2015 Valuation Handbook Guide to Cost of Capital. Market Results Through 2014 Duff & Phelps

Transcription

1 2015 Valuation Handbook Guide to Cost of Capital Market Results Through 2014 Duff & Phelps

2 New in the 2015 Valuation Handbook Guide to Cost of Capital The 2015 Valuation Handbook Guide to Cost of Capital includes TWO vital sets of valuation data: (i) the equity risk premia, size premia, and industry risk premia data previously published in the Morningstar/Ibbotson SBBI Valuation Yearbook, and (ii) the risk and size premia previously published in the Duff & Phelps Risk Premium Report. The Valuation Handbook Guide to Cost of Capital is in its second year of publication with the release of the 2015 edition. The inaugural 2014 edition was self-published by Duff & Phelps; starting in 2015, the Valuation Handbook Guide to Cost of Capital is published by John Wiley & Sons, marking a significant milestone for the Valuation Handbook. Several other additions have been made to the 2015 book: We expanded our discussion in Chapter 3 of the risk-free rate and the equity risk premium with analyses of the effects of flight to quality and massive central bank monetary interventions on these two important cost of capital inputs. We added a table of debt betas (by credit grade) to Chapter 5. The observed betas by debt rating can be used in conjunction with the equity beta unlevering and levering formulas which require debt beta estimates. Chapter 11, Real Estate, has been added. This new chapter introduces a discussion on real estate and associated rates of return, examines volatility characteristics of U.S. real estate compared to other U.S. asset classes, and provides a table of data that can be used as inputs in performing valuations of individual real property investments. In 2015 we produced two additional valuation data resources: the Valuation Handbook Industry Cost of Capital, and the International Valuation Handbook Guide to Cost of Capital. We welcome reader comments, questions, and suggestions. Your feedback is an important source of information for helping us to constantly improve the Valuation Handbook Guide to Cost of Capital, and our related valuation data resources. To order additional copies of the Valuation Handbook Guide to Cost of Capital, or other Duff & Phelps valuation data resources published by John Wiley & Sons, please go to:

3 2015 Valuation Handbook Guide to Cost of Capital Valuation professionals have relied on the Morningstar/Ibbotson SBBI Valuation Yearbook since 1999 for critical year-end data for estimating the cost of capital, but that publication ended with the 2013 edition. Duff & Phelps, the premier global valuation and corporate finance advisor with expertise in complex valuation, dispute and legal management consulting, M&A, restructuring, and compliance and regulatory consulting, has partnered with John Wiley & Sons to produce a new annual source for this data: the new Valuation Handbook Guide to Cost of Capital. The 2015 Valuation Handbook Guide to Cost of Capital includes TWO vital sets of valuation data: (i) the equity risk premia, size premia, and industry risk premia data previously published in the SBBI Valuation Yearbook, and (ii) the risk and size premia previously published in the Duff & Phelps Risk Premium Report. The valuation data and methodology in the 2015 Valuation Handbook Guide to Cost of Capital can be used to develop cost of equity capital estimates using (i) the build-up method and (ii) the capital asset pricing model (CAPM). The 2015 Valuation Handbook Guide to Cost of Capital includes data through December 31, 2014, and is intended to be used for 2015 valuation dates. Morningstar / Ibbotson SBBI Valuation Yearbook (discontinued) Duff & Phelps Risk Premium Report (no longer published separately) NEW: 2015 Valuation Handbook Guide to Cost of Capital Includes optional intra-year quarterly updates

