Impact of Covid-19 on Valuations and Debt

Marta Zadravec

The extensive economic changes provoked by the COVID-19-crisis have led to some urgent questions regarding the business valuation.  In the process of business valuation, one should consider “all significant information that could have been obtained with due care up to the valuation date”. Therefore, business plans within the detailed planning phase would need to be adapted accordingly, if the consequences of the COVID-19-crisis were already foreseeable on the valuation date.

Many factors lead to a massive increase in planning uncertainty at the present. First, long-term health implications cannot be evaluated orderly at the moment. Second, governments around the world found themselves forced to arrange significant economic restrictions in light of these health-related insecurities. Especially the shutdown of entire industries has affected the economy in a negative manner. Third, nobody can anticipate how long those restrictions will last.

The effects of the COVID-19-crisis are not limited to the short view, long-term aspects have to be considered additionally. Even though the global development of the current situation cannot be anticipated accurately, it can be assumed that long-term negative effects on cash flows strongly depend on a company’s business model and thereby its robustness and resilience.

Due to the current market situation, cash flows need to be adjusted in the detailed planning phase. Nonetheless, whether the crisis has to be considered in the terminal value strongly depends on the underlying business model and is therefore not that clear. This also applies to the growth rate within the terminal value. At the present, there are no hints indicating the requirement of adjusting the long-term valuation parameters when the underlying business model can be seen as robust.

Negative Interest Rate

Since the base interest rate is usually seen as a proxy for the risk-free rate, it plays a crucial role in business valuation. In the context of the Capital Asset Pricing Model (CAPM) the base interest rate plays an important role in determining the cost of capital as well as the market risk premium. To begin with, the low-interest environment has existed even before the COVID-19-crisis. By the mid of 2019, negative risk-free rates were already observable. However, after the interest situation has somewhat improved and interest rates turned positive again (at least temporarily), the COVID-19-crisis has triggered a renewed downward-trend. The spot rate of the 10-year Croatian Government Bonds fell to an historical low of about 0,99%.

Source: Tradingeconomics

The COVID-19 Beta Effect

For some companies, we observe that Beta as a measure of the volatility of the company’s equity value relative to the market has decreased. This reflects an increase in correlation between the company’s equity return and that of the overall market. To the extent an analyst believes the cost of equity should have increased to reflect a higher risk in the projected financial information, an offsetting adjustment can be made to the company-specific risk premium that compensates for the change in the risk-free rate and a possible beta decline. The order of magnitude of any adjustments to the company-specific premium will depend on the company’s specific risk profile in terms of factors such as profitability relative to its peers, financial and operating leverage, liquidity, operational efficiencies to name a few.

In finance, the relationship between an equity’s returns and that of the overall market is measured by beta. Stocks with betas over 1.0 have greater systematic risk than the market as a whole. So if the market rises 1%, high beta, riskier stocks like tech, pharma, and luxury goods companies will increase by more than 1%. Conversely, if the S&P 500 drops 1%, they will fall by a greater percentage.

Source: Damodaran

Company specific risk premium

If Covid-19 happened to affect the subject company more dramatically than its competitors due to specific circumstances (e.g. severe outbreaks and/or lockdowns in locations of manufacturing plants, contingency plans, and procedures not put in place, key personnel being in quarantine or caught in a lockdown abroad, etc.), an increase in company-specific risk premium may make sense. Still, because this premium is very subjective, it should be considered only if the valuer is not able to assess the duration and intensity of adverse circumstances on cash flows.


It is sensible to put more effort in developing reasonable forecasts of cash flows or scenarios, instead of risking overestimating a discount rate. This is especially the case if V-shaped or U-shaped recovery can reasonably be expected for a subject company, implying quicker recovery. Valuers also need to keep in mind the long-term aspect and avoid undue wariness. Arguably, residual value calculation and assumptions do not need to be changed. This is not the first nor the last crisis, it shall also pass, and recovery will follow. On the other hand, not all industries have been affected dramatically, or even adversely, global demand for certain products has increased, many have switched to e-commerce, shifted to remote working, etc. In terms of methods to be employed, depressed multiples due to sell-off will definitely be a conundrum for some time. Possible distressed M&A activity may also distort transaction multiples. Therefore, results obtained from an income approach may be more meaningful than those from the market approach.