As this issue rolls off the (virtual) presses, BVWire is attending the AICPA & CIMA Forensic and Valuation Services Conference. The kickoff session of the three-day event, which was presented by Carla Nunes and Jim Harrington, both with Kroll, discussed the cost of capital ramifications of the Russia-Ukraine War and global inflationary pressures.
Uncertainty and volatility: The raising of interest rates by the major central banks and the war have led to progressively weaker growth forecasts for the U.S. and other economies. “There will be a lot of pressure on earnings over the next couple of years,” said Nunes in a recent video. Revenue growth will depend on the ability to pass on increased costs to customers, but costs may outpace revenue growth and the price increases could weaken demand.
The increased uncertainty about economic growth and company earnings could result in a variability around expected cash flows, which makes equity risk higher. Recently, Kroll increased its recommended U.S. equity risk premium (ERP) from 5.5% to 6.0% when developing USD-denominated discount rates as of Oct. 18, 2022. This is matched with the higher of a normalized risk-free rate of 3.5% or the spot 20-year U.S. Treasury yield as of the valuation date if it is higher than 3.5%, Kroll said in a recent update.
Also, increased financing costs raise the cost of debt, so there may be less M&A activity, Nunes remarked, and you could see valuations going down.
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