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Using the WACC methodology to improve the assessment of projects in the french farming industry. Empirical evidences from farm's results of Isère

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par Anaël BIBARD
Grenoble Graduate School of Business - MBA 2012
  

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3.3 Bond Yield Plus Risk Premium Model

The first method to estimate the capitalization rate was the method used by the French tax authority. Farming consultants have to keep in mind that their valuation methods can be used as the base of the calculation for a capital gain on the sale of a company. The tax authority therefore has the right to modify the tax base if it considers that the results do not represent a fair value at the time of the transaction. The most common tax adjustment in those cases is the hidden donation, when the tax authority considers that the company or its shares (not publicly tradable in the case of most farms) are undervalued. This is why it is necessary to include the methods used by the administration in this study. In reality, this method is based on the CAPM, as the risk premium is the difference with the total expected return minus the risk-free return. The actualization rate formula can be presented in this way:

A: Actualization rate,

Rf: Risk free rate,

â: Beta,

Rp: Risk premium for the French market.
3.3.1 Risk-Free Rate

As presented by Sharpe (1964) it was assumed that everyone can borrow or lend its funds at a «pure rate of interest». This risk-free rate is considered by the tax authority as the government bonds rate (Direction Générale des Impots, 2006), and was assumed in this paper as equivalent to the French government debt reference rate, given by the French central bank (a 12 month average of the 10 years bonds monthly average was used).

3.3.2 Beta and Risk premium

The risk free rate has to be increased by a risk premium, justified by the necessary supplementary yield that a risky asset needs to deliver compare to a pure interest rate. The tax authority recommends using the historical risk premium observed in the French economy, which can be increased to consider the size of the company studied. For the calculations, the references of the tax authority were used, and an increase to consider that we are dealing with micro-capitalization.

The first bias that arises is easy to consider, as stated by Damodoran (2011), would be to include 2008 stock results in our time-frame: the major crash observed this year would diminish the results significantly, leading investors to think that the risk would be lower after the 2008 crisis than before. However, from a pragmatic point of view, this could be considered as logical: there is less risk of a major historical crisis after it happens than before, like there are less risks of a centenary flood after ones happen.

The Beta is used to consider the risk relative to the company and the sector in which it operates (Direction Générale des Impots, 2006). Once again, the tax authority produced some recommendation and we will base our calculation on it. We will compare this beta with the beta observed by another author for agriculture in France.

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