The following article provides brief and concise information on the relationship between investments and depreciation in perpetual retirement.
The evaluation reason
The reason for a company valuation can be diverse. This includes, among other things, the substantiation of entrepreneurial decisions, valuation based on legal regulations or valuation based on contractual agreements.
The basis for entrepreneurial decisions includes valuations in connection with profitability calculations and investment decisions as well as their financing, the purchase and sale of companies and IPOs, as well as fundamental issues of value-oriented corporate management.
Statutory valuation reasons arise from the valuation standards of external accounting (HGB, IFRS, etc.) or tax legislation. The object here is regularly to evaluate companies or company-like valuation units once or regularly. This includes valuations as part of initial consolidation (e.g. purchase price allocation) or subsequent assessment (impairment test) or valuation in connection with the Conversion Tax Act.
Valuations based on company law regulations result in particular from the stock corporation law regulations for the conclusion of company contracts or for integration or squeeze out (determination of appropriate compensation, severance payment in shares and cash settlement). In addition, the Transformation Act, for example, provides for the determination of cash settlement payments and exchange conditions in connection with the examination of the merger or division report.
Valuations on a contractual basis are carried out in particular when shareholders join and leave a partnership, in inheritance disputes and inheritance divisions, and in cases of severance payments in family law.
On the role of the evaluator
The current standards for company valuation, in particular the IDW S1 of the IDW, recognize the various roles of the valuer. These usually include the role of neutral expert, the role of advisor and the role of arbitration expert/mediator.
In the function of a neutral appraiser, a company valuer acts when he uses comprehensible methodology to determine a company value that is independent of the individual values of the parties concerned. In this context, we speak of so-called objectified corporate value.
In the advisory function, the evaluator determines a subjective decision value. This can take into account the individual framework conditions, such as taxation or expectations of corporate development. As part of this subjectized company valuation, upper or lower price limits are often also determined from the perspective of a buyer or seller as part of a transaction.
In the role of arbitration expert/mediator, the evaluator involved in a conflict situation has the role of determining a settlement value or proposing this as a mediator, taking into account the various subjective values of the parties involved.
An at least indirect link between the evaluation reason and the role of the evaluator is obvious. For example, well-founded entrepreneurial decisions often implies the determination of a decision value. In connection with legal valuation, the determination of an objectified company value is regularly in the foreground. However, there does not necessarily have to be a causal link; for example, an objectified value can also be determined for entrepreneurial initiatives in a first step in order to determine a decision value.
Business valuation methods
Valuation theory and practice has various methods for determining value. The various variants of income value methods and market value methods are most commonly used. Earned value methods include the DCF process and the income value method. Market value methods are understood to mean the various variants of the multiplier process. There are also individual value-oriented processes and special approaches tailored to the occasion and the sectors.
Market value methods are understood to mean the various variants of multiplier methods. There are also individual value-oriented processes and special approaches tailored to the occasion and the sectors.
DCF and income value method
The DCF process determines the company value by discounting future cash flows. Cash flows represent expected cash surpluses that could be distributed to investors or distributed without affecting operating business. The basis for determining the expected cash surpluses is a financial plan from which the valuation-relevant cash flow can be derived. This must be discounted at the valuation date, taking into account the business and financial risk of the company. The income value process follows the same basic structure; in contrast to cash surpluses, i.e. the result, form the basis of valuation.
Read more about this topic here: DCF rating
In addition to net present value calculations, valuation practice includes the so-called multiplier method as a simplified form of pricing (see IDW S 1, item 143). The multiplier process is based on comparative pricing. Duplicators are derived from the capital market data of suitable listed comparative companies and transferred to the company to be valued. The value of the company is calculated as the product of a company's earnings figure regarded as representative with the earnings multiplier of the comparable companies. The multiplier is calculated from the ratio of value value to earnings figure of the comparable companies.
