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Pitfalls in applying the small company risk premium for tax and duty purposes
Published on 01 Apr 16 by "THE TAX SPECIALIST" JOURNAL ARTICLE
At the centre of many tax controversies are valuation issues. These cases typically involve either new valuation issues or require a re evaluation of conventional, but not necessarily correct, approaches to existing valuation issues. In assessing the market value of the total assets of a “small” company using the discounted cash flow (DCF) valuation method, many practitioners routinely add a small company risk premium to the cost of equity derived using the capital asset pricing model to arrive at the discount rate adopted under the DCF valuation method.
This article examines the potential pitfalls of this practice: failure to recognise the true subject of valuation, incorrect triangulation of empirical evidence from the US markets to the Australian market, and double-counting for risk. The article also explains why this common practice is problematic and why the recognition and avoidance of this unsound practice is important in achieving a credible valuation outcome for tax and duty purposes.
Author profile
Dr Hung Chu
Hung is a Director of Lonergan Edwards & Associates Limited. Dr Hung Chu completed his master degree in Finance and Banking (with Merit among the top 2% of graduates) from the University of Sydney and his doctoral degree in Finance from the University of Technology, Sydney (graduated on Chancellor's List for Exceptional Scholarly Achievement in PhD research). He has 12 years of experience in the provision of valuation services and numerous technical papers published in academic and practitioners' journals. - Current at 11 July 2019
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