4 Table of Contents 2015 Valuation Handbook Guide to Cost of Capital Acknowledgements Introduction ix x Chapter 1 Cost of Capital Defined 1-1 Introduction 1-1 Income Approach Overview 1-2 Discounting versus Capitalizing Concepts 1-2 Valuation Date 1-5 Basic Cost of Capital Concepts 1-5 Sources of Capital 1-9 Cost of Capital Input Assumptions 1-10 Capital Structure Considerations 1-15 Calculating WACC 1-16 Estimates of Cost of Capital are Imprecise 1-18 Key Things to Remember about Cost of Capital 1-19 Chapter 2 Methods for Estimating the Cost of Equity Capital 2-1 Basic Framework 2-1 Types of Risk 2-5 Cost of Equity Capital Estimation Methods 2-7 Build-up 2-9 CAPM 2-10 Other Cost of Equity Capital Estimation Methods 2-14 Key Things to Remember about the Methods for Estimating the Cost of Equity Capital 2-16 Chapter 3 Basic Building Blocks of the Cost of Equity Capital -- Risk-free Rate and Equity Risk Premium 3-1 The Risk-free Rate and Equity Risk Premium: Interrelated Concepts 3-1 Spot Risk-free Rates versus Normalized Risk-free Rates 3-2 Methods of Risk-free Rate Normalization 3-12 Spot Yield or Normalized Yield? 3-15 Equity Risk Premium 3-17 Estimating the Equity Risk Premium 3-18 Duff & Phelps Recommended ERP 3-30 Concluding on an ERP 3-33 Chapter 4 Basic Building Blocks of the Cost of Equity Capital -- Size Premium 4-1 Size as a Predictor of Equity Returns 4-1 Possible Explanations for the Greater Returns of Smaller Companies 4-2 The Size Effect: Empirical Evidence 4-2 The Size Effect Over Longer Periods 4-3 The Size Effect Tends to Stabilize Over Time 4-6 The Size Effect Changes Over Time 4-7 Criticisms of the Size Effect 4-8 Data Issues 4-11 Has the Size Effect Disappeared in More Recent Periods? 4-17 Relationship of Size and Liquidity 4-21 Key Things to Remember about the Size Premium 4-24 Chapter 5 Basic Building Blocks of the Cost of Equity Capital -- Betas and Industry Risk Premia 5-1 Beta 5-1 Differences in Estimation of Equity Betas 5-7 Full-Information Beta 5-11 Industry Risk Premia 5-12 Full-Information Beta Methodology 5-16 Debt Betas 5-23

5 Unlevering and Levering Equity Beta 5-25 Key Things to Remember about Betas and the Industry Risk Premia 5-26 Chapter 6 Basic Building Blocks of the Cost of Equity Capital -- Company-specific Risk Premia 6-1 Introduction 6-1 Adjustments for Differences in Risk 6-2 Adjustments for Risk in Net Cash Flows and Biased Projections 6-5 Adjustments for Other Risk Factors 6-7 Matching Fundamental Risk and Return 6-8 Key Things to Remember about Company-specific Risk Premia 6-10 Chapter 7 The CRSP Deciles Size Premia Studies and the Risk Premium Report Studies -- A Comparison 7-1 History of the CRSP Deciles Size Premia Studies 7-1 History of the Risk Premium Report Studies 7-2 Data Sources 7-2 Definitions of Size 7-6 Time Period Examined 7-6 Number of Portfolios 7-6 Portfolio Overlap 7-7 Guideline Portfolio Method and Regression Equation Method 7-7 Risk Premia Over CAPM (Size Premia) 7-8 Smoothed Premia versus Average Premia 7-11 OLS Beta versus Sum Beta 7-11 Risk Premia Over the Risk Free Rate 7-12 Unlevered Premia 7-12 Risk Study 7-12 Characteristics of Companies in Portfolios 7-13 Online Applications 7-13 Chapter 8 CRSP Deciles Size Premia Examples 8-1 Build-up Example 8-1 CAPM Example 8-4 Key Things to Remember about the CRSP Deciles Size Premia 8-7 Chapter 9 Risk Premium Report Exhibits -- General Information 9-1 Appropriate Use of the Risk Premium Report Exhibits 9-1 How the Risk Premium Report Exhibits are Organized 9-1 Cost of Equity Capital Estimation Methods Available 9-3 Proper Application of the Equity Risk Premium (ERP) Adjustment 9-3 Smoothed Premia versus Average Premia 9-7 The Guideline Portfolio Method versus the Regression Equation Method 9-7 Example: Calculating an Interpolated Premium Using the Regression Equation Method 9-9 Tips Regarding the Regression Equation Method 9-10 Can the Regression Equation Method be Used if the Subject Company is Small? 9-10 Size Study or Risk Study? 9-10 Key Things to Remember About the Risk Premium Report Exhibits 9-11 Chapter 10 Risk Premium Report Exhibits -- Examples 10-1 Size Study 10-1 Reasons for Using Additional Measures of Size 10-1 The Difference Between the Size Study s A Exhibits and the B Exhibits 10-2 The Difference Between Risk Premia Over the Risk-free Rate and Risk Premia Over CAPM 10-2 Calculating Custom Interpolated Premia for Smaller Companies 10-6 Overview of Methods Used to Estimate Cost of Equity Capital Using the Size Study 10-9 Size Study Examples: Assumptions Used Size Study Examples Unlevered Cost of Equity Capital Overview of the Methodology and Assumptions Used to Unlever Risk Premia Estimating Cost of Equity Capital Using the Build-up 1-Unlevered Method 10-22

