Cost of Capital Study 2011-2012-KPMG

8/10/2019 Cost of Capital Study 2011-2012-KPMG

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CORPORATE FINANCE

Cost of Capital Study2011/2012

Developments in Volatile Markets


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Cost of Capital Study 2011/2012 | 3

Foreword 5

Summary of Findings 6

1 Introduction 8

1.1 Foundations and Objectivesof the Study 8

1.2 Data Collection 8

2 Organization and Execution of the

Impairment Test 10

2.1 Timing, Frequency, Triggering Eventsand Reversals 10

2.2 Number of Cash Generating Units

and Changes to their Structure 14

2.3 Determination of Recoverable Amount 15

2.4 Composition of the Carrying Amount 19

2.5 Use of Impairment Test for

Other Purposes 19

3 Measurement of Cash Flows 20

3.1 Preparation of Budget Calculations

and Determination of Sustainable Year 20

3.2 Growth Expectations in Budget

Calculations 24

3.3 Plausibility Check of Budget

Calculations Used 25

3.4 Foreign Currency Translation 26

3.5 Tax Rate 28

4 Cost of Capital Parameters 30

4.1 Risk-free Base Rate 31

4.2 Market Risk Premium 344.3 Beta Factor 35

4.4 Other Risk Premiums 37

4.5 Cost of Equity 384.6 Cost of Debt 39

4.7 Capital Structure 40

4.8 Weighted Cost of Capital 41

4.9 Growth Rate 42

5 Outlook Overall Economic Development 44

5.1 Expected EconomicDevelopment 2012 44

5.2 Development of Interest Rate

Level 2012 47

6 Your Industry Specialists 48

Table of Contents

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4 | Cost of Capital Study 2011/2012

CAPM Capital Asset Pricing Model

CGU Cash Generating Unit

DAX Main German Stock Index

DCF Discounted Cash Flow

EBIT Earnings Before Interest and Taxes

EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization

EBT Earnings Before Taxes

ECB European Central Bank

FREP German Financial Reporting Enforcement Panel

HFA IDW Expert Committee

IAS International Accounting Standards

IASB International Accounting Standards Board

IDW Institute of Public Auditors in Germany, Incorporated Association

IFRS International Financial Reporting Standards

SMI Swiss Market Index

WACC Weighted Average Cost of Capital

List of Abbreviations

2012 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firmhas any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo andcutting through complexity are registered trademarks of KPMG International.


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The sovereign debt crisis rising worldwide and particularly

in Europe since mid-2010 has called into question the ini-

tial signs of an economic recovery. The economic growth

observed around the globe did not indicate any clear ten-

dencies during 2010 and 2011. The increasingly volatile

economy and capital markets as well as the continuously

decreasing interest rate level reflect the uncertainty remain-

ing in the short and medium term outlook for companies.

An adequate incorporation of the current risks and uncer-tainties in budget figures, not only for impairment tests, but

also for planning and company controlling purposes, is a sig-

nificant challenge to the corporate decision-makers.

The current economic developments are relevant, espe-

cially when calculating the cost of capital as a centralparameter for any value-related corporate decision. Average

capital costs af ter corporate taxes of 7.9 percent were taken

as the basis in the fiscal year 2010/2011. Compared to his-

torical figures and in the context of the current market situ-

ation, this further decrease raises the question of whether

and how accurately the current low level of capital cost is

realistically reflected in the budget figures of the compa-

nies. Particular attention must be paid to the equivalence

between the growth margin and return expectations under-

lying the budget figures and the declined capital costs.

This years Cost of Capital Study offers the opportunity to

understand the real effects of the continuing difficult mar-

ket environment on the accounting and valuation practice of

companies, in particular with respect to the cost of capital.

Furthermore, it provides insights into the practical handling

of forecasts in a volatile market environment.

Following our studies in the years 2006 to 2010, we are

delighted to present to you our sixth edition of the Cost of

Capital Study.

As in the previous edition, this year we also included the

assessment of particularities specific to certain industries,

as well as an outlook on the future economic development.

The history of meanwhile five studies enables us to present

increasingly conclusive trend analyses of the development

of different parameters and other organizational aspectsobserved over time. Should you be interested in more

detailed industry-specific assessments, we will be happy

to provide these to you.

Our analysis can be divided into following four main areas:

Organization and execution of impairment tests

Measurement of cash flows

Cost of capital parameters

Overall economic outlook

As in previous years, in addition to the current analyses and

our comments, we provide brief supplementary summariesof the essential rules of IAS 36 regarding impairment tests.

We conducted our survey between June and Septem-

ber 2011. Consequently, in our analysis we included finan-

cial statements from September 2010 to August 2011.

This study is an empirical analysis aiming to provide aninsight into currently applied corporate practices. Informa-

tion and remarks in this study will not deliver a complete

picture of the proper handling or interpretation of the regula -

tions for impairment tests.

We would like to thank all participating companies and par-

ticularly the staff in charge. Thanks to you, we were once

again able to increase our response rate among all partici-

pants and therefore improve the results of this study.

Foreword

Prof. Dr. Vera-Carina Elter

Partner, Corporate Finance

KPMG AG Wirtschafts-

prfungsgesellschaft

Dr. Marc Castedello


KPMG AG Wirtschafts-

prfungsgesellschaft



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Summary of Findings

Collected data

A total of 493 companies in Europe

were contacted; 137 companies

participated (total response rate of27.8 percent).

Participation rate: 70 percent

DAX- 30, 45 percent MDAX and

40 percent SMI.

Highest response rate in the sectors

industrial products (35 responses)and consumer products & services

(21 responses).

Significance of the impairment test

Regarding their financial statementsfor the period 30 September 2010

to 31 August 2011, 23 percent of

the surveyed companies stated that

they recognized a goodwill impair-

ment (previous year: 26 percent).

On average, these companies

wrote-off 16.5 percent of the good-

will on their balance sheet.

51 percent of the companies recog-

nized goodwill impairment, assetimpairment, or both (decrease com-

pared to previous year: 4 percent).

The percentage of companies that

performed an impairment test based

on a triggering event decreased sig-nificantly to 37 percent compared to

the previous year (53 percent). The

main reason stated was deteriorat-

ing long-term prospects.

Only 11 percent of the companiesrecognized an appreciation in the

value of individual assets.

Organization and execution of the

impairment test

Approximately 29 percent made

adjustments to their CGU structurecompared to the previous year

(complete restructuring of CGUs:

14 percent).

73 percent created a maximum of

ten CGUs for the goodwill impair-

ment test. For the asset impair-

ment test, 31 percent of the sur-

veyed companies created more than

20 CGUs.

69 percent of the companies calcu-

lated solely the value in use and only

18 percent calculated solely the fair

value less costs to sell; 13 percent

calculated both. Of these compa-nies 68 percent stated that the value

in use was higher than the fair value

less costs to sell.

