Current Update in Valuation
DUFF & PHELPS RISK PREMIUM REPORT
- Sorts companies by 8 different measures of
size –
25 size-ranked portfolios vs. Morningstar 10
deciles ranked by market value of equity
© 2009 National Association of Certified Valuation Analysts 1
Current Update in Valuation
25 size-ranked portfolios for 8 different
measures of size:
1. Market value of common equity
2. Book value of common equity
3. 5-year average net income
4. Market value of invested capital
5. Total assets
6. 5-year average EBITDA
7. Net sales
8. Number of employees
© 2009 National Association of Certified Valuation Analysts 2
Current Update in Valuation
The criteria for the Duff & Phelps study are:
1. Companies must be in both the Compustat and the CRSP databases
2. SIC Code other than Financial Services (SIC=6)
3. Publicly Traded for 5 Years
4. Established History of Sales and Profitability
5. Sales > $1 million in each of last 5 years
6. Positive 5-Year-Avg. EBITDA
7. Positive Book Value
8. Debt/MVIC < 80%
© 2009 National Association of Certified Valuation Analysts 3
Current Update in Valuation
Companies that pass this test have been:
– Traded for several years
– Selling at least a minimal quantity of
product
– Able to achieve some positive cash flow
© 2009 National Association of Certified Valuation Analysts 4
Current Update in Valuation
Companies not meeting the criteria were
“excluded” from the base set and placed in a
separate “High Financial Risk” portfolio
© 2009 National Association of Certified Valuation Analysts 5
Current Update in Valuation
© 2009 National Association of Certified Valuation Analysts 6
Current Update in Valuation
© 2009 National Association of Certified Valuation Analysts 7
Current Update in Valuation
• Thus,
– Using the riskless rate of 4.7% as of the
Valuation Date
– The Duff & Phelps data would indicate a
required rate of return on equity ranging from
15.8% to 17.3%, with an average of 16.4%
© 2009 National Association of Certified Valuation Analysts 8
Current Update in Valuation
Results using Duff & Phelps Risk Premium Report
have been very close to results using
Morningstar build up method –
• < 1.0% difference
• Corroborating Method
• Both methods represent “Returns After
Corporate Taxes”
© 2009 National Association of Certified Valuation Analysts 9
Current Update in Valuation
ERPs developed by the Duff & Phelps data
can be used to calculate a discount cost of
equity using a build-up model or the
modified capital asset pricing model
(MCAPM)
© 2009 National Association of Certified Valuation Analysts 10
Current Update in Valuation
The Report suggests that the “smoothed” average
premium is the most appropriate indicator for
most of the portfolio groups. The “smoothed”
premium refers to how the premium is
determined.
It can be calculated based on a regression
analysis, with the average historical ERP as the
dependent variable and the logarithm of the
average sorting criteria as the independent
variable.
© 2009 National Association of Certified Valuation Analysts 11
Current Update in Valuation
• One benefit of the “smoothed” premium is if an
analyst is estimating the required rate of return
for a company significantly smaller than any of
the companies found in the smallest of the 25
portfolios, it is appropriate to extrapolate the
ERP using the slope and constant terms from
the regression relationships used in deriving the
“smoothed” premiums.
© 2009 National Association of Certified Valuation Analysts 12
Current Update in Valuation
EXAMPLE:
Using the build-up method to determine a
required rate of return on equity, assume
the subject company has the following
characteristics:
© 2009 National Association of Certified Valuation Analysts 13
Current Update in Valuation
EIGHT MEASURES OF SIZE AMOUNT
MARKET VALUE OF EQUITY $120 MILLION
BOOK VALUE OF EQUITY $100 MILLION
5-YEAR AVERAGE NET INCOME $10 MILLION
MARKET VALUE OF INVESTED $180 MILLION
CAPITAL
TOTAL ASSETS $300 MILLION
5-YEAR AVERAGE EBITDA $30 MILLION
SALES $250 MILLION
NUMBER OF EMPLOYEES 200
© 2009 National Association of Certified Valuation Analysts 14
Current Update in Valuation
• Using each of the exhibits A-1 through A-8
(for each of the size measurements) we
extract the following ERP data:
© 2009 National Association of Certified Valuation Analysts 15
Current Update in Valuation
SMOOTHED
AVERAGE
GUIDELINE ERP *
PORTFOLIO
EIGHT MEASURES OF SIZE COMPANY EXHIBIT
SIZE
MARKET VALUE OF $120 MILLION A-1 24 12.3%
EQUITY
BOOK VALUE OF EQUITY $100 MILLION A-2 24 11.3%
5-YEAR AVERAGE NET $10 MILLION A-3 23 11.4%
INCOME
MARKET VALUE OF $180 MILLION A-4 24 12.0%
INVESTED CAPITAL
TOTAL ASSETS $300 MILLION A-5 23 11.2%
5-YEAR AVERAGE EBITDA $30 MILLION A-6 24 11.8%
SALES $250 MILLION A-7 23 11.1%
NUMBER OF EMPLOYEES 200 A-8 25 12.6%
MEAN 11.7%
MEDIAN 11.6%
© 2009 National Association of Certified Valuation Analysts 16
