Since there are very few comparable statistics, analysts often need to assemble their own matrix of required asset return rates for enterprises with intangibles, Steve Shaw (Financial Seminars) told attendees at last month’s ICAEW Valuation Community Annual Conference in London. ‘The important thing is that you’re consistent between one [valuation] and the next,’ he said, even though the tax benefits of FRS102 separable assets have been reduced.
Shaw presented with Ashley Higgs (Smith & Williamson). The two well-known analysts reviewed WACC conclusions for two comparable firms: one capital-intensive and one a knowledge firm. In the first case, a combination of a 4% discount rate for intangibles (83% of total assets) and a 25% rate on intangibles (17% of assets) results in a 10% WACC. By comparison, a 4% discount rate on the knowledge firm’s tangible assets (23% of assets) and 18% on intangibles (77% of assets) results in a WACC ‘fulcrum’ of 15%.
This model is simplified, since, as most analysts realise, not every intangible has the same required rate of return. Typically, Shaw sees descending discount rates similar to the following example:
- In process R&D—20%;
- Unpatented technology—16%;
- Patents and external use technology—11%;
- Workforce in place—10%;
- Customer relations—10%; and
- License agreements—10%.
Shaw discussed the valuation methods best matched to complicated scenarios such as purchase price allocations, negative goodwill, and insolvency. In particular, he relies on contributory asset charge. It is ‘used to reflect the use of all assets in the production of a margin,’ Shaw says. Each benefitting asset (a customer relationship, for example) ‘pays a hypothetical rent to use other contributing assets.’
This question comes up frequently in BV, particularly in purchase price allocations where discount rates tend to increase for assets further down on the balance sheet. So it’s relatively normal to use different discount rates, and it’s logical to see how other evaluations—for instance, regarding the new right to use lease standards—might also require multiple discount rates.
Shaw and Higgs recommend that business valuers also conduct a test of the weighted discount rate across all asset classes to ‘guarantee the average discount is in line with the discount rate for the entity as a whole.’
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