BVWire Australia Issue #14-1 | 15 September 2015

 

Selecting risk-free rates for valuation

Using and calculating risk-free rates can be important tools in capital asset pricing. The risk-free rate compensates investors for the time value of their money as well as the expected rate of inflation over a particular investment period.

With the growing level of global market uncertainty in recent years, investors are seeking lower risk investments. This, in turn, has prompted valuers to use longer-term views in selecting risk-free rates, reflecting longer-term expectations, rather than rely on spot or currently observed rates.

In the October issue of Business Valuation Australia, Fiona Hansen, director at PPB Advisory, analyses the impact of today’s economic and market environment on risk-free rates as an input to the capital asset pricing model.

“Most importantly, in selecting the risk-free rate for valuations, the best available data should be used, and it should be considered in conjunction with the other inputs to the discount rate to ensure consistency,” she advises. She also urges valuers and investors to be aware of the internal consistency between the risk-free rate and the market risk premium in the formula for the capital asset pricing model.

Read more on Hansen’s perspective on selecting risk-free rates in the upcoming Business Valuation Australia.

back to top

Multisegment firms gain diversification premium

A study on the impact that diversification has on the valuation of Australian businesses finds that multisegment firms can reap a significant diversification premium. The authors of the study, Chongwoo Choe, Tania Dey, and Vinod Mishra, peg that premium at between 12.4% and 18%, depending on “the measures of diversification and excess value.”

The study, which appeared in the Australian Journal of Management, Volume 39, No. 3, also reported that evidence suggests that multisegment firms can benefit even more from diversification when long-term incentives—including stock and stock options—can be used to motivate their executives.

The authors based their findings on a sample of 766 segment-year observations from 2004 to 2008, for firms that were listed on the Australian Stock Exchange as of August 2009.

back to top

Comments sought on quality review standards

The International Association of Consultants, Valuators and Analysts (IACVA) is seeking comments on a draft paper on quality review standards. The purpose of the proposed standards, the IACVA says, is to “enhance and enrich the public trust” in work done by members of the profession. Comments should be submitted to qc@iacva.org by 1 October .

“The awareness of stakeholders of valuation and appraisal services has increased significantly in the last decade,” according to an overview of the draft paper. “This has, of course, caused many to take a closer look at our profession, and especially how valuation and appraisal engagements are performed, how reports are written and presented by professionals to stakeholders.”

In asking how the profession ensures the delivery of quality services and reports, the draft report notes that “the answers to that question are not always flattering.” The draft goes on to point out, “Unlike [with] other professions, there is no uniform system for monitoring or inspection.” The quality review standards are intended to fill that gap.

A copy of the draft can be viewed here.

back to top

Campaign for best practices on valuation practices

The U.S. Appraisal Practices Board has issued an exposure draft on the measurement and application of market participant acquisition premiums and is seeking public comment on the paper.

The draft was issued on 1 September, and the deadline for submitting comments (to VFRComments@appraisalfoundation.org) is 1 November. The board has announced that it is open to making revisions to the draft, based on the comments it receives.

“Because of the need for financial statements to be both reliable and relevant, valuation practices must provide reasonably consistent and supportable fair value conclusions,” wrote the APB working group that prepared the draft. “To this end, it is believed that guidance regarding best practices surrounding certain specific valuation topics would be helpful.”

The working group states that the document is intended as a “helpful guidance” for professionals who prepare fair value measurements, rather than an “authoritative valuation standard.”

The exposure draft can be found here.

back to top

Cash flows more value-relevant than earnings in Australia

What is the difference in the value relevance of operating cash flow and earnings in stock price before and after mandatory IFRS adoption? That is the question a recent study, “Operating Cash Flow and Earnings Under IFRS/GAAP: Evidence From Australia, France & UK,” sought to answer. “We find that operating cash flows seem to be more value-relevant than earnings within and across a country border after a switch to IFRS in Australia and the UK, and earnings seem to be more value-relevant than operating cash flows in France,” the study’s three authors reported. They formulated their conclusion by looking at firms in the three International Financial Reporting Standards (IFRS) countries between 2003 and 2012. IFRS are promulgated by the International Accounting Standards Board (IASB), while generally accepted accounting principles (GAAP) are promulgated in the United States by the U.S. Financial Accounting Standards Board (FASB).

“Operating cash flow and earnings convey incremental explanatory power to explain share prices in Australia, France and the UK,” observed the authors, Lious Ntoung Agbor Tabot, Irene Pison Fernandez, and Pilar F. Cibran. “After a switch to IFRS in 2005, our study shows that the difference in account number (operating cash flows and earnings) reduces across country border but increases within country when both the IFRS and local accounting standards are used.

“Taken together,” the authors continue, their findings suggest that “after a switch to the mandatory IFRS adoption, even though income statement and the statement of cash flow are very vital for strategic decisions, investors in Australia and UK are more likely to pay more value relevance to the statement of cash flow than income statement whereas in France, income statement is more required than statement of cash flow.”

A link to the study can be found at the website of the Social Science Research Network here.

back to top

We welcome your feedback and comments. Contact the editor, Louis Berney, at editorau@bvresources.com.
Share on LinkedIn

Was this BVWire— Australia forwarded to you? Get on the list,



In this issue:

Risk-free rates

Diversification premium

Quality review standards

Best practices in valuation

Cash flows v. earnings


 

 

 

 

Copyright © 2015. All rights reserved.


Business Valuation Resources, LLC

1000 SW Broadway, Suite 1200
Portland, OR 97205
P: 0011-1-503-291-7963
Toll-free: 1-800-809560
W: bvresources.com/australia
E: editorau@bvresources.com