Value Your Business Now! A down-to-earth, step-by-step guide to business valuation by Kenneth Bonnici

Author:Kenneth Bonnici [Bonnici, Kenneth]
Language: eng
Format: mobi
Published: 2012-12-12T14:00:00+00:00

Source: (Bloomberg) http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Source: (Financial Times) http://markets.ft.com/research/Markets/Bonds

Now remember, what you need to take is the yield not the coupon rate. At the time of writing the current yield on thirty-year government bonds in the US (Treasury bonds), UK (Gilts) and Germany averaged around 3%. Let’s go with that as our risk free rate for the purpose of our worked example. I’ve put this in cell I6 of the “DiscountRate” sheet in the DIY Template.

Equity risk premium (ERP)

The equity risk premium is the "extra return" that investors collectively demand for investing their money in company shares, instead of holding it in something less risky like those government bonds we’ve just mentioned. You estimate the ERP by looking at stock market data, lots of it. You just need a degree in mathematics and statistics, a fetish for economics and financial markets, a powerful PC, patience and loads of spare time on your hands to analyse insane amounts of historical stock market data for an old and mature market like the US Stock Exchange. Your mission, should you chose to accept, is to establish the incremental returns of the stock market over time, over and above risk free rates. Piece of cake, but you don’t really have the time, right? No problem. Fortunately there are some very bright people out there whose job is precisely to do all this exciting number crunching for us and hand us what we need on a plate. And the ERP magic number here is 5%. And the good thing is that it doesn’t really change all that much.

It may seem strange that ERP doesn’t change much with all the havoc ravaging stock markets everywhere from time to time. Well, this is because ERP is derived from long-term historical market data, so this premium includes both periods of positive (good times) and negative (bad times) equity returns, and the stock market has seen plenty of bad times over its history. Therefore, the argument is that the ERP already reflects the possibility of negative or low returns and so it does not need to be adjusted materially to reflect current market circumstances. In short, taking 5% for ERP is fine if you assume a long-term view and it’s certainly good enough for our DIY valuation. So we’re sticking with 5%. This goes in cell I8 of sheet “DiscountRate” in the Template

Beta

This is where it may start to start getting a bit tricky. Despite the Greek, it’s not though and I’ll do my best to explain it simply, so please don’t walk out on me just yet.

Now as we’ve said, beta is a measure of the risk of a market sector in relation to the overall market average. It tells you if the industry you operate in is more risky than the market average, or less, and to what extent. It is measured as a factor of 1, with 1 being the market average. So anything above 1 is more risky, whereas anything below is less.

Like ERP, estimating betas requires looking at a loads of historical stock market data to identify patterns and trends.

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