Impact of the discount rate on the income-based value of the company in the squeeze-out process in the Czech Republic

According to Act 216/2005 of Coll. amending Law No. 513/1991 of Coll., the Commercial Code, since 2005, the shareholders of joint stock companies in the Czech Republic owning at least 90% of a company’s shares had been given the option of gaining ownership of the remaining shares from minority shareholders (i.e. squeezing-out minority shareholders) by providing them an adequate cash compensation for their shares. Since most of the companies either did not have their shares publicly traded directly prior to the squeeze-out or the value of the shares did not fulfil the definition of market value as defined by the International Valuation Standards, the appropriate compensation had to be calculated using the income based valuation approach performed by an independent valuer. The valuation process and its results have often created shareholder tension manifesting in post-closing litigation. The specifics of the complaints have typically been related to the prognosis of the key value drivers determining the income value of the company and its shares. This paper focuses on the discount rate as one of the key value drivers used for the conversion of future cash flows to the present value of the company and its shares. The discount rate reflects the risk factors associated with the business and the required return on the capital employed. The common misconception of the impact of the discount rate on the company value is that the higher the estimated discount rate, the lower the actual value of the company will be based on the valuer’s calculations. The goal of this paper is to demonstrate the double-edged influence of this value driver on the value of the shares which are being calculated for the purpose of determining appropriate compensation in the process of a squeeze-out of the hypothetical joint stock company XYZ.