More than half of listed companies

compared total recoverable amountsacross all CGUs with market capital-

ization.

22 percent of the companies also

used the results of the impairmenttest for value-driven company con-trolling or product and segment

controlling.

Measurement of cash flows

Almost 90 percent of the surveyed

companies prepared their group

budget maximum three months inadvance of the impairment test.

45 percent of the participants pre-

pared an integrated budget. Only

19 percent prepared a statement of

anticipated income without forecast-

ing any balance sheet figures. More

than 80 percent projected their bud-get figures for a period of three

years.

In most cases the definition of the

sustainable year was based on

the last budget year with top-downadjustments in some cases.

51 percent of the surveyed com-

panies did not perform plausibility

checks of their planning based on

a market and competitive environ-ment comparison.



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Cost of capital parameters

62 percent of the surveyed compa-

nies derived the risk-free rate based

on the yield of national governmentbonds with an average maturity

period of 15 years. 38 percent used

the yield curve to determine the

base rate. The average base rate

applied was 3.3 percent which is a

decline compared to the previousyears base rate.

The average market risk premium

applied is 5.1 percent.

The majority of the surveyed com-

panies derive their beta from a peer

group, based on an average histori-

cal observation per iod of 3.7 years.

For the determination of the capi-

tal costs, 66 percent of companies

applied a country risk premium pre-

dominantly between 1 and 5 per-

cent.

Depending on the industry, the aver-

age cost of equity applied by the

surveyed companies for the fiscal

year 2010/2011 ranged between

7.5 percent and 11.1 percent, andamounts to 9.1 percent on average,

which is significantly lower than in

the previous year (9.8 percent).

The average cost of debt is 5.2 per-

cent and varies by industry between

4.5 and 5.8 percent.

To determine the debt-equity ratioapplied for the derivation of the

value in use, 32 percent of the sur-

veyed companies used peer group

data (fair value less costs to sell:

54 percent). The average debt-

equity ratio applied amounts to48 percent.

The WACC average amounts to

approximately 7.9 percent (previous

year: 8.2 percent). Depending on the

industry, it ranges between 6.4 per-

cent and 8.4 percent.

In the fiscal year 2010/2011, the

majority of surveyed companies

applied a growth rate between 0 and

2 percent 1.5 percent on averageapplying the value in use approach

and 1.2 percent applying the fair

value less costs to sell approach.

Outlook overall economic

development

57 percent of the companies expect

a positive development of the over-all economic situation in 2012.

The same tendency applies to theassessment of the individual eco-

nomic situation of the surveyed

companies.

69 percent of all surveyed compa-

nies expect an increased interestrate level in 2012 compared to the

previous year.



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1.1 Foundations and Objectives

of the Study

The cost of capital is required for all

value-related corporate decisions. Inaddition, there are a number of occa-

sions on which legal requirements

apply to the use of capital costs such

as the IAS Impairment Test. Despite

the detailed guidance provided in the

standard, the IAS Impairment Testaccording to IAS 36 remains a highly

complex process. Therefore, the cen-

tral issue guiding all analyses of our

investigation is how the often ambig-

uous wording and interpretation of

details required are implemented in

practice. Particularly in the context of

the ongoing debt crisis, the underlying

capital costs and budget figures used

for impairment tests are considerably

affected by the current fluctuationson the financial markets. This study

reflects the different approaches typi-

cally resulting from the interpretation

room provided by IAS 36. Additionally,

we present the growth expectations

underlying the budget calculations in

the context of the current market vola-

tility as well as with regard to the antic -ipated future economic development

across the individual industries.

We have summarized our analysis in

distinct sections addressing each of

the following issues:

Organization and execution ofimpairment tests,

Derivation of cash flows,

Cost of capital parameters,

Outlook overall economic

development.

The purpose of each question is

described briefly at the beginning of

the section. To make the study more

comprehensive, we have outlined the

essence of some of the applicableIFRS rules where necessary.

To the extent permitted by the data,

we also assessed the cost of capital

by country, industry and stock market

segment. Additionally, we compared

this years findings to the results of

previous years studies (trend analysis).

1.2 Data Collection

This year we contacted a total of

493 companies in Europe (previ-

ous year 740), 137 of which (previousyear 152) participated in the survey.

The response rate of 27.8 percent ishigher than that of the previous year

(20.5 percent).

The response rate in Germany was

31.6 percent (previous year: 32.8 per-

cent). Above-average participation

was achieved again in DAX- 30 and

MDAX. 70 percent of the DAX-30 and

44.9 percent of the MDAX companies

participated in this years study.

1 Introduction

27.8 %of the companies contacted

participated in this years survey.

70.0 %of DAX-30 companies againparticipated in this years survey.



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The companies were surveyed

between June and September 2011.

The fiscal year 2010/2011 shown

below includes group balance sheet

dates between 30 September 2010

and 31 August 2011.

Industry analysis: Separate statistical

assessments were made for industries

with a minimum response rate of five

responses. We would like to point out

that some companies did not answer

all the questions. The highest responserate was achieved in the sectors indus-

trial products(35 companies) and con-

sumer products & services(21 com-

panies). The industrial productssector

includes companies operating in differ-

ent manufacturing sectors as well ascompanies mainly producing industrial

intermediate products.

Country Numbers ofcompaniescontacted

Numbers ofresponse

Response rate

Germany 275 87 31.6 %

Austria 74 8 10.8 %

Switzerland 108 38 35.2 %

Others* 36 4 11.1 %

Total 493 137 27.8 %

Figure 1

Breakdown of participants by country

* All EuroStoxx-50 companies are contacted.

Source: KPMG

Figure 2

Composition of sample by industry

Source: KPMG

1 Automotive

2 Building & Construction

3 Chemicals

4 Computer & Semiconductors

5 Consumer Products & Services

6 Energy & Power Generation

7 Entertainment & Media

8 Financial Services

9 Industrial Products

10 Internet & E-Commerce

11 Life Science & Healthcare

12 Software

13 Telecommunications

14 Transport & Logistics

1 2 3 4 5 6 7 8 9 10 11 12 13 14

35

30

25

20

15

10

5

0

7

2

17

2

21

87

12

35

1

11

25

7



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In general, IAS 36 provides compa-

nies with sufficient room for interpre-

tation concerning the recognition of

the individual operational reality. This

allows companies to take into account

individual company-specific assump-

tions and premises. IAS 36 does not,for instance, set a specific date for the

execution of an impairment test. The

test does not necessarily have to take

place at the end of the fiscal period;

however, once the initial choice of date

is made, the test has to be consistently

executed at the same time in the con-

secutive periods (consistency principle

as per IAS 36.10). In exceptional cases

the reference date may be changed.

