Impairment Testing

Why?

Different business units and divisions generate cash flows with different risk profiles. More volatile cash flows imply riskier business. Riskier businesses have to be more profitable. Hence apply return requirements adjusted for risks in discounting future cash flows of business units and projects. In some cases comparable business units are valued in the market and corresponding market return requirements can be obtained from market prices. Often sufficiently comparable data does not exist and cash flows generated by the respective business units have to be used as the basis of estimating return requirements.

How?

Use risk preferences and benchmark of company shareholder as base for determining risk premia. Seek answer for the following question: What risk premia would the shareholder require from Cash Generating Units if he had the inside information of risk profiles of cash flows of all units? Effectively company market beta and market return requirement become benchmarks to units. Risk-adjusted discount rates to be determined represent return requirements on total capital, not just equity.

Our Service

We offer listed companies a practical Monte Carlo simulation tool to convert company’s stock price’s volatility and return requirement to business unit level return requirements and/or risk adjusted discount rates according to business units’ cash flows in the past and planned in the future.

Results

The risk adjusted discount rates obtained have the following properties:

  • They are based on the time value of money and the specific risks of cash generating business units.
  • They represent the risk profile of the representative shareholder of the listed company.
  • They coordinate the views of the shareholders and the management of the listed company in that if these return requirements are applied, then both the owners and the management of the company want to hold the same business structure in the company.