5.3 Capitalization Using the Bond Yield Plus Risk
Premium
The range obtained using this method is [9.3% ; 12.7%], far
from the 2.5% to 4.5% commonly used by the practitioners in agriculture, and
even the historical ROA around 4.0% to 6.8% observed for the groups 2 and 3 of
the farms from Isère (leverage between 40 and 80%). On the contrary,
some specializations reached this range in terms of ROE, with 11.3% for grain.
The first conclusion we can draw from these results is that farmers of
Isère do not reach the required rate of return calculated for some
specializations. The second conclusion is that we can now safely assume that
most practitioners do not use the appropriate actualization rate in their
consulting activities, leading farmers to base their decisions on
overoptimistic results.
It is common sense to think that the first observation comes
partially from the second. As a matter of fact, most of the farmers from the
database studied in this research based their financial decision partially on
the business plans calculated by the CERFRANCE Isère. Now, it is
established that the risk premium was not enough taken into account in these
business plans, leading some farmers to start a project without an appropriate
economical assessment. This statement is particularly true when farms are sold
to new farmers, because the valuation methods used by practitioners tend to
overestimate the value of the company. In this case, the new farmer buys a farm
which is too expensive regarding its expected performances, which decreases
strongly the net present value of his investment. Eventually, this leads the
overall sector to underperform on the long run.
This eventuality is hard to prove, but has to be considered.
In Isère, the consultants calculate the price of farm using two
valuation methods, as recommended by the tax authorities (Direction
Générale des Impots, 2006). The most commonly used are the
patrimonial method and the profitability method. The first one is easy to
implement and requires the evaluation of the net assets of the farm. Buildings
and equipments are valued at their resale price. In one sense, this is the
value of the company if it had to be sold parts by parts. The second one is
based on the actualization rate: we divide the reproducible net cash flow
generated by the actualization rate. It is the NPV of a perpetual cash flow. A
difference between 3% and 9% multiplies the value of the farm by 3 with this
method! The most usual discount factors used by practitioners are 2 to 4 times
lower than the range [9.3% ; 12.7%] obtained with the method recommended by the
tax authorities, which means that the difference can be really important.
5.4 The WACC Methodology
The elements observed in part 5.3, regarding the results of
the method bond yield plus risk premium proposed by the tax authorities, are
consistent but higher than what is obtained with the WACC methodology for the
average farm in Isère. This method confirms that the actualization rates
used by practitioners are undervalued. However, it gives really different
results depending on the leverage of the companies. Therefore, it gives a
strong advantage to this approach for the practitioner, who will be able to
adapt his actualization rate to the particularity of each farm. Another
advantage is the possibility to choose the best financing solution for a new
investment, considering the overall
leverage of the farm in order to modify its capital structure to
reduce the WACC. The consequence of this modification should be the increase of
the profit generated by the farm.
On the other side, the method proposed by the tax authorities
has the strong advantage to be easier to implement and to learn for the
consultants. The other advantage of the bond yield plus risk premium as
presented by the French tax authority is its origin itself: in case of
litigation with the administration, the choice of the actualization rate will
be easier to defend with the method they recommend. The power of this argument
is reduced by the recognition of legitimacy of other methods from the
administration itself, without describing or citing them however (Direction
Générale des Impots, 2006).
Finally, we can observe that the WACC methodology should be
more accepted by the practitioners, as it gives lower results for the average
farms in Isère. This element has to be considered, because such a strong
modification of the actualization rates used by the consultants would signify
that all their previous studies were significantly wrong. It could lead to a
movement of rejection from these practitioners.
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