Furthermore, within the given frame-

work CGUs may be tailor-made to the

planning and steering structures of

the respective companies. Despite

the well-defined requirements of thestandard, there are two subjects aside

from the definition of CGUs that are

frequently discussed in the context of

the practical organization and execu-

tion of impairment tests: the consis-

tent determination of the recoverable

and the carrying amount that is in linewith the requirements of the standard.

In order to analyze the prevalent prac-

tice more closely, we investigated the

following questions:

When is the annual impairment testexecuted? How often are impair-

ments made and of what amount?

How are triggering events deter-

mined? Were any reversals recog-

nized in the past fiscal year?(Section 2.1)

How many different CGUs are the

calculations based upon? Is there

an alteration in the CGU structure

compared to previous years?(Section 2.2)

How is the recoverable amount

determined and which valuation

method is used? (Section 2.3)

Which balance sheet items does the

carrying amount comprise?

(Section 2.4)

For what other purposes are the

results of the impairment test being

used? (Section 2.5)

2.1 Timing, Frequency, Triggering

Events and Reversals

The selection of a reference date is

an essential aspect of the impair-ment testing process for several rea-

sons. First of all, the companys staff

has a lower workload if the valuation

date and the consolidated balance

sheet date do not coincide. The test

can, therefore, be executed indepen-

dently of the preparation of the finan-

cial statements. Furthermore, if the

impairment test is based on a DCF

approach, the latest budget figures

for CGUs adopted by the companysbodies should be included in the cal-

culations. For these reasons, the endof the planning process would be the

most suitable time for the execution of

an impairment test.

For 61 percent of the companies, the

reference date for the execution of the

impairment test lies before the groups

balance sheet date.

Industry analysis:The analysis ofthe various industries yields different

results. In the energy & power gen-

eration industry (71 percent) and thefinancial services industry (67 per-

cent), the majority of impairment tests

are performed as of the groups bal-

ance sheet date. In the life science &

healthcareindustry this is true for

100 percent of the companies.

2 Organization andExecution ofthe Impairment Test



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For companies recording goodwill

impairment, goodwill was written-

down in the fiscal year 2010/2011 by

an average of 16.5 percent (previous

year 13.5 percent).

Industry analysis:Findings vary sub-

stantially across the individual indus-

tries. It stands out that with 59 percent

(previous year 66 percent) signifi-

cantly more companies of the chemi-calsindustry wrote-down individual

assets as compared to the total group

of surveyed companies. Far fewer

companies of the entertainment &

media industry recognized an impair-

ment loss compared to previous year

(43 percent as opposed to 77 percent).

55 percent of the life science & health-

carecompanies recorded an asset

impairment in 2010/2011.

16.5 %is the amount by which goodwill was

written-down on average in the fiscal

year 2010/2011.

The impairment of assets is of

particular relevance for pharma-

ceutical companies as there

are higher market risks associated

with the investment in R&D. To

account for the market uncertainties,

companies usually build expectancy

values weighting the future cashflows with the probability of their

occurance.

Christian Klingbeil


Figure 4

Execution of an impairment

Total (in percent)

Source: KPMG

28

15

49

8

Figure 5


Not listed companies (in percent)

Source: KPMG

Goodwill Impairment

Asset Impairment

Both

No Impairment

1911

37

33

The fairly stable positive price trend

of media stocks and the favorable

development of the advertising

market certainly contributed to

the fact that significantly fewerimpairments were recorded at

media companies in 2010/2011.

Prof. Dr. Vera-Carina Elter


Figure 6


Chemicals (in percent)

Source: KPMG

53

35

6

6

Figure 7


Entertainment & Media (in percent)

Source: KPMG

Goodwill Impairment

Asset Impairment

Both

No Impairment

15

57

14

14



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Considering the volatility of the mar-

kets mainly attributable to the current

financial and sovereign debt crisis, it

is of particular interest to explore the

extent to which companies performedimpairment tests based on triggering

events. This was the case for 37 per-

cent of companies participating in the

survey, which represents a decline

of 16 percent as opposed to previous

year. The impairment of assets makes

up the greatest portion of impairment

tests triggered by a specific event

(27 percent).

Industry analysis:The energy &

power generationindustry is an ex-

ception to the overall trend described.

Here, an above-average 92 percent of

the companies performed an impair-

ment test based on triggering events,which can be attributed to the changes

in the energy and climate policies.

However, this observation does not

reflect the impact of the earthquake

and the tsunami in Japan, and the

resulting nuclear disaster in Fukushima

in March 2011, because the state-

ments made by participating energy

companies are as of balance sheet

date for the fiscal year 2010, which

was within the calendar year 2010 for

all companies.

Fewer companies than the overall

average performed an impairment

test based on a triggering event in the

financial servicesand industrial prod-uctssectors with 23 and 20 percent,

respectively.

As major reasons for the performanceof impairment tests based on trig-

gering events, companies stated the

deteriorated long-term outlook, price

declines and a sales slump. In the pre-

vious year, 25 percent of the participat-

ing companies stated a slump in sales

to be the primary reason. This percent-

age declined to 12 percent in the fis-

cal year 2010/2011. In addition to the

deteriorated long-term outlook, the

energy & power generationindustrystates price drops in particular as a rea-

son for triggered impairment tests.

It is, however, surprising that the sur-

veyed companies in the consumer

products & servicesindustry did notstate price decreases as a triggering

event in the last fiscal year. Compared

to the total of surveyed companies,

64 percent of the surveyed retail com-

panies noted the deteriorated long-

term outlook as triggering event, as

opposed to 50 percent in the previous

year.

With the exception of goodwill, IAS 36

allows the recognition of reversals

for individual assets if an unsched-

uled impairment has previously been

recorded. In the context of first signsof economic recovery and considering

the impairments for individual assets

recorded in the previous years, it may

be assumed that some companies rec-

ognized reversals for the respective

assets. However, the sample shows

that only 11 percent of the participat-

ing companies recognized reverse

amounts for individual assets. Non-

listed surveyed companies, on theother hand, recognized value apprecia-

tion of individual assets considerably

more often in the fiscal year 2010/2011

(30 percent).

Figure 8

Specification of triggering event

Total (in percent)

Source: KPMG

Drop in orders

Price decline

Worsening long-run expectations

Cost of capital

Others

45

12

10

5

28



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2.3 Determination of Recoverable

Amount

Background IFRS

recoverable amount

According to IAS 36.18, the recov-

erable amount is determined as

the higher of fair value less costs to

sell and value in use. The standard

does not require necessarily cal-

culating both value in use and fair

value less costs to sell if one of them

already exceeds the carrying amount

(IAS 36.19). This gives companies

the freedom to choose the valuationconcept they wish to use in the first

step.