6 Estimating Cost of Equity Capital Using the Capital Asset Pricing Model (CAPM) Estimating Cost of Equity Capital Using the Build-up 2 Method Risk Study Overview of Methods Used to Estimate Cost of Equity Capital Using the Risk Study Risk Study Examples Build-up 3-Unlevered High-Financial-Risk Study Overview of Methods Used to Estimate Cost of Equity Capital Using the High-Financial-Risk Study Estimating Cost of Equity Capital Using the Build-up 1-High-Financial-Risk Method Estimating Cost of Equity Capital Using the CAPM-High-Financial-Risk Method Comparative Risk Study Using the Comparative Risk Study to Refine Build-up Method Estimates Using the Comparative Risk Study to Refine CAPM Estimates Chapter 11 Real Estate 11-1 Individual Real Estate Assets 11-1 Real Estate Investment Trusts (REITs) 11-2 Structure of Real Estate Entities 11-2 Correlation of U.S. REITs Compared to Other U.S. Asset Classes 11-3 Summary Statistics of U.S. REITs Compared to Other U.S. Asset Classes 11-5 Real Estate Property Valuation Inputs 11-8 Key Things to Remember about Real Property Valuation Chapter 12 Answers to Commonly Asked Questions 12-1 Glossary Index Appendix 1 -- Definitions of Standard and Poor s Compustat Data Items Used to Calculated the Risk Premium Report Exhibits Appendix 2 -- Changes to the Risk Premium Report Over Time Appendix 3 -- CRSP Deciles Size Premia Study: Key Variables Appendix 4 -- Risk Premium Report Study Exhibits

7 2015 Valuation Handbook Guide to Cost of Capital Don t Forget the Quarterly Updates! 1 Hardcover book Data through December Quarterly Updates = Data through March, June, and September 2015 Full year of coverage Essential Industry Risk Premia Data Year Round December March June September To order: Add the Quarterly Updates for a Full Year of Industry Risk Premia (IRPs), Debt Betas, and Other Essential Information In addition to other essential year-end cost of capital inputs, the hardcover 2015 Valuation Handbook Guide to Cost of Capital includes industry risk premia (IRPs) for approximately 250 U.S. industries, updated through December An IRP is a special kind of beta modified so that it can be used within the context of a build-up estimate of the cost of equity capital. The hardcover 2015 Valuation Handbook Guide to Cost of Capital also includes debt betas for properly unlevering and levering betas using the Miles-Ezzell, Harris-Pringle or Fernandez formulas. These formulas are often superior to the simple and often inappropriately applied Hamada formula. 1 IRPs and debt betas are updated quarterly with data through March, June, and September Ensure that you are using the most up-to-date IRP and debt beta data available: add the Quarterly Updates, and keep your data library current. 1 See Chapter 12 of Cost of Capital: Applications and Examples 5 th ed. by Shannon P. Pratt and Roger J. Grabowski (John Wiley & Sons, 2014) 2 Quarterly Updates are (i) optional, and (ii) not sold separately. Quarterly Updates are delivered in PDF format.

8 Additional Duff & Phelps Valuation Data Resources Published By Wiley To order additional copies of the 2015 Valuation Handbook Guide to Cost of Capital or other Duff & Phelps valuation data resources, please go to: