana-lyzed carefully. It should be noted, that the market risk premium should never be considered as a stand-alone pa-rameter – valuation professionals should rather keep in mind that the single parameters of the discount rate are re-lated to each other and therefore interact with one another. As initially stated, the market risk premium is the differ-ence between the expected return of the market portfolio and the risk-free rate. Hence, those variables have a direct impact on the market risk premium and thus an integrated approach is required. Furthermore, all other assumptions underlying a valuation, e.g. assumptions concerning cash flows, growth rates or the economic situation, should be analyzed and taken into consideration when deriving the discount rate.

Johannes Kroner
jkroner@deloitte.at
+43 (0)1 537 00 2823

As the risk free rate constitutes a fundamental part of the discount rate used for valuations, its development takes effect on the value of businesses and other assets. The end of the year, December 31, is by nature a commonly used valuation date – many business valuations and impairment tests are typically performed on that date. Therefore, the very low risk free rate of this year’s end can be expected to be widely applied. All else equal, a lower risk free rate leads to lower discount rates, which, in turn, lead to higher valuation results. Considering only the direct effects of the risk free rate and ignoring other possibly adverse effects that might go along with a low risk free rate, one would wind up with an inconsistent valuation and unnaturally high values.

As a result, valuation professionals should, amongst other things, specifically pay attention to the consistency of the planning assumptions with the applied discount rate, the determination and level of the market risk premium, or the assumptions regarding the sustainable growth rate.

From a simplified perspective, the nominal risk free rate can be seen as the sum of the “real” risk free rate plus the expected inflation rate. Assuming that the real risk free rate is more or less stable over time, the observed, nominal risk free rate somehow reflects people’s view on the economic future. A low nominal risk free rate implies inflation and real growth expectations at low levels. Hence, these relationships should be considered when analyzing a business plan or determining a sustainable growth rate. Apart from that, the initially described “flight to quality” – the investor’s search for safer investments – also affects, besides the risk free rate, the risk premiums for risky asset clas-ses. Therefore, the equity risk premium can be expected to rise.

Johannes Kroner
jkroner@deloitte.at
+43 1 537 00-2823

After dipping to 2,62% at the end of September 2011, the risk free rate recovered but dipped again in the middle of November, thereby hitting 2,58%. Within ten days it shot back to over 3,00% to plunge to a new historic all-time low at 2,42% on December 15, 2011. In general, the risk free rate has been steadily declining since its peak at 4,09% at the beginning of April 2011.

An analysis of short- and mid-term risk free rates (i.e. one, three, five, and ten years) and the expected average inflation rates (source: EIU) for the according maturities shows that the real yield for the afore mentioned maturities is expected to be negative, ranging from -1,82% (one-year) to -0,36% (ten-year).

As initially suggested, the currently low levels of the risk free rate reflect the uncertainty and fear in financial markets. The German Government Bonds, on which the calculation of the risk free rate according to Svensson is based on, are considered a safe haven. The currently unstable market situation on financial markets, the ongoing European Government debt crisis which emerged from the Greek debt crisis, and the inability of European politicians to calm markets or provide promising solutions, support a more conservative investor behavior among European investors in general. December was characterized by a continuing stream of bad news such as the announcement of the rating agency Standard & Poor’s that it put its long-term sovereign ratings on 15 members of the Eurozone on “CreditWatch with negative implications” or the downgrade of Belgium’s credit ratings by Moody’s in the middle of December. A “flight into quality” often goes along with such events and explains – at least partly – the recent declines of the risk free rate.

The calculation of the risk free rate is based on the yield curve according to Svensson, the parameters of German Government Bonds and the according spot rates.

Johannes Kroner
jkroner@deloitte.at
+43 (0)1 537 00 2823

Die moderne Unternehmensbewertung stellt hohe Anforderungen an die damit befassten Personen: Sie erfordert Kenntnisse über grundle-gende finanzwirtschaftliche Theorien, Kenntnisse im Bereich der Rechnungslegung, der Statistik und der Ökonomie.Im ihrem gerade erschienenen Buch haben sich Aschauer/Purtscher das Ziel gesetzt, die für die Unternehmensbewertung notwendigen Grundlagen leicht verständlich zu vermitteln, wobei sie gleichermaßen die theoretische Basis der Unternehmensbewertung als auch die An-wendung in der Praxis ausführlich behandeln. 

Sowohl Studierenden als auch Praktikern soll dieses Buch als Hilfsmittel dienen, schnell in die komplexe Materie der Unternehmensbewertung einzusteigen, die Diskussionen und Problemfelder aber trotzdem in der notwendigen Tiefe nachvollziehen zu können.

Die Autoren sind anerkannte Experten im Fach Unternehmensbewertung – Dr. Ewald Aschauer ist Universitätsassistent an der WU Wien, Abteilung für Unternehmensrechnung und Revision; Dr. Victor Purtscher ist Partner bei Deloitte und Leiter des Bereichs Valuation Services; beide sind Mitglieder der Arbeitsgruppe Unternehmensbewertung der Kammer der Wirtschaftstreuhänder. Dieses Buch ist auf Basis ihrer zahlreichen Publikationen, Vorträge sowie langjährigen praktischen Erfahrung im Bereich der gutachterlichen Unternehmensbewertung entstanden.

Weitere Informationen (Inhaltsverzeichnis, Leseprobe etc.) unter

http://www.lindeverlag.at/titel-0-0/einfuehrung_in_die_unternehmensbewertung-4310/

Victor Purtscher
vpurtscher@deloitte.at
+43 (0)1 537 00 2800