The two valuation concepts are

based on different valuation per-

spectives which must be taken intoconsideration for the actual applica-

tion and which entail correspond-

ing advantages and disadvantages

regarding their feasibility and amount

of work required.

How is the value in use deter-

mined?

The value in use equals the cash

value resulting from the estimated

expected future cash flows from thecontinuous use of an asset, a CGU

or a group of CGUs and the cash

outflow at the end of the useful life

(IAS 36.31). The cash flows applied

in the value in use calculation reflect

the available information concern-

ing current and future business pros-

pects, as well as company-specific

factors, which possibly are solely

applicable to the individual company

and are generally not transferable to

other companies.

The value in use reflects the internal

perspective of the company/CGU

exploiting the asset. The capital

value-oriented valuation method isto be applied. Adopting this valuationperspective means that the company

needs to consider real synergy

effects between CGUs and assets in

the derivation of its cash flows. On

the contrary, cash flows from future

restructuring activities for which no

specific planning exists at the time,

as well as cash flows from expansion

investments of the CGU or the asset,

respectively, must be eliminated.

Cash flows from financing and taxesshould not be taken into account

either.

How is the fair value less costs to

sell determined?

The fair value less costs to sell is

the amount that could be gener-

ated for an asset or a CGU between

knowledgeable, willing and mutu-

ally independent business partners

after deducting the cost of sales(IAS 36.6; IDW RS HFA 16 mar-

gin # 8). In this case, the perspec-tive of a typified market participant

is assumed. Costs to be deducted

are costs for legal services or simi-

lar transaction costs, transport costs

as well as costs to bring an asset

or a CGU into condition for sale

(IAS 36.28). In practice, costs to sell

are often determined at one to twopercent of the fair value for purposes

of simplification.

The fair value less costs to sell mustprimarily be determined based on

market-price oriented methods

according to IAS 36.25 f. Accord-ingly, the asset and/or CGU or at

least comparable assets and/or

CGUs, would have to be traded in

the active market and their market

prices would need to be transfer-

able to the asset or the CGU, respec-

tively. The income approach is to be

used only if such market prices donot exist.

Even though the internal manage-

ment planning usually serves as

basis for the determination of thefair value less costs to sell, whenapplying the income approach, it

must be ensured that none of the

relevant planning parameters (such

as price and volume development,

profit margin development, etc.) are

determined according to the inter-

nal management perspective, but

are rather supported by observable

market data (for example industry

reports, analysis reports, peer group

analyses). As opposed to the deri-vation of cash flows for the value in

use, real synergy effects must be

eliminated from the planning figures

when deriving cash flows for the cal-

culation of the fair value less costs

to sell.

With regard to the determination of

the fair value less costs, regulations

set forth in IFRS 13: fair value mea-

surement must be considered in the

future containing detailed regula-

tions on the determination of the fairvalue.



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Our study shows that the vast major-

ity of surveyed companies (82 percent;

previous year: 86 percent) determined

the value in use, while 31 percent of

the companies (previous year 29 per-cent) determined the fair value less

costs to sell. By contrast, 86 percent

of Swiss companies determined only

the value in use.

Industry analysis:The high percent-

age of companies adopting a value

in use calculation is also reflected in

the different industries except for theenergy & power generationindustry,

where 37 percent of the companies

determine the fair value less costs

to sell.

Due to the current sovereign debt cri-

sis the factors crucial to the determi-

nation of the fair value less costs tosell such as market prices obtained

from the stock market or from compa-

rable transactions are still quite vola-

tile. The observable price fluctuations

are therefore a possible explanation

for the increased proportion of compa-

nies exclusively calculating the value in

use. Due to these market fluctuations,

in the selection of a valuation concept

the companies took into consider-ation that a valuation based on transac-

tion prices at lower values will lead to

lower values than a valuation based on

the own use of a CGU and/or asset.

As was the case in previous years,68 percent of companies that deter-

mined both value in use and fair value

less costs to sell stated that the value

in use is the higher of the two values.

However, there is a decreasing trendfor this figure observable over time

(2008/2009: 79 percent, 2009/2010:

71 percent).

Due to the lack of comparable market

data for the respective CGU, the fairvalue less costs to sell is usually deter-

mined based on the income approach.

In order to compare the performed

valuation with the estimation of a mar-

ket participant, the sum of the recover-

able amounts of all CGUs can also be

validated against the market capitaliza-

tion of the listed entity. Hence, the fair

value less costs to sell per CGU, or the

respective underlying planning, may

need to be adjusted accordingly so asto ensure that they truly reflect current

market assessments.

Of listed companies that determined

the value in use 64 percent used this

plausibility check, while only 53 per-cent of the listed companies that

determined the fair value less costs

to sell compared the calculated value

to the market capitalization. DAX-30

companies, on the other hand, stated

significantly more often that they per-

form a comparison between market

capitalization and totals of value in

use and/or fair value less costs to sell

(value in use 73 percent, fair value lesscosts to sell 78 percent).

82 %of the surveyed companies determined

the value in use to measure the

recoverable amount.

Figure 12

Applied measure of value

Total (in percent)

Source: KPMG

Value in Use

Fair Value less costs to sell

Both

69

18

13

To verify the determined recoverable

amount,

70 %of surveyed DAX-30 companies

compared total recoverable amounts

across all CGUs with the marketcapitalization of the company.



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Background IFRS 13

fair value measurement

Beside the harmonization of IFRSand US GAAP, the standard also

aims to provide a consistent defini-

tion of fair value, create a frameworkfor the determination of the fair value

and define the central information to

be provided in the notes.

The definition of fair value according

to IFRS 13 is the price that would

be received for selling an asset or

paid to transfer a liability in an orderly

transaction between market partici-

pants at the measurement date.

In contrast to the previous regula-

tions for the determination of the fair

value the following aspects are spec-ified, in particular:

IFRS 13 defines a three- level input

parameter hierarchy for the fair

value determination, whereas

directly observable, unmodified

market prices represent the first

level, while parameters that can-

not be observed in the market,but must be analyzed for commer-

cial viability, represent the thirdlevel. Parameters of the second

level include direct and indirect

(derived) market parameters that

are subject to certain limitations.

If a determination of the fair valuecan be made based on market

transactions, parameters of the

principal market should be used.

This is the market with the high-

est level of activity/volume. If the

principal market cannot be deter-

mined, the most favorable market

should be used, for example the

one maximizing the proceeds from

the asset sale or minimizing thedebt level.

A special rule applies for the valu-

ation of non-financial assets.

