For the industry specific cost of capital derivation on the respective valuation date (monthly), of the MSCI World Index (Developed Countries) are classified into industry groups according to the Global Industry Classification Standard (GICS). The industries include:
The discount rate is based on the weighted average cost of equity and debt capital (so-called weighted average cost of capital; WACC). Therefore, the weighting reflects the relative percentages of equity and debt in the company´s capital structure. For the determination of the capital structure, the median is used for each industry group. For functional purposes, the weighted average cost of capital is broken down into the components, cost of equity and cost of debt capital, while being calculated.
For the industries banking and insurance, only the components of the cost of equity are included.
The mentioned cost of capital derivation is executed on a EUR basis. The country risk premium in Belgium is included in the risk free rate as we use the Belgian Government bond.
2.1.1. General information
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 components risk-free rate, risk premium (market risk premium and beta factor) and the small firm premium are differentiated.
2.1.2. Risk-free rate
The determination of the risk-free rate is based on a LT yield curve, which is determined by taking into account the current interest rates as well as interest structure data published by the Belgian National Bank (“BNB”). The yield of the Belgian Government Bond 20 years is considered.
The determined yield curve establishes the connection between interest rates and terms to maturity applicable for zero bonds with no credit default risk. The use of zero bond factors with an adequate term to maturity derived from the yield curve ensures the necessary compliance with the term to maturity equivalence between the alternative investment and the financial surpluses that are to be valued.
2.1.3. Beta factor
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 EUR, of the capital market information service provider S & P Capital IQ, are applied. The MSCI World Index with its price data, also converted into EURs, is respectively selected as a reference index.
2.1.4. Market risk premium
The future anticipated market risk premium can be estimated on the basis of the historical difference between the returns on securities carrying risks, for example, on the basis of a stock index and the returns of (quasi) risk-free capital market investments. Empirical studies of the European capital market have shown that investments in shares, depending on the period of observation, have achieved an average of 4.5% to 6.5% higher returns in the past than (quasi) risk-free capital market investments. In light of the current Belgium market an equity market risk premium of 5.5% is assumed.
2.1.5. Small Firm Premium
The Small Firm Risk Premium is the additional risk premium required by an investor to invest in a “small” company in comparison with the quoted comparable companies. Based on the study of Ibbotson, we show a premium of 3.67%, which is the rate applicable to companies with a market capitalisation lower than €500m.
2.2.1. Risk-free rate
The interest rate considered for the cost of debt corresponds to the euro swap rate 20 years.
2.2.2. Credit spread
The credit rating is based on credit ratings of comparable companies observable on the capital market. The corresponding credit spread is calculated over a historical period of 15 years based on the differential between short term funding (4 years) and swap rates.
2.2.3. Tax Shield
While determining the WACC, also the deductibility of debt interest with regard to potential tax payments (so-called tax shield) has to be considered. As operating income tax rate, the long term Belgian tax rate of 25% (applicable as from 2020) 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 average 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).
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