The following article provides brief and concise information on the relationship between investments and depreciation in perpetual retirement.
The cash flow of the “perpetual pension” is regarded as an extremely value-sensitive parameter in the DCF assessment. This is determined, among other things, by the amount of sustainable investments. Depreciation has a secondary effect; although initially ineffective, there is a valuation-relevant cash effect due to the tax relief.
Investments and depreciation are often set at the same rate in the perpetual pension. This is usually wrong. The easily understandable reason for this is that investments are made at current procurement costs, while depreciation reflects historical costs. Both cost variables are not the same if the price increase rate is > 0. The rule of thumb for the difference between investments and depreciation is: AFA period/ 2 * price increase. Investments with a useful life of 20 years and an average price increase of 2% p.a. are therefore ~ 20% higher than depreciation. In principle, this fact always applies and not just to the “perpetual pension”. For evaluators, knowledge of the effect is important because the financial planning is usually provided by the client and/or management, while setting the perpetual pension is the original task of the appraiser. Neglecting this effect results in an overvaluation due to the abovementioned tax relief from the overestimated depreciation. Key message: Investments should reflect replacement costs, while depreciation should reflect historical costs. Typical mistake: Investments and depreciation are set at the same rate. Takeaways:
- A high average useful life of fixed assets widens the gap between investments and depreciation
- The development of procurement prices is the second major factor influencing the difference between investments and depreciation
- If the investment intensity of the valuation object is high, i.e. a comparatively high proportion of depreciation costs in the total costs of the appraisal object, this effect has a significant influence on the valuation.