According to the standard, the

highest and best use of the asset

is relevant for the valuation, which

could also mean a use other than

the current one, as far as it is phys-ically possible, legally permissible

and financially reasonable. Further-

more, the highest and best use

may also be realized in combina-

tion with other assets and debt,

which results in a joint evaluation.

Figure 13

Comparison with market capitalization

Value in Use

Listed companies (in percent)

Source: KPMG

Figure 14

Comparison with market capitalization

Fair Value less costs to sell

Listed companies (in percent)

Source: KPMG

Lower or equal

Slightly higher

Considerably higher

More than twice as high

Significantly higher

Was not considered

19

36

76

21

11

9

74

47 20

13



18/52


19/52


2.4 Composition of the

Carrying Amount

The calculated recoverable amount is

then compared to the carrying amount

to determine whether an extraordi-

nary impairment loss needs to be rec-

ognized at the CGU level. According tothe equivalence principle, it must beensured that the assets and possible

debt obligations grouped in a CGU are

related to the cash flows defining the

basis for the calculation of the recover-

able amount.

Of all surveyed companies 40 percent

(previous year 45 percent) included

liquidity in the carrying amount. A totalof 27 percent (previous year 36 per-

cent) included corporate assets in the

carrying amount. As in previous years,

the majority of the surveyed compa-

nies (80 percent) did not include losses

carried-forward from taxes in the car-

rying amount. Pension provisions,

however, were included by 33 per-

cent of the companies (previous year

53 percent). Two-thirds of the sur-

veyed companies thus classified pen-sion provisions as financial liabilities.

Deferred tax liabilities from purchase

price allocations were included in the

carrying amount by 31 percent (previ-

ous year 45 percent) of the companies.

2.5 Use of Impairment Test for

Other Purposes

In principle, it is necessary to carry

out the impairment test according toIAS 36 in preparation for the annual

financial statements. The CGU valu-

ation results based on a DCF calcula-tion prepared for impairment test pur-

poses, as well as the related analyses,

calculation of budget figures and capi-

tal cost can also be used for other pur-

poses within the company.

A total of 22 percent of the surveyed

companies used the results of the

impairment test for additional pur-

poses. A total of 9 percent of the com-

panies used the results for value-

driven controlling and 13 percent for

product and segment controlling. Thedata shows that the results and analy-ses from the impairment test are only

seldom used for purposes of the inter-

nal corporate accounting.

The impairment test according to

IAS 36 must be distinguished fromthe impairment test for investments

in individual company financial state-

ments according to IDW RS HFA 10,

application of principles of IDW S 1

for the evaluation of investments and

other company interests for the pur-poses of financial statements based

on commercial law. This is also true

for cases in which the CGU is equal to

the legal entity relevant for the valua-tion of the investment. One of the rea-

sons is that tax losses carried forward,

for example, cannot be considered for

the evaluation as per IAS 36 (see also

Section 3.5). Generally, company-spe-

cific tax payments must be used as a

basis for valuations for the purposes

of IDW RS HFA 10, while for the pur-

pose of IAS 36 valuations typified tax

payments are assumed. Furthermore,

the valuation of investments is usu-ally based on company-specific capi-

tal costs, while for purposes of IAS 36,

assumptions by typified market partici-

pants are used (see Section 4).

Liquidity

Jointly used assets

Tax losses carry

Deferred taxes

Pension provisions

0 20 60 1008040

40 60

27 73

31 69

8020

33 67

Figure 15

Carrying amount

Total (in percent)

Source: KPMG

Considered in the carrying amount

Not considered in the carrying amount



20/52


If the recoverable amount is calcu-

lated based on a DCF method, then it

should correspond to the present value

of the future cash flows expected from

the examined CGU. The cash flows

are usually derived from the company

budget prepared on a company/grouplevel. This basis may possibly be modi-

fied depending on the valuation con-

cept selected. The equivalence prin-

ciple is also crucial to determining the

cash flows. Therefore, consistency in

the determination of cash flows and

the cost of capital as well as in the cal-

culation of the recoverable amount and

carrying amount needs to be ensured.

Consequently, the following questionsarise:

When was the group budget pre-

pared? What level of detail and plan-

ning horizon are used for the budget

calculation? How is the sustain-

able budget year derived?(Section 3.1)

What future growth expectations

are reflected in the budget?

(Section 3.2)

What plausibility checks were

applied to the budgeted figures?

What are the effects of the financial

and economic crisis on the budget

used as basis? (Section 3.3)

What principles are applied for thecurrency conversion?

(Section 3.4)

What is the basis for computing the

tax expense for measuring the cash

flows? (Section 3.5)

3 Measurement ofCash Flows

3.1 Preparation of Budget

Calculations and Determination

of Sustainable Year

IAS 36 requires up-to-date measure-ment parameters both to determine

the value in use and the fair value

less costs to sell. Thus, according to

IAS 36.33 current budgets or manage-

ment planning must be used to deter-

mine the cash flows for the calculationof the value in use. If budget figures

serve as basis for the impairment test,

it is of crucial importance how up-to-

date the company/group budgets are.

Figure 16

Time of preparation of group budget

Total (in percent)

Source: KPMG

Up to one monthbefore theimpairment test

2 to 3 monthsbefore theimpairment test

4 to 6 monthsbefore theimpairment test

6 months andlonger before theimpairment test

35

54

47

80

60

40

20

0



21/52


Industry analysis:By contrast, sur-

veyed companies from the energy &power generationand automotive

industries tend to prepare their bud-

gets earlier, in some cases more than6 months prior to the execution of

the impairment test (13 percent and

14 percent, respectively). A similar

trend was observed last year.

Other important aspects for the prep-

aration of the budget are its level of

detail and the length of the planning

horizon. Due to current market volatil-

ity it is often useful to perform a two-

step extrapolation of the cash flow

predictions beyond the time period

covered by the detailed budget (hori-zon for detailed budget according toIAS 36 is generally five years). Ulti-

mately, the standard two- phase model

consisting of a detailed planning phase

and a terminal value year is trans-

formed into a three-phase model,

allowing companies to adjust their

budget during the second planning

phase in order to converge to a sus-

tainable budget level as basis for the

calculation of the terminal value.

About half the par ticipating compa-

nies (45 percent) prepared a so-called

integrated budget with cash flows

derived from the planning figures of

the income statement, balance sheet

and cash flow statement. Some of the

other companies prepared detailedforecasting for the income statement;

others only prepared budgets for

selected items on the income state-

ment. In the cases when a balance

sheet forecast was prepared, it was

in part done as a detailed budget and

in part only for selected items. Only

19 percent of the surveyed companies

prepared a statement of anticipated

income without forecasting any bal-ance sheet figures.

