Background to the supplement

Against the backdrop of the persistently low interest rate environment, the IDW's Technical Committee for Business Valuation and Business Administration (FAUB) published a clarifying amendment in July 2016 on the derivation of the present value-equivalent uniform riskfree base rate. This amendment was adopted in the F & A to IDW Standard 1 as amended in 2008 (appendix to question 3.2.).

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Need for clarification

The amendment was necessary to clarify the application of the present value factor formula for terms of more than 30 years. It was specified that the interest rate in year 30 must exceed the assumed long-term growth rate. Otherwise, a sufficiently long period must be used as a basis in order to correctly derive the present value-equivalent uniform riskfree base rate.

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The present value-equivalent uniform riskfree base rate

The present value-equivalent uniform riskfree base rate is a key parameter in business valuation, particularly in the discounted cash flow (DCF) method. It is used to discount future cash flows to their present value. The formula for calculating the present value factor assumes that the interest rate in year 30 is above the long-term growth rate. If this is not the case, the measurement period must be extended to ensure the accuracy of the present value.

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Application in practice

In practice, this means that valuers need to be particularly careful when carrying out valuations in a low interest rate environment. The present value equivalent uniform riskfree base rate must be calculated in such a way that it reflects the long-term reality of interest rates, especially if these are lower than the growth rate.

Steps for deriving the riskfree base rate:

1. Check the term: Ensure that the term of more than 30 years complies with the conditions.
2. Apply formula: Apply the present value factor formula to calculate the riskfree base rate.
3. Take long-term growth rate into account: Ensure that the interest rate in year 30 exceeds the long-term growth rate.
4. Extend period: If necessary, extend the valuation period in order to correctly derive the present value-equivalent uniform riskfree base rate.

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Wrapping it up

The IDW's addition on the derivation of the present value equivalent uniform riskfree base rate underlines the importance of accurate calculation in a low interest rate environment. It is critical that the valuation period and underlying interest rates are carefully reviewed and adjusted to ensure an accurate business valuation. Smart Zebra's tools and expertise support this process efficiently and reliably.

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