For the industry specific cost of capital derivation on the respective valuation date (monthly), the companies of the MSCI World Index (Developed Countries) are classified into industry groups according to the Global Industry Classification Standard (GICS). The industries include:
Cost of equity is measured against the (expected) return on an adequate alternative capital investment. While determining objectified business values, the alternative investment and the corresponding yield are generally characterised by an investment in a bundle of publicly listed corporate shares (stock portfolio), adjusted to incorporate the risk structure of the business to be valued.
For the derivation of the cost of equity, the following components: risk-free rate, beta factor, market risk premium, country risk premium and the small cap premium are differentiated.
Cost of equity is measured against the (expected) return on an adequate alternative capital investment. While determining objectified business values, the alternative investment and the corresponding yield are generally characterised by an investment in a bundle of publicly listed corporate shares (stock portfolio), adjusted to incorporate the risk structure of the business to be valued.
For the derivation of the cost of equity, the following components: risk-free rate, beta factor, market risk premium, country risk premium and the small cap premium are differentiated.
The determination of the risk-free rate is based on the yield to maturity of long-term government bonds. To ensure that the government bond yield is risk free, coupon payments should not be included (to avoid any reinvestment risk) and the issuing country must be rated AAA. For ratings below AAA a country risk premium is applied.
In general, for the risk-free rate the bonds are used issued by the government which reflect the target company’s planning currency. The standard assumption is to take the 15 years government bond yield into account.
For the presented derivation the yield on a 15 years Swiss government bond is applied as a risk-free rate. The yield is based on the interest rate data retrieved from Bloomberg. In case risk free rates are negative, they are floored at 0.0%.
For the derivation of the beta factors, the median of the indebted beta factors (raw) of the individual companies of the respective industry group, derived from the market, is used. The monthly returns over a period of five years (60 data points), taken from the price data, converted into CHF, of the capital market information service provider S&P Capital IQ, are applied. The MSCI World Index with its price data, also converted into CHF, is respectively selected as a reference index.
The market risk premium calculation (“MRP”) is based on a multi-step approach that considers four different sources. In addition to an implied equity risk premium (iERP) based point estimate calculation, performed by PwC Switzerland on a bi-monthly basis, three more sources are considered: MRPs guidance by IDW (currently a range of 6.0% to 8.0% is recommended), average recommendation of the other Big4 companies in Switzerland and the iERP data published monthly by Damodaran. In light of the current Swiss market, the current EMRP recommendation ranges between 5.5%-6.0% with 6.0% as a default.
A country risk premium is applied if the cash flows to be discounted incur in a country that has a rating below AAA (i.e. the government bond is not risk free).
This is based on the assumption that all companies in one country have the same exposure towards country risk.
If a country risk premium is applied, the CDS is subtracted from the (risky) government bond yield to estimate the risk free rate. In the Euro area the German government bond is always used as a risk free rate.
The country risk premium equals the CDS spreads for the corresponding government bond as provided by Bloomberg/CapitalIQ. In case of the Euro area the difference between the German government bond yield and the government bond yield of the respective country is taken as country risk premium.
Please note that the presented derivation excludes the country risk premium.
Based on PwC Switzerland best practice, a small cap premium is included in the cost of equity calculation.
Research on historical data indicates that stock returns are lower for larger firms. This implies a size premium. Our analysis on the small cap premium is based on Krolls’ data and is updated annually in spring. The premium is calculated for three different firm size ranges (“Mid-Cap”, “Low-Cap”, “Micro-cap”) based on the firm’s market capitalization.
The presented derivation includes a small cap premium range of 0.95%-2.0%, which is a range commonly applied for the Swiss companies.
See section 2.1.2.
The credit rating is based on credit ratings of comparable companies observable on the capital market. The corresponding credit spread is calculated based on a 15 years yield curve in USD for a given rating. Based on PwC Switzerland best practice, the USD curve is used due to the high liquidity of the US bond market.
While determining the WACC, the deductibility of debt interest with regard to potential tax payments (so-called tax shield) has to be considered. As a general rule, the overall approximate range of the maximum corporate income tax rate on profit before tax for federal, cantonal, and communal taxes is between 11.9% and 21.6%, depending on the company’s location of corporate residence in Switzerland. With the entry into effect of the TRAF as of 1 January 2020, the special cantonal tax regimes (e.g. the regimes for holding companies, domicile companies, mixed trading companies) were abolished. At the same time, most cantons reduced or will reduce their CIT rate with a resulting effective tax rate of some 12% to 15% in the majority of the cantons and introduced internationally accepted replacement measures such as an Organisation for Economic Co-operation and Development (OECD) compliant patent box, an R&D super deduction, and other measures.
For the presented derivation the income tax rate of 13.5% (average effective cantonal tax rate) was used.
The equity and debt ratio for the calculation of the weighted average cost of capital, are derived based on the industry group´s median indebtedness (Gearing). Within the definition of the (net) indebtedness of the companies in an industry group, in addition to financial debt, pension provisions are also taken into account and all liquid funds are deducted (Net debt).
See above.
For the derivation of the trading multiples for each industry (for banking and insurance see below), the quarterly company specific multiples, published by S&P Capital IQ, are used. The multiples are calculated on the basis of future oriented benchmarks (analyst estimates, reference time + 1 year). For the derivation of the industry specific multiple, the median is determined respectively.
The depicted multiples are so-called entity multiples.
EBITDA multiple: Entity value / earnings before interest, tax, depreciation and amortisation
EBIT multiple: Entity value / earnings before interest and tax
The depicted multiples for the industries banking and insurance are so-called equity multiples.
Price-earnings ratio (P/E ratio): market capitalisation / net income
Price-to-book ratio (P/B ratio): market capitalisation / book value of equity