Industry analysis:A substantial num-

ber of the companies from the finan-

cial servicesindustry prepared a

detailed budget for the income state-

ment, but forecasted only selected

figures from the balance sheet. Com-panies in the automotiveindustry, on

the other hand, prepared complete

budgets including a balance sheet and

an income statement (29 percent) or

complete integrated budgets (about

71 percent).

Almost

90 %of the companies based theimpairment test on a budget no older

than three months.

45 %of the surveyed companies prepared

an integrated budget.

Planning ofP&L items/no planningof BS items

Planning ofthe wholeP&L/noplanning

of BS items

Planning ofthe P&L andspecial ofBS items

Planning ofthe P&L andall BS items

Integratedplanning(P&L, BS andcash flow)

10

22

14

45

9

60

40

20

0

Figure 17

Level of detail of the budget figures

Total (in percent)

Source: KPMG



22/52


The determination of the planning

period length is tied to a number of

issues. While a longer forecast periodmay lead to rather inaccurate fore-

casts, a too short time horizon may

lead to the reflection of short-term

effects in the companys cash flows

resulting in a distortion of the com-

pany value or goodwill. Hence, the per-

petual annuity needs to be adjusted toreflect such effects.

For the majority of the participating

companies (43 percent) the length of

the planning period was five years.Another 35 percent of survey partici-

pants applied a budget period of three

years. Of the 16 percent of companies

using a different time horizon, 60 per-

cent used 4 years, while all othersapplied a significantly longer horizon.

Across the different industries the

majority of companies also used bud-

get terms of at least three years.

Budgets of financial service

providers are characterized by the

profitability of portfolio business

and new business as well as

the required equity; off-balance

sheet items, such as assets under

management, also play a significant

role. For banks, insurance

companies and asset managers the

value-driven planning of income

statement, risk assets, equity and

liquidity is thus given priority.

Gernot Zeidler



Planning ofthe wholeP&L/noplanningof BS items



0 0

29

71

0

80

60

40

20

0

Figure 19

Level of detail of the budget

Automotive (in percent)

Source: KPMG



Planning ofthe wholeP&L/noplanningof BS items



9

55

9

18

9

80

60

40

20

0

Figure 18

Level of detail of the budget

Financial Services (in percent)

Source: KPMG




23/52


The calculation of perpetual annuity is

a central element in the determination

of the present value of cash flows. As

a general rule, the calculation of per-

petual annuity should be applied basedon what is called a steady state.

Depending on the development of

cash flows during the detailed planning

period different assumptions can be

made. For example, if the companys

cash flows are assumed to grow sub-

stantially during the detailed planning

stage and this development cannot be

expected to continue in perpetuity, a

(generally flat) discount can be made,or a representative average of the bud-

get years can be used.

Ninety percent of the companies used

the last year of the detailed budget as

a basis for the calculation of the per-petual annuity. About half of these

companies performed top-down

adjustments for the last year of the

detailed planning period (43 percent).

Industry analysis:A similar distribu-

tion is evident across the different

industries. It should be pointed outthat about 87 percent of the compa-

nies in the energy & power generation

industry performed top-down adjust-

ments on the last year of the detailed

budget. As in the previous year, a sig-

nificant number of companies in the

automotiveindustry (17 percent),

used an average of the budget years

to determine the perpetual annuity,

which is a rather conservativeapproach.

More than

80 %of the participants projected their

budget figures for at least three years.

Figure 20

Budget horizon

Total (in percent)

Source: KPMG

5

35

43

16

1

One budget year without simplifiedrolling forward

One budget year with simplifiedrolling forward

Three planning years

Five planning years

Other number of planning years

Figure 21

Determination of the sustainable planning

period

Total (in percent)

Source: KPMG

Last projected year

Last projected year andtop-down adjustment

Average of projected years

Others

7

47

43

3



24/52


25/52


Background IFRS

Which adjustments are to be

made to the budget for value in

use and fair value less costs to

sell?

The value in use determines thevalue of the specific asset/CGUassuming a continuous use by the

company. However, this perspec-

tive includes only the earnings

potential of the asset/specific

CGU without further modification

at the time the impairment test is

performed. For the determination

of the value in use it must there-

fore be ensured that the cash

flows do not include any effects

from future restructuring efforts,

which the company did not yetcommit to, or any future capital

expenditures for business expan-

sions, which would increase the

earning power of the asset/CGU

(IAS 36.33 (b), IAS 36.44 ff.).

Existing commitments to capi-

tal expenditures for upcoming

expansions as at valuation date

must, however, be reflected in

the cash flows and thus taken

into account for the determination

of the value in use (IAS 36.48).

The planning premises under-lying the measurement of fair

value less costs to sell, on the

other hand, have to be evalu-

ated in terms of their conformity

with the overall market expecta -

tions. Therefore, management

budgets should not be adopted

for calculation purposes without

further examinations. The cen-

tral planning parameters, such assales growth, profit margin devel-

opment and long-term growth,

should thus be derived based on

market expectations (for exam-

ple industry or analyst reports).

Genuine synergy effects that are

enterprise-specific and would not

apply to potential buyers or wouldnot apply in the same amount

should be disregarded as well.

3.3 Plausibility Check of Budget

Calculations Used

A comparison of the central planningparameters and the expectations of

market participants is of particular

importance for determining the fair

value less costs to sell. However, acomparison is also recommended

for the calculation of the value in use,

given the regulatory requirements. The

comparison may be based on industry

or analyst reports, as well as multiples.

With regard to plausibility checks of

budget figures, the data shows that

about half of the participating compa-

nies (51 percent) did not perform any

plausibility checks based on compari-

son of margins with competitors, the

use of multiples, or the analyses ofanalyst reports. The majority of com-

panies that performed market com-

parisons based their plausibility checks

on multiples (17 percent) and analyst

reports (18 percent).

Industry analysis:These general ten-

dencies also apply to the individual

industries. With regard to the financial

servicesand life science & healthcare

industries, it is remarkable that 78 per-

cent and 91 percent of the surveyed

companies respectively, did not per-form plausibility checks of their bud-

gets based on market comparisons.

This share is substantially higher thanin other industries. On the other hand,

83 percent of the participants from the

entertainment & mediaindustry based

the plausibility checks of their budget

calculation on market comparisons.

With only 34 percent, the number of

surveyed Swiss companies perform-

ing market comparisons of their bud-

get calculations is considerably lowerthan the percentage of the total sur-

veyed companies performing such

comparisons.



26/52


27/52


Background IFRS

What is the rule for handling

currency differences within

a CGU?

If there is a difference between

the reporting currency, for exam-ple the currency in which the car-rying amount is presented, and

the currency in which the corre-

sponding cash flows occur, then

a currency translation is required

for impairment test purposes.

