CSRC Regulatory Guidance on Discount Rate Calculation in Income Approach

With reference to a guidance document issued by the China Appraisal Society (“CAS”) in relation to discount rate calculation, the China Securities Regulatory Commission (“CSRC”) launched the Regulatory Guidance - Valuation (the “Guidance”) in January 2021 to standardize the parameters of discount rate calculation in the income approach.

The Guidance provides specific requirements for the parameters in Capital Asset Pricing Model (“CAPM”) and Weighted Average Cost of Capital (“WACC”), including risk-free rate, market risk premium, beta, capital structure, specific risk premium and expected return of debt.

With AVISTA’s experience in business valuation, the key points of the Guidance for the discount rate calculation are outlined below.

Background and Objective

The discrepancies for the current valuation practices in the income approach have been prevailing among valuation entities (“Entities”), ranging from sample selection, parameters’ determination and calculation methodology. Meanwhile, the valuation process may also be influenced by complicated and subjective judgment, which would impact the reliability of company’s financial data and valuation result.

Accordingly, the CSRC formulates the Guidance in order to standardize the discount rate calculation, thereby enhancing the regulations in the valuation industry.

Fundamental Requirements

The Guidance enumerates 3 fundamental requirements to the Entities highlighting the consistency and reasonableness in the discount rate calculation.

1. The Entities must formulate a set of consistent principles and methods for discount rate calculation. Upon formulation, the principles and methods could not be revised at discretion afterward to ensure the consistency of valuation projects.
   
   
2. The Entities must ensure the reasonableness of discount rate calculation on multiple valuation dates. The Entities should clarify any significant changes of parameters from the previous valuation date in the valuation report.
   
   
3. The Entities must ensure the alignment between discount rate and expected return, which requires CAPM in line with the Free Cash Flow to the Equity (“FCFE”) and WACC in line with the Free Cash Flow to the Firm (“FCFF”).
   
   

Instructions on Parameters

The Guidance provides instructions for 6 parameters typically used in the discount rate calculation. In general, the Guidance requires the Entities to disclose parameter-related methods, analytical processes and data sources in the valuation reports. The details of the instructions to each parameter are specified below.

1. Risk-free rate
   • China 10-year or above government bond and its yield to maturity should be adopted under the assumption of going concern.
     
     
2. Market risk premium
   • If the primary business of the target company to be valued (the “Target”) is within China’s territory, the historical risk premium data of China Securities Market index should be adopted as a priority.
     
     
3. Beta
   • The Entities should take into account the enterprise size, profitability, growth, etc. in their consideration of comparability of comparable company to determine the beta, as well as select the beta with the appropriate time horizon.
     
     
4.  Capital structure
   
   • The Entities must conduct analysis for the discrepancies between the Target and comparable company as well as the development stage of the Target with reference to the adopted capital structure, alongside disclosure and clarification.
     
     
   • The debt-to-equity ratio should be measured by market value. Clarification should be provided in the valuation report if book value is used.
     
     
5. Specific risk premium
   
   • The Entities must evaluate the Target’s risk characteristics, enterprise size, core competitiveness, etc. when determining the specific risk premium.
     
     
6. Expected return of debt
   
   • The Entities must assess the Target’s operating performance, capital structure, credit risk, etc. if Loan Prime Rate (“LPR”) is taken as reference.
     
     
   • The Entities must assess the Target’s financing options, cost of debt, solvency, etc. if non-market interest rates are adopted.
     
     

To read the full Regulatory Guidance released by CSRC, please click here. (Available in Chinese version only)

AVISTA’s Professional Services for Business Valuation

As a professional valuation and financial advisory firm, AVISTA provides reliable business valuation services and accommodates the valuation needs in various transactions, including merger and restructuring. Our valuation experts are ready to advise you on asset valuation in compliance with the latest regulatory guidance.

For further information or enquiries regarding the potential valuation impact of the CSRC’s regulatory guidance on discount rate calculation, please feel free to contact us.

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