Read more about this topic here: Basics of the multiplier process
Simplified income capitalization approach in accordance with section 199 of the Valuation Act
The simplified income value procedure is a procedure intended for tax purposes. First, the sustainable return to be achieved in the future must be determined. This is done by averaging the operating profit of the last three financial years. The calculation of operating profit is regulated by law, additions, and deductions are ultimately included in the adjustment for unsustainable circumstances, and an appropriate entrepreneurial wage must also be considered. The so-called capitalization factor (Section 203 of the Valuation Act) is then applied to the average adjusted operating profit. This is the reciprocal of the capitalization interest rate, which consists of the base interest rate and a surcharge of 4.5%. The base interest rate is published monthly by the Bundesbank. The surcharge is enshrined in law and covers entrepreneurial risks.
The simplified income value method can therefore be regarded as a special form of multiplier procedure. The result variable is determined in the past and the multiplier are not determined in a company-unspecific way and only in terms of the base interest rate on the market.
In addition to the methods mentioned above, there are other assessment methods used in practice. These include the individual value-based methods based on net asset value and liquidation value. However, these methods are generally only used in special cases or to estimate the lower value limit. In valuation practice, however, the DCF process and the multiplier method are doomed and will therefore be examined in more detail below.
Taxes in business valuation
The value of a company is determined by the amount of cash inflows to the shareholder. These net inflows must be calculated taking into account the income taxes of the company and, in principle, the personal income taxes of the company owners arising from the ownership of the company. In business valuation theory and practice as well as in case law, the need to take personal income taxes into account is indisputable.
Due to the value relevance of personal income taxes, the determination of the objectified company value requires occasional typification of the shareholders' tax circumstances. An objectified company valuation therefore uses a typical tax rate, even though the actual tax situation of the shareholders may be known.
The classification can be carried out directly, i.e., by explicitly defining the tax effect at the level of the company and the shareholders when calculating cash surpluses and in the capitalization interest rate. An indirect classification, on the other hand, is when there is no explicit consideration of the personal taxes of the shareholders. The effect of taxation on the cash surplus and on the capitalization interest rate is equal and therefore negligible.
Read more about this topic here: Taxes in objectified company valuation
Auf- und Abschläge in der Unternehmensbewertung
The use of surcharges and reductions in company valuation is an ambivalent issue. Almost none of the current so-called Premiums & Discounts has a reliable theoretical basis. However, they are regularly used in valuation practice and for good reason. However, the evaluator is all the more required to handle surcharges and reductions carefully and to act in accordance with his role as evaluator and the reason for the evaluation.
Premiums & Discounts are rated at various points. As a rule, they are collected on a lump sum basis, although there is at least a quasi-empirical basis for individual facts. These include, for example, the country risk premiums regularly published by Aswarth Damodaran.
The most commonly used indirect surcharges and reductions include the following:
- Country Risk Premium: Country risk premiums are used to record country-specific risks. These include political risks, risks from payment restrictions, etc. The Country Risk Premium is implemented by adding a premium to the cost of capital rate
- Small-cap premium: Fama and French have focused intensively on the topic of small-cap premium for the time being, with the result that the return achieved on investments in smaller companies was historically significantly higher than the expected return on the basis of current capital market theory. A small-cap premium can be taken into account via a premium in the cost of capital rate.
The most commonly used direct mark-ups and reductions include the following:
- IPO discount: The survey is carried out as part of initial placements on the stock exchange and serves as a risk buffer for investors and issuing banks. This is usually determined as a lump sum in% of the equity value and depends on investor feedback from roadshows, market conditions, etc.
- Conglomate discount: This “conglomerate discount” is set for corporate groups with heterogeneous business models. The reason for this is that such groups of companies do not offer any financial diversification advantages; according to current theory and practice, investors can achieve this through intelligent portfolio management. Synergies are also few, if in doubt none at all. However, managing a conglomerate presents corporate management with unequal and difficult tasks in decision-making, investment allocation, etc. The determination is usually also based on a lump sum of the equity value.
- Control Premium/Minority Discount: If a shareholder has control over a company, he can exert greater influence on the direction of the company. The minority shareholders are partly at the mercy of these decisions. As long as there is equality of interest, this is not a disadvantage, but there is always the potential for the majority shareholder to make entrepreneurial decisions in his favor. This is reflected in a surcharge for control over the company and a discount for minorities.