The common approach here is to

discount the expected cash flows

in the currency of their origin in

the first step (IAS 36.54). Special

attention must be paid to the fact

that individual inflation expecta-

tions in the separate currencyregions, as well as other factors,

may lead to different cost of capi-

tal. Therefore, discounting the

cash flows in the corresponding

currency region should be based

on reasonable cost of capital. The

resulting recoverable amount is

then converted into the report-

ing currency at the spot rate onthe day of the impairment test

and compared with the carrying

amount.

If a CGU generates cash flows

in several currencies, it is advis-

able to first convert the differ-

ent expected cash flows into the

reporting currency. Forward rates

are recommended, in particu-

lar, those for the respective plan-

ning year. For example, the cash

flows of the third planning year

should be converted at the cor-

responding three-year forwardrate. Applying the forward rate

of the reporting currency allows

for capturing the influences previ-

ously mentioned in the individual

costs of capital for each currency

region. Finally, the cash flows

expressed in the reporting cur-

rency can be discounted with thecost of capital for the reporting

currency region without furtheradjustments. The resulting recov-

erable amount must then be com-

pared to the carrying amount.

Constant conversion rates for

future foreign currency cashflows can be applied only in

exceptional cases. Particularly

when deriving the costs of capi-

tal, the consistency between

cash flows and the inflationexpectations considered must

be ensured.

The majority of companies (78 per-

cent) converting their cash flows from

foreign currency before discounting

them used budget exchange ratesdefined by the group (previous year

76 percent). The number of surveyed

companies performing conversions

based on forward rates of the planning

period declined to 12 percent (previous

year 16 percent).

Companies discounting cash flows in

foreign currency prior to conversion

mostly base these on the local capital

costs (45 percent). Another 32 percent

apply capital costs adjusted for infla-

tion delta or country risk premium. Six-

teen percent apply unadjusted capital

costs of the reporting currency to the

discount. Of Swiss companies, 89 per-cent use customary local or adjusted

capital costs for the discount of foreign

currency cash flows.

Figure 26

Exchange rates in the case of multiple foreign

currencies

Total (in percent)

Source: KPMG

Cash flows converted into reporting currencyand discounted

Spot rate

Forward rate for the planning period Given exchange rate of the group

Cash flows discounted in foreign currency

69

7

8

54

31

Figure 27

Cost of capital for discounting foreign currency

Total versus Switzerland (in percent)

Source: KPMG

Total

Switzerland

Cost of capital of thereporting currency

Cost of capital of thereporting currency

adjusted

Cost of capital of theforeign currency

616 18

45

71

80

70

60

50

40

30

20

100

32



28/52


29/52


2012KPMGInternationalCooperative(KPMGInternational),aSwissentity.MemberfirmsoftheKPMGnetworkofindependentfirmsareaffiliatedwithKPMGInternational.KPMGInternationalprovidesnoclientservices.Nomember

firmhasanyauthoritytoobligateorbindKPMGInternational

oranyothermemberfirmv

is-

-visthirdparties,nordoesKPMGInternationalhaveanysuchauthorit

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30/52


In addition to the general methodol-

ogy applied for the determination of

the cost of capital parameters, we ana-

lyzed the overall level of capital cost

currently observable at the surveyed

companies. Accordingly, we first

investigated each parameter and thenthe resulting WACC. We examined

in particular, how the approaches to

derive the cost of capital for the mea-

surement of a value in use differ from

those to determine the fair value less

costs to sell.

First, the following questions were

asked:

What values were used for

the base rate (Section 4.1),

the market risk premium

(Section 4.2),

beta factors applied

(Section 4.3),

other risk premiums

(Section 4.4),

applied equity costs (Section 4.5),

applied loan capital costs(Section 4.6),

by the companies?

What is the capital structure consid-

ered in the calculation? (Section 4.7)

How much is the companys

WACC? (Section 4.8)

Was a growth discount used and if

so, of what amount? (Section 4.9)

4 Cost ofCapital Parameters

Background IFRS

How does the determination of

the cost of capital parameters

depend on the choice between

fair value less costs to sell and

value in use?

In contrast to the cash flows to be

discounted, the parameters consid-

ered in the WACC do not depend onthe choice between the valuation

concepts value in use and fair value

less costs to sell. Despite the dif-

ference in perspectives of the valu-

ation measures, the cost of capital

parameters should reflect a market

estimate, e.g. the view of a poten-

tial buyer. In exceptional cases

the determination of the beta fac-

tor applied in the calculation of the

value in use can deviate from theview of a potential purchaser; this is

explained in detail below.

The perspective of an acquirer can

be regularly reproduced by deriv-

ing the cost of capital parametersfrom a peer group instead of apply-

ing certain parameters that are spe-

cifically identified for the reporting

entity. This concerns in particular

the capital structure, the cost of

debt as well as the beta factor. This

is based on the assumption that the

market does not evaluate a com-

pany in an isolated state, but in the

context of comparable companies.Should this assumption be incorrect

in a particular case, a justification is

to be provided.

The major difference between the

cost of capital applied in the calcu-lation of the fair value less costs to

sell and the cost of capital applied

in the value in use concept may

result from the general principle of

risk equivalence. Accordingly, the

cost of capital should reflect the risk

level of expected cash flows. For

the calculation of the fair value less

costs to sell, the market expecta -

tion alone is relevant for the deter-

mination of cash flows, so that therespective cost of capital derived

from market parameters does not

need to be adjusted. Since man-agement expectations are of par-

ticular relevance when deriving

the cash flows for calculating the

value in use, increases or reduc-

tions to the underlying cost of capi-

tal derived from market parameters

may be required to accommodatethe higher or lower risk of manage-

ment expectations as compared to

the market expectations.

The appropriate measurement of

the individual parameters can beseen in the following table.



31/52


4.1 Risk-free Base Rate

The majority of the participating com-

panies (62 percent) relied on the use

of national government bonds to deter-

mine the risk-free rate. However, the

number of companies applying this

method has decreased over the pastfew years. On the other hand, there

is an increasing trend for companies

using yield curve data to determine the

risk-free rate (38 percent). The use of

yield curve data is in accordance withthe recommendations of the IDW,

which is also confirmed by the high

number of German companies in inter-

national comparison, around 52 per-

cent (previous year also 52 percent),

applying this method.

Similar to the trend observable forgovernment bond yields, the aver-

age risk-free rate applied by the sur-

vey participants declined from 4.3 per-

cent in 2008/2009 to 3.9 percent in

2009/2010 reaching its lowest point at

3.3 percent at present.

When assessing the average risk-free

rate applied by all surveyed compa-nies, we would like to point out that

the data stems from different coun-

tries, partly different currency areas

and different reporting dates.

Companies outside Germany make up

the greatest fraction of surveyed com-

panies applying government bonds

(85 percent). The average term of

maturity of underlying government

bonds applied amounts to 15 years.

3.3 %is the risk-free rate used on average by

all surveyed companies.

Measuring cost of capital parameters

Cost of equity Risk-free rate: bond yield curve/time equivalent

government bonds Market risk premium before personal taxes

Beta from peer group

Cost of debt Financing costs of potential purchaser, for example

derived from

ratings of peer group companies

returns from industrial bonds of peer group

companies

coverage ratios of peer group companies

Debt-equity Market-based financing structure of a potential

ratio purchaser; for example derived from the capital

structure of peer group companies

Tax rate Marginal tax rate of the respective country

(weighted average if applicable)

With

52 %the surveyed German companies

tended to use yield curve data for thedetermination of the base rate.



32/52


Trend analysis

Until the end of 2010 a declining risk-

free rate was observable, which only

began to rise again in the beginning

of 2011.

Reduced capitalization rates due to

decreased risk-free rates require a

detailed analysis of the yield level in

the budget calculation.

Stefan Schniger


Euro area

Switzerland

Figure 30

Average risk-free rate

Euro area versus Switzerland (in percent)Source: KPMG

Fiscal year2007/2008




3,8

4,44,0 4,1

2,7

3,53,0

4,5

6

4

2

0

The European risk-free rate declined

significantly in 2009 mainly due to

the financial and economic crisis.

After a short rise in mid-2009, therisk-free rate continued to decline

from September 2009, reaching a

low of 3.25 percent in the last quarter

of 2010. During the first half of 2011

the rising tendency returned; how-ever, this trend reversed again during

the second half of the year and has

led once more to declining risk-free

rates since then. The development of

Swiss government bonds shows simi-lar fluctuations. Despite the similar

trend, however, the interest rate level

applied in the different currency areas

differed substantially. In the fiscal year

2010/2011, Swiss companies used an

average risk-free rate of 2.7 percent.

Figure 31

Average risk-free rate

Bond yield curve of ECB and Switzerland

(in percent)

Source: KPMG

ECB bond yield curve

Euro area risk-free rate referred to the cost of capital study

Bond yield curve of Switzerland

Swiss risk-free rate referred to the cost of capital study

5.0

4.5

4.0

3.5

3.0

2.5

2.0

1.5

09.08 01.09 05.09 09.09 01.10 05.10 09.10 01.11 05.11 09.11

Figure 29

Derivation of the risk-free rate*

(in percent)

Source: KPMG

Total

Germany

Remaining countries

Government bonds

Bond yield curve

Others

* Multiple answers were allowed in response to this question,

making it possible that the total deviates from 100 percent.

50 60 80 90 1007030 40

62

49

85

11

38

52

0 10 20

12

7

10



33/52


* This is also to be considered for the application of yield curve

data from ECB and Swiss National Bank since similar

developments were also observable for countries other than

Germany.

The derivation of capital costs for

impairment tests and general company

appraisals needs to be exercised with

caution in the context of the unusually

low risk-free rate level during the lastquarter of 2010 and the second half

of 2011. Particular ly the yield of Ger-

man government bonds is strongly

impacted by the current uncertainty

and the volatility of the markets. Inves-

tors worldwide are searching for safe

investment opportunities. A large num-

ber of market participants view Ger-

man government bonds as one of the

few remaining safe harbors. This ledto an increased demand for German

government bonds and consequently

declining yields,* with investors willing

to accept close to zero or even nega-

tive real interest rates, as current andexpected rates of inflation are higher

than the interest rates for German gov-

ernment bonds. In our opinion, the

acceptance of a negative real interest

rate for German government bonds in

particular, can only be viewed as atemporary effect. Assuming that the

current interest rate level does not

properly reflect the long-term market

expectations concerning real interest

rates and inflation, a higher market

risk premium can be applied to com-pensate for these effects. As risk pre-

miums cannot be reliably derived for

shorter historical periods, the develop-

ment of the German government bond(real) interest rates can therefore pro-

vide valuable indications for the deriva-

tion of a premium range to be added to

the long-term risk premium observable

on the market.

Therefore, the determination of the

costs of capital must be critically eval-

uated within the framework of impair-ment tests and business appraisals

in general. Given the current market

environment, a mere continuation

of the approach applied in the past

would most probably lead to inad-

equate results. Should the current,

low risk-free rates be directly applied

for impairment test purposes with-out any adjustments of the remaining

capital cost parameters, the assump-

tions underlying the companys bud-

get might have to be reassessed to

ensure risk equivalency between cash

flows and capital costs. This is rele-

vant in particular for the determination

of the terminal value as availability of

capital at lower costs in the mid and

long-term could lead to declining com-

pany returns as a result of adjustment

mechanisms on the competitive mar-

ket (for example emergence of newcompetitors).

Figure 32

Development of German risk-free base rate

3-month average, not rounded

(in percent)

Source: KPMG

6.0

5.5

5.0

4.5

4.0

3.5

3.0

2.5

2.0

03.0

2

06.0

2

09.0

2

12.0

2

03.0

3

06.0

3

09.0

3

12.0

3

03.0

4

06.0

4

09.0

4

12.0

4

03.0

5

06.0

5

09.0

5

12.0

5

03.0

6

06.0

6

09.0

6

12.0

6

03.0

7

06.0

7

09.0

7

12.0

7

03.0

8

06.0

8

09.0

8

12.0

8

03.0

9

06.0

9

09.0

9

12.0

9

03.1

0

06.1

0

09.1

0

12.1

0

03.1

1

06.1

1

09.1

1

Figure 33

Yield

10-year yield government bond versus inflation rate

(in percent)

Source: KPMG

Yield of the latest available government bond with a 10-year maturity

Rate of change to previous month in percent

Delta between bond yield and inflation rate

6.0

5.0

4.0

3.0

2.0

1.0

0

1.0

2.0

01.0

2

05.0

2

09.0

2

01.0

3

05.0

3

09.0

3

01.0

4

05.0

4

09.0

4

01.0

5

05.0

5

09.0

5

01.0

6

05.0

6

09.0

6

01.0

7

05.0

7

09.0

7

01.0

8

05.0

8

09.0

8

01.0

9

05.0

9

09.0

9

01.1

0

05.1

0

09.1

0

01.1

1

05.1

1

09.1

1



34/52


4.2 Market Risk Premium

The market risk premium describes

the yield in excess of the risk-free rate

required by an investor for holding the

market portfolio.

The market risk premium is usually

determined retrospectively based on acomparison between observable long-

term stock yields and risk-free bond

yields over a certain historical period.

Despite the recent financ

Documents

Cost of Capital Study 2011-